On March 1, Judge Liles C. Burke of the Northern District of Alabama issued a Memorandum Opinion (“Opinion”) and Final Judgment, finding that the Corporate Transparency Act (“CTA”) is unconstitutional. We blogged on this lawsuit when it was filed in November 2022.
The opening paragraph of the Opinion is worthy of repetition:
The late Justice Antonin Scalia once remarked that federal judges should have a rubber stamp that says STUPID BUT CONSTITUTIONAL. See Jennifer Senior, In Conversation: Antonin Scalia, New York Magazine, Oct. 4, 2013. The Constitution, in other words, does not allow judges to strike down a law merely because it is foolish, burdensome or offensive. Yet the inverse is also true—the wisdom of a policy is no guarantee of its constitutionality. Indeed, even in the pursuit of sensible and praiseworthy ends, Congress sometimes enacts smart laws that violate the Constitution. This case, which concerns the constitutionality of the Corporate Transparency Act, illustrates that principle.
Having set the tone, the Opinion proceeds to reject the government’s three arguments that Congress had the authority to enact the CTA under the following enumerated and broad powers:
1. Congress’ ability to oversee foreign affairs and national security;
2. Congress’ ability to regulate under the Commerce Clause; and
3. Congress’ taxing power.
As we will discuss, the Opinion reaches its conclusions by generally taking a broad view of States’ autonomy and a narrow view of the ability of Congress to regulate primarily “local” activity in the name of protecting national security. It also finds that Congress cannot regulate the act of incorporation alone, and that the CTA presumably could pass constitutional muster if it applied only when a reporting entity actually begins to engage in commercial activity. The immediate, nationwide effects of the Opinion are hard to predict at this time, other than to observe simply that the Opinion will have significant impact, and that confusion will ensue.
A Simple Question
Early on, the Opinion observes that millions of corporations are formed every year for various lawful purposes, including for-profit corporations, benefit corporations, non-profits, holding companies, political organizations, “and everything in between.” The Opinion frames the case as “present[ing] a deceptively simple question: Does the Constitution give Congress the power to regulate those millions of entities and their stakeholders the moment they obtain a formal corporate status from a State?” The Opinion answers this question by finding that the CTA exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals[.]”
Standing
The Opinion first finds that the plaintiffs have standing – that is, the ability to sue in federal court and have the Court even address their claims. The plaintiffs are the National Small Business Association (“NSBA”), which describes itself in the complaint as “an Ohio nonprofit mutual benefit corporation [that] is one of the leading and oldest associations of small businesses in the United States, with members in all fifty States and the District of Columbia,” and an individual member of the NSBA. The government argued in part that the individual plaintiff lacked standing because he lacked any concrete injury which the Court could address because his “injuries aren’t traceable to the CTA or redressable by a favorable decision because he has already disclosed at least some of the [reporting information required by the CTA] while complying with other regulatory requirements, like ‘tax returns, passport forms, and bank account applications.’” The Opinion readily dismisses that argument, finding that standing existed because the CTA requires the plaintiff to disclose sensitive personal information to the Financial Crimes Enforcement Network (“FinCEN”) for law enforcement purposes.”
Congressional Power: Foreign Affairs and National Security
As noted, the government argued that Congress had three grounds for authority to enact the CTA.
First, the government argued that Congress could enact the CTA under its ability to oversee foreign affairs and national security: “Congress concluded that collecting beneficial ownership information ‘is needed to . . . protect vital Unite[d] States national security interests’; ‘better enable critical national security, intelligence, and law enforcement efforts to counter money laundering, the financing of terrorism, and other illicit activity’; and ‘bring the United States into compliance with international anti-money laundering and countering the financing of terrorism standards.’”
However, the Court found this argument lacking, because corporations are “creatures” of state law: “So although the CTA does not directly interfere with or commandeer State incorporation practices, the CTA still ‘convert[s] an astonishing amount of traditionally local . . . conduct into a matter for federal enforcement, and involve[s] a substantial extension of federal police resources.'” (quoting Bond v. United States, 572 U.S. 844, 863 (2014)). Further, the Opinion states that “the CTA’s congressional findings are not enough to conclude that a regulation in the purely domestic arena of incorporation is an “exercise[] of authority derivative of, and in service to” Congress’ foreign affairs powers, especially in light of the States’ historically exclusive governance of incorporation.”
Congressional Power: The Commerce Clause
Second, the government argued that Congress could enact the CTA under its ability to regulate commerce under the Commerce Clause. Specifically, the government argued that Congress could enact the CTA under all three categories of its Commerce Clause powers, that is, the powers to regulate: (1) the channels of interstate and foreign commerce, (2) the instrumentalities of, and things and persons in, interstate and foreign commerce, and (3) activities that have a substantial effect on interstate and foreign commerce.
The Opinion first discusses a seminal case on the Bank Secrecy Act (“BSA”), California Bankers Association v. Shultz, 416 U.S. 21 (1974), in which the Supreme Court rejected an effort by banks and bank customers to enjoin the enforcement of certain reporting and record keeping requirements authorized by, and promulgated under, the BSA. Condensing greatly, the Opinion distinguishes Shultz by finding that “unlike the challenged disclosure requirements in Shultz, the CTA regulates most State entities, not just entities that move in commerce. . . . The reporting and record-keeping requirements at issue in Shultz were upheld largely because they governed negotiable instruments and money actually moving in foreign and interstate commerce.” (emphasis in original).
