Is the Corporate Transparency Act Unconstitutional?

I sometimes get the question, "Is the Corporate Transparency Act Unconstitutional?".

There is a case pending in federal court in Alabama that will soon answer that question.

In November, 2022, National Small Business United ("NSBU") filed suit in federal court in Alabama (National Small Business United v. Yellen), seeking to have the Corporate Transparency Act declared unconstitutional.

Since then, the plaintiff filed a motion for summary judgment and the parties entered into a consent order. The consent order eliminated the need for discovery and set a schedule for the Treasury Department to respond. In essence, both sides agreed that the case could be determined by the court on summary judgment motions.

Under the consent order, the Treasury Department is scheduled to file their responsive motion and brief in support on or before March 29, 2023. Here's what we expect to see and what is likely to happen next.

Who is National Small Business United?

National Small Business United is the legal name for the organization that calls itself the National Small Business Association. (It's not clear why their legal name is different from their tradename.) According to its website, the organization has over 65,000 members in all 50 states and represents "pragmatic, non-political, small-business advocacy."

According to its "Priority Issues" brochure, the organization favors a variety of business-favorable policies, including the expansion of tax cuts, reducing the cost of health care, preventing the IRS from "targeting small business" and reforming the U.S. immigration system. Number 5 of its list of priorities seeks to "repeal the Corporate Transparency Act."

In its Corporate Transparency Act Issue Brief, the organization describes the CTA as a law that "will require ONLY certain businesses with fewer than 20 employees" to file beneficial ownership reports with FinCEN. It explains that because "large companies are mostly exempt" that only small business will end up reporting. The organization estimates that "millions of small-business owners will be faced with an additional $5.7 billion in regulatory paperwork" as a result.

Why Does NSBU Claim the CTA is Unconstitutional?

National Small Business United has six arguments that the CTA is unconstitutional:

1. The CTA infringes on the States' sovereign powers over the formation and governance of entities under State law.

2. The CTA does not regulate commerce. Rather, it imposes obligations on the States and State entity filers at the moment of entity formation, which is an entirely ministerial act. The NSBU argues that the "ministerial act" of forming a corporation or LLC is not a "commercial activity" over which Congress can assert its Article I power to "regulate Commerce."

3. The CTA's application to all entities formed under State law sweeps in entities engaged solely in activities confined to the territory of the State in which they are formed and entities that do not engage in any commercial activity at all. By covering entities engaged in purely intrastate activities and entities engaged in "non-commercial activities" the law exceeds Congressional authority to regulate interstate commerce.

4. The CTA infringes upon individuals' rights to apply for, form, own and provide for the self-governance of entities under State law.

5. By compelling the disclosure of "sensitive" personal information for law enforcement purposes under penalty of criminal sanctions for non-compliance, and, in certain cases, allowing federal and foreign government agencies to access such sensitive information regarding U.S. persons without U.S. court authorization, the CTA enables "unreasonable searches and seizures" of the "right of the people to be secure in their persons, houses, papers, and effects" with no prior suspicion of wrongdoing, in violation of the Fourth Amendment. . . . . These aspects of the CTA also violate the privilege against self-incrimination and privacy rights protected by the Fifth and Ninth Amendments.

6. The CTA is unconstitutionally vague because its definitions of "applicant" and "beneficial owner" have no evident analogues in relevant State entity laws, providing insufficient notice of who is subject to its criminal sