CURRENT MONTH (March 2024)
Federal Court Declares Corporate Transparency Act Unconstitutional
On March 1, 2024, the U.S. District Court for the Northern District of Alabama struck down the Corporate Transparency Act (CTA) and held that it exceeded Congress’s authority under the Constitution. At stake is the entire superstructure of collection and maintenance of beneficial ownership information (BOI) that, in turn, has given rise to increased (and possibly ill-advised) ethical responsibilities for business lawyers under the ABA’s newly adopted amendments to Model Rule 1.16.
The case arose in November 2022, when National Small Business United, d/b/a the National Small Business Association (NSBA), and a major shareholder of an NSBA member filed suit against the Treasury Department and its Financial Crimes Enforcement Network (FinCEN). The plaintiffs sought a declaratory judgment that the CTA is unconstitutional, because it exceeds Congress’s authority under Article I of the Constitution and, in addition, violates the First, Fourth, Fifth, Ninth, and Tenth Amendments.[1] Plaintiffs also sought an injunction preventing enforcement of the CTA against them.
The linchpin of the Government’s argument in favor of constitutionality is that Article I gives Congress express power to “regulate commerce with foreign nations” under the Commerce Clause (and, as an adjunct to that that power, under the Necessary and Proper Clause). Under that power, the Government argues, Congress may regulate innumerable business entities created by different sovereigns (to wit: the States, Indian tribes) starting at the instant they are granted their business charters, regardless of whether they are general business corporations, not-for-profit corporations, associations of various stripes, holding companies, limited liability companies, and so forth.
The CTA’s definition of “reporting company” in 31 U.S.C. § 5336(a)(11) is very broad, and even though the list of exemptions is itself quite extensive, those exemptions are merely a matter of legislative grace that could be altered or eliminated at the stroke of a legislative pen. The breadth of this fundamental assertion of authority is what has given rise to constitutional concern.
Also giving rise to concern is that the stakes are high for beneficial owners, since it is they, rather than reporting companies, who may be subject to enforcement action and criminal penalties:
The CTA’s disclosure requirements aren’t toothless, either: knowing or willful violations carry serious civil and criminal penalties. A willful provision of false or fraudulent beneficial ownership information or failure to report “complete or updated beneficial ownership information to FinCEN” by “any person” is punishable by a $500 per day civil penalty and up to $10,000 in fines and 2 years in federal prison, [31 U.S.C.] § 5336(h)(1), (3)(A); a knowing and unauthorized disclosure or use of beneficial ownership information by “any person” is punishable by a $500 per day civil penalty, along with a $250,000 fine and 5 years in federal prison, § 5336(h)(2), (3)(B); and a knowing and unauthorized use or disclosure while violating another federal law “or as part of a pattern of any illegal activity involving more than $100,000 in a 12-month period” by “any person” is punishable with a $500,000 fine and 10 years in federal prison, § 5336(h)(3)(B)(ii)(II).
Crucially (at least for standing purposes), these severe penalties apply to individuals, not reporting entities. For starters, a disembodied corporate entity cannot be sentenced to federal prison. Beyond that, although the CTA does not define “person,” it does define both “United States person” (§ 5336(a)(14)) and “Foreign person” (§ 5336(a)(7)) to include corporations, partnerships, and trusts, and uses those terms in other provisions. See § 5336(a)(11)(B)(xx). Yet the statute does not use those terms in its penalty provisions, so the statute can be read only to penalize individual beneficial owners and applicants, not reporting entities.
The ultimate result of this statutory scheme is that tens of millions of Americans must either disclose their personal information to FinCEN through State-registered entities, or risk years of prison time and thousands of dollars in civil and criminal fines.[2]
Certainly, the court acknowledged, Congress can legislate to regulate commercial intermediaries, such as banks, as it has done in the Bank Secrecy Act (BSA).[3] The court distinguished the CTA, however, finding that it was unlike the BSA’s regulation of financial institutions because those institutions regularly move funds in foreign and interstate commerce.[4] The court also rejected the government’s argument that state-registered entities would almost certainly engage in interstate commerce, finding that the act of incorporation of an entity under state law, without more, was insufficient to implicate the Commerce Clause. In the court’s view, the CTA suffered from overbreadth, as, unlike the challenged BSA disclosure requirements in the Shultz decision, “the CTA regulates most State entities, not just entities that move in commerce.”[5]
The court also rejected the Government’s “Necessary and Proper Clause” argument to support congressional authority to enact the CTA. Contrasting the CTA with FinCEN’s Customer Due Diligence Rule, which applies to financial institutions and requires them to collect nearly identical BOI, the court found that the latter does so in a constitutionally permissible manner because it indisputably regulates intermediaries in commerce.[6]
Finally, the court rejected the Government’s attempt to defend the CTA as falling within the taxing power. The court found that the penalties for CTA violations are not “taxes,” as they are not paid into the Treasury, are not connected to income thresholds, are not enforced by the Internal Revenue Service, and are not found in the Internal Revenue Code.[7] The Court further found that the creation of a database containing BOI for tax administration purposes was not an adequate basis for linkage to the taxing power under the Necessary and Proper Clause.[8]
Thus the district court granted Plaintiffs’ motion for summary judgment. The decision, resting on the court’s view of limited congressional authority under Article I of the Constitution, affects only the CTA and not any state law analogues like New York’s recent LLC Transparency Act. Also, according to FinCEN, “[o]ther than the particular individuals and entities subject to the court’s injunction, . . . reporting companies are still required to comply with the law and file beneficial ownership reports as provided in FinCEN’s regulations.”
To no one’s surprise, the Department of Justice, on behalf of FinCEN and the Treasury Department, quickly filed a notice of appeal on March 11, 2024. Stay tuned.
In its decision, the district court ruled solely on the basis of Article I of the Constitution and did not address the claims under the Bill of Rights. ↑
Nat’l Small Bus. United v. Yellen, 2024 U.S. Dist. LEXIS 36205, at *8–*9 (N.D. Ala. Mar. 1, 2024). ↑
Id. at *31–*33, citing, inter alia, California Bankers Ass’n v. Shultz, 416 U.S. 21 (1974) (upholding BSA against challenge to its reporting and record keeping requirements). ↑
Id. at *33–*34. ↑
Id. at *33. ↑
Id. at *49–*51. ↑
Id. at *56. ↑
Id. at *57–*58. ↑