The Opinion states that Congress could have “easily” written the CTA to pass constitutional muster by “imposing the CTA’s disclosure requirements on State entities as soon as they engaged in commerce,” or by “prohibiting the use of interstate commerce to launder money, ‘evade taxes, hide . . . illicit wealth, and defraud employees and customers.’” However, according to the Opinion, “that is not what the CTA does. Because the CTA doesn’t regulate the channels and instrumentalities of commerce or prevent their use for a specific purpose, it cannot be justified as a valid regulation of those channels.”
Continuing, the Opinion found that the possibility – even “near certainty” – of future economic activity by covered reporting entities was insufficient to justify the CTA as an exercise of Congressional authority under the Commerce Clause. Also critical to the Opinion’s analysis was the finding, and the government’s concession, that the act of incorporation, standing alone, is not enough under the Commerce Clause.
Accordingly, the fact that most, but not necessarily all, covered reporting entities would or do use the channels of commerce could not salvage the CTA. The Opinion describes the following as the “central question”: “Does Congress have authority under the Commerce Clause to regulate non-commercial, intrastate activity when ‘certain entities, which have availed themselves of States’ incorporation laws, use the channels of commerce, and their anonymous operations substantially affect interstate and foreign commerce?’” The Opinion obviously answers its own question in the negative, stating that “the plain text of the CTA does not regulate the quintessentially economic activities the Government asserts or require entities to engage in those activities to be regulated.” Further, the Opinion states that the CTA lacks any express jurisdiction element – an explicit “jurisdictional hook” – which would limit its reach to a discrete set of activities with an explicit connection with or effect on interstate commerce.
The Opinion compared the CTA with the Customer Due Diligence (“CDD”) Rule, a regulation enacted under the BSA which requires covered reporting entities – defined by the CDD Rule in a manner similar but not identical to the CTA – to report beneficial owners – also defined broadly and in a manner similar to the CTA – to banks and other financial institutions. According to the Opinion, “FinCEN’s CDD [R]ule and the CTA provide FinCEN with nearly identical information, but the CDD [R]ule does so in a constitutionally acceptable manner.” Apparently, the difference is that an entity subject to CDD Rule reporting is already engaged in commercial activity because it is attempting to open an account at a financial institution. The Opinion rejected the government’s argument that failing to regulate corporate entities immediately upon their formation would “leave a gaping hole” in the fight against money laundering.
Congressional Power: Taxing Power
Third, the government argued that Congress could enact the CTA under its taxing power.
Although the government conceded that the CTA’s civil penalties are not a “tax,” it invoked the Necessary and Proper Clause of the Constitution and argued that “the collection of beneficial ownership information [under the CTA] is necessary and proper to ensure taxable income is appropriately reported[.]” However, the Opinion found that providing access to the CTA’s database for tax administration purposes failed to establish a sufficiently close relationship under the Necessary and Proper Clause: “It would be a ‘substantial expansion of federal authority’ to permit Congress to bring its taxing power to bear just by collecting ‘useful’ data and allowing tax-enforcement officials access to that data.”
Finally, having struck down the CTA on the grounds that Congress lacked the power to enact it, the Opinion does not address the plaintiff’s other arguments that the CTA also violates the First, Fourth and Fifth Amendments.
Consequences?
The Court issued a Final Judgment, enjoining the defendants (the Treasury Department, the Secretary of the Treasury, and the then-acting Director of FinCEN), as well as any other agency or employee acting on behalf of the United States, from enforcing the CTA against the plaintiffs.
It is no insight to observe that things are going to be (more) confusing and messy in regards to the CTA. Exactly what will happen, however, is very hard to predict at this moment. Although the Opinion is “limited” to the Northern District of Alabama, it will have immediate and national effects. The extent of the Opinion’s immediate application is a question beyond the scope of this blog post. The NSBA has members in every state, and the organization is presumably going to enjoy a massive surge in membership, because the Final Judgment states that it applies to the NSBA. Other plaintiffs may file “copycat” litigations. Presumably, the government will appeal the Opinion to the U.S. Fifth Circuit Court of Appeals, although that is not clear at this time. Conceivably, given the importance of the CTA and the pure and broad constitutional issues presented by the Opinion as to the power of Congress, this issue could go to the Supreme Court.
Finally, and although political prognostication can be dangerous, it is difficult to envision the current U.S. Congress passing, at least anytime soon, a new version of the CTA with sufficient “jurisdictional hook” language – or at least a version of the CTA that otherwise matches or strongly resembles the current version. Even though Congress itself of course passed the CTA, some members of Congress nonetheless have been criticizing FinCEN, fairly or not, regarding how it has been implementing the CTA – for example, by stating that “[t]he CTA was created to be a national security tool, not just a tool for the Bureaucratic regime.” Therefore, if Congress were inclined to provide a “legislative fix” – and there would be pressure to do so by law enforcement groups and the international community – the CTA likely would undergo debate and revisions.
Meanwhile, reporting by entities to the CTA database already has begun, and the deadline – at least, the deadline prior to March 1 – for existing covered entities to file reports is December 31. Tens of millions of entities are covered by the CTA. Further, FinCEN has yet to issue proposed regulations on how the existing CDD Rule applicable to banks and other financial institutions will be revised to align with the CTA – a project that apparently just got sidetracked, or at the very least, even more incredibly complicated.
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