We previously blogged on the lawsuit filed by the National Small Business Association (“NSBA”) and one of its individual members, which sought to challenge the constitutionality of the Corporate Transparency Act (“CTA”). Most recently, we analyzed the March 1 decision in that case by the Northern District of Alabama court, finding the CTA to be unconstitutional and enjoining the United States government from enforcing it against the plaintiffs.

The government sought an appeal before the Eleventh Circuit, and last Monday the Treasury Department filed its appellate brief. Before the District Court, the government argued that Congress had authority to enact the CTA under three distinct enumerated powers: (1) oversight of foreign affairs and national security; (2) its Commerce Clause-derived regulatory authority; and (3) its power to tax. The government’s brief on appeal focuses primarily on regulation of commercial activity, and its value as a component of the federal focus on combatting financial crime.

As we previously discussed, the District Court’s Opinion found in part that the CTA was constitutionally defective because it (according to the Court) attempted to regulate the act of incorporation, a purview of the individual States, in the name of national security.  The District Court noted, however, that the CTA presumably would pass constitutional muster were its applicability limited to actual engagement in commercial activity by an incorporating entity (because such a limitation would serve as a “jurisdictional hook” tying the regulation to the flow of interstate commerce).

The government highlights this conclusion as the first of two “principal errors” underpinning the district court’s ruling. It notes that, contra the District Court’s assertion, the CTA does not regulate the act of incorporation: it neither preempts state law on incorporation, nor limits the class of entities that can be incorporated, nor alters the means by which incorporation is accomplished, nor requires incorporation of any entity. Rather, the government argues, the CTA uses incorporation as a proxy for the category of entities that can engage in economic transactions in their own name and thus can potentially be used as vehicles for financial crimes without disclosing their owners.

The government further highlights provisions that cut against the District Court’s finding:

  • that reporting entities must keep FinCEN updated as to their ownership on an ongoing basis, rather than merely upon incorporation (31 U.S.C. Section 5336(b)(1)(D));
  • that domestically-owned “inactive” companies are exempt (31 U.S.C. Section 5336(a)(11)(B)(xxiii)); and
  • that nonprofits, political organizations, and some trusts are also exempt (31 U.S.C. Section 5336(A)(11)(B)(xix).

The government seized on the Court’s admission that the CTA would “pass constitutional muster” if limited to entities actually engaging in commercial activity, arguing that the difference between the Court’s “acceptable” version of the statute and the actual CTA would not be a meaningful one – but also arguing that because incorporated non-exempt entities can engage in commercial activity, their ownership information should be available if and when they do.

The second “principal error” in the District Court’s Opinion, according to the government, was the determination that the CTA is unrelated to the federal aim of curbing financial crime. The District Court deemed the CTA “far from essential” in light of the existence of FinCEN’s 2016 Customer Due Diligence rule (“CDD Rule”), which requires some (but not all) financial institutions to retain beneficial ownership information about some (but not all) entity customers – which the District Court characterized as “nearly identical information” to that required by the CTA.

The government took issue with both the equivalency drawn between the two regulations and the analytical standard to which the Court held the CTA (i.e. whether it was “absolutely necessary” to achieve the government’s desired policy aim).  First, the government noted that the CDD Rule solicited information from only a subset of the entities covered by the CTA – that is, those entities choosing to bank with covered financial institutions – and that information was reported to only those financial institutions and not to the government.  Thus, the beneficial ownership information reported to financial institutions under the CDD Rule is not centralized or immediately available to federal law enforcement. Second, the government noted (citing U.S. v. Comstock, 560 U.S. 126 (2010)) that the Necessary and Proper Clause gives Congress the power to enact statues that are “convenient, or useful” in helping it exercise its authority. And the government pointed to language in the CTA requiring the Treasury Department to rescind some provisions of the CDD Rule and revise others, specifically to harmonize their regulatory provisions (FinCEN has yet to issue these proposed regulations).

As noted supra, the government spent the lion’s share of its word count on Congress’ authority under the Commerce Clause – devoting only a paragraph to the taxing power and a page and a half to foreign policy and national security authority. This focused approach seems designed to hone in on the District Court’s “principal errors” and avoid getting sidetracked, whether in debates on the national security bureaucratic regime or in justifying reliance on taxing authority for what the government concedes is not actually a tax.

With a statutory compliance deadline of January 1, 2025 for existing entities covered by the CTA, and with the CTA already applicable to newly-formed covered entities, time is of the essence in clarifying whether and to whom the CTA should apply going forward. Amicus briefs have been filed, and a joint motion to expedite briefing and oral argument has been granted. The appellees’ response brief is due on May 13, 2024; the government’s reply brief, if any, is due on June 3, 2024.

We will continue to follow developments in this case.

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