by Gina Parlovecchio, Brad Resnikoff, Matthew Bisanz, and Daisy Gray

On March 1, 2024, the US District Court for the Northern District of Alabama declared the Corporate Transparency Act (“CTA”) unconstitutional, and suspended its enforcement against the plaintiffs in that case. While most companies remain subject to its requirements for now, this decision may presage more broadly applicable relief through subsequent judicial or administrative action.

The CTA requires many entities conducting business in the United States to disclose beneficial ownership information to the Financial Crimes Enforcement Network (“FinCEN”), a law enforcement arm of the US Department of Treasury. The court, in enjoining the CTA’s enforcement against the plaintiffs, found that the CTA exceeds constitutional limits on Congress’s power. In the wake of the decision, FinCEN announced that it intends to respect the court’s decision and will not enforce the CTA beneficial ownership requirements against the plaintiffs, but its silence as to other parties implies that everyone else must continue to comply.

In this Legal Update, we discuss the case, National Small Business Association, et al. v. Yellen, FinCEN’s response, and our predictions for what will come next.

Background

Enacted in 2021 as part of the National Defense Authorization Act (“NDAA”), the CTA requires certain legal entities to register with FinCEN and to disclose their ultimate, natural person beneficial owners.[1] The CTA was enacted to “help prevent and combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity, while minimizing the burden on entities doing business in the United States.”[2] FinCEN’s final rule became effective on January 1, 2024.[3]

Six weeks after FinCEN released its final rule, Plaintiffs Isaac Winkles and the National Small Business Association (“NSBA”) brought suit in the Northern District of Alabama against the Treasury, as well as Treasury Secretary Janet Yellen and Acting Director of FinCEN Himamauli Das, both in their official capacities (collectively, the “Government”).[4] Plaintiffs alleged that Congress lacked authority under Article I of the Constitution to enact the CTA’s mandatory disclosure requirements, and that those disclosure requirements run afoul of the First, Fourth, Fifth, Ninth, and Tenth amendments. The parties filed cross-motions for summary judgment.

The Court’s Opinion and Order

On March 1, 2024, the district court granted the Plaintiffs’ Motion for Summary Judgment, and issued a final judgment enjoining the Government from enforcing the CTA against the Plaintiffs.[5] While the Government contended that the CTA was a permissible exercise of Congress’ authority pursuant to (1) Congress’s foreign affairs power; (2) Congress’s ability to regulate interstate and foreign commerce; and (3) Congress’s taxing power, the court rejected each argument in turn, emphasizing that that regulation targeted “local” activity. The court ultimately concluded that the regulation was an unconstitutional exercise of congressional power, declining to address Plaintiffs’ arguments that the CTA also ran afoul of the First, Fourth, and Fifth Amendments.[6] However, the court limited its holding to the Plaintiffs in the case before it, permanently enjoining Defendants from enforcing the CTA against the Plaintiffs.

The court framed the question before it as “deceptively simple,” asking whether the Constitution gives Congress the power to regulate the millions of corporate entities incorporated under State law and their stakeholders “the moment they obtain a formal corporate status from a State[.]”[7] After determining that both the individual and organizational Plaintiffs had standing, the court addressed the Government’s arguments that the CTA was a permissible exercise of Congressional power pursuant to (1) Congress’s foreign affairs and national security powers; (2) the Commerce Clause; or (3) Congress’s taxing power.

Standing

The court began its opinion by determining that both the individual and organizational Plaintiffs had standing to bring their claims in federal court. According to the court, “[t]he mandatory disclosure of personal information to FinCEN for law-enforcement purposes satisfies the injury requirement for Winkles’ First, Fourth, and Fifth Amendment claims.”[8] By virtue of those claims, Winkles “is a party to an otherwise justiciable case or controversy,” and therefore, he also had standing to challenge the CTA as congressional overreach.[9] Because Winkles had individual standing and is a member of the NSBA, the NBSA had organizational standing.

Foreign Affairs & National Security

The court then addressed whether the CTA was a constitutional exercise of Congress’s enumerated powers, considering each of the Government’s proposed bases in turn.

The court rejected the Government’s theory that the CTA is within Congress’s foreign affairs and national security powers because collecting beneficial ownership information is necessary to “‘protect vital US 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.’”[10] Emphasizing that “incorporation is an internal affair,” the court concluded that Congress’s foreign affairs powers could not “justify CTA’s regulation of ‘creatures of state law,’ which are ordinarily within the sovereign purview of the States.”[11]

The court also rejected the Government’s position that “regulation of purely internal affairs may be necessary and proper to effectuate Congress’s foreign affairs powers if foreign actors (or enough foreign actors) participate in those internal affairs to illicit ends.”[12] The court reasoned that the Government’s reading would render the Necessary and Proper Clause practically limitless, and reemphasized that Congress’s foreign affairs powers “do not extend to purely internal affairs,” such as corporate formation.[13]

Commerce Clause

Next, the court rejected the Government’s argument that the CTA falls under Congress’s Commerce Clause authority. In doing so, the court distinguished between the activities regulated by the CTA—the act of incorporation—and economic activities that regulated entities may subsequently pursue.

The court first addressed the Government’s argument that the CTA validly regulates the channels and instrumentalities of commerce because reporting entities “frequently utilize the channels of commerce.”[14] Explaining that the CTA “regulates most State entities, not just entities that move in commerce,” the court concluded that the CTA “doesn’t regulate the channels or instrumentalities of commerce or prevent their use for a specific purpose[.]”[15] In other words, that some regulated entities may subsequently use the channels or instrumentalities of interstate commerce does not justify congressional regulation of the entire class of regulated entities. The court noted, however, that Congress could “easily” have written the CTA to pass constitutional muster by imposing the “disclosure requirements on State entities as soon as they engaged in commerce,” or by “prohibiting the use of interstate commerce to launder money” and other illicit activities.[16]

Turning next to the Government’s argument that the aggregate effect of legal entities’ withholding beneficial ownership information substantially affects commerce, the court likewise found an insufficient nexus between the regulated activities and commercial activity. The court again emphasized that the CTA “is not a facial regulation of commercial activity[.]”[17] According to the court, while the subsequent activities engaged in by regulated entities may, in the aggregate, have an effect on interstate commerce, the object of the regulation itself is not an economic activity. At bottom, the court concluded that Congress lacked authority to enact the CTA because “[t]he proximity and degree of connection between the formation of an entity and its activities is too attenuated[.]”[18]

The court also rejected the Government’s argument that the CTA is necessary and proper, reasoning that FinCEN’s 2016 Customer Due Diligence (“CDD”) rule and the CTA “provide FinCEN with nearly identical information”—and the CDD “does so in a constitutionally acceptable manner.”[19] Because of the similarities between the two pieces of legislation, the court did not credit the Government’s argument that “failure to regulate corporate entities upon formation would leave a gaping hole” in Congress’s fight against money laundering.[20]

Taxing Power & Necessary and Proper Clause

Finally, the court rejected the Government’s argument that Congress acted pursuant to the Necessary and Proper Clause in enacting the CTA because “the collection of beneficial ownership information is necessary and proper to ensure taxable income is appropriately reported[.]”[21] While recognizing the relationship between the taxing power and the CTA’s disclosure requirements, the court found lacking a “sufficiently close relationship” between the two.[22] According to the court, 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.”[23] Given that “unfettered legislative power,” the court concluded that the CTA’s provisions were not a “proper” means to effectuate the policy goals embedded in the taxing power.[24]

After granting the Plaintiff’s Motion for Summary Judgment, the court entered a final declaratory judgment finding the CTA unconstitutional as exceeding constitutional limits on Congress’s power. The court permanently enjoined the enforcement of the CTA against the Plaintiffs.

Takeaways

While members of the NSBA and Winkels do not need to comply with the CTA’s requirements for now, there is no indication that FinCEN intends to let any other regulated party avoid compliance. Indeed, on March 4, 2024, FinCEN issued guidance in response to the court’s opinion, stating that “FinCEN will comply with the court’s order as long as it remains in effect.”[25] Though FinCEN acknowledged that the plaintiffs in the case—the NSBA, members of the NSBA, Winkles and reporting companies for which he is the beneficial owner—will not be required to report beneficial ownership to FinCEN as a result of the Order, its silence as to other non-plaintiff reporting companies implies that FinCEN expects all others to comply. Additionally, FinCEN stated that it is interpreting the court’s decision to apply only to persons who joined the NSBA prior to the issuance of the decision, again implying that a person cannot now join the NSBA to avail themselves of the relief.

The broader effects of the court’s opinion remain uncertain. As the Court noted, Congress could have “easily” written the CTA to pass constitutional muster, raising the possibility that Congress may, down the road, address this gap in the legislation. Further, the court did not address the plaintiffs’ claims under the First, Fourth, and Fifth amendments, nor were other avenues of challenge (e.g., APA compliance) pursued in this case, meaning that even an “easy” fix by Congress may not resolve all concerns with the lawfulness of the CTA and its implementation.

More likely is the possibility that parties across the country will file similar lawsuits seeking a similar result—or a different one, thereby increasing the likelihood of drawing the US Supreme Court into the fray. Already, another party in the Northern District of Ohio has filed a similar lawsuit, but this one seeks a nationwide injunction against the enforcement of the CTA.[26] That case is in its early stages. Additionally, other parties may seek to intervene into the Alabama litigation to avail themselves of the same relief that was provided to the named plaintiffs, a strategy that was recently used in the Section 1071 litigation in Texas.[27]

Ultimately, the CTA remains in effect for all covered entities, aside from the NSBA plaintiffs. Affected parties should watch the possible appeal of this case to the Eleventh Circuit and the Northern District of Ohio case and future announcements from FinCEN about how these developments will impact a party’s duty to report.

Footnotes

[1] 31 U.S.C. § 5336.

[2] 87 Fed. Reg. 59,498 (Sept. 30, 2022).

[3] 88 Fed. Reg. 83,499 (Nov. 30, 2023).

[4] Complaint, Nat’l Small Bus. United v. Yellen, No. 5:22-cv-01448-LCB (N.D. Ala. Nov. 15, 2022).

[5] Nat’l Small Bus. United v. Yellen, No. 5:22-cv-01448-LCB, 2024 WL 899372 (N.D. Ala. Mar. 1, 2024).

[6] The Court addressed only the constitutionality of the statute, not the rulemaking that implemented the statute. That rulemaking may remain subject to challenge on other grounds (e.g., compliance with the Administrative Procedure Act (“APA”)).

[7] Id. at *1.

[8] Id. at *5.

[9] Id.

[10] Id. at *7.

[11] Id. at *8.

[12] Id. at *9.

[13] Id. at *10.

[14] Id. at *11.

[15] Id. at *13

[16] Id.

[17] Id. at *14.

[18] Id. at *16 (citing United States v. Lopez, 514 U.S. 549, 567 (1995) (internal quotation marks omitted)).

[19] Id. at *18.

[20] Id.

[21] Id. at *20.

[22] Id.

[23] Id. at *21 (citing Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 560 (2012) (internal quotation marks omitted)).

[24] Id.

[25] FinCEN, Notice Regarding National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.) (Mar 4, 2024).

[26] Complaint, Robert J. Gargasz Co. v. Yellen, No. 1:23-cv-02468 (N.D. Ohio Dec. 29, 2023).

[27] See, e.g., America’s Credit Unions, CUNA Urges Parity By Filing Motion to Intervene in District Court 1071 Ruling (Aug. 10, 2023).

Gina Parlovecchio, Brad Resnikoff, and Matthew Bisanz are Partners, and Daisy Gray is an Associate at Mayer Brown LLP. This post first appeared on the firm’s blog.

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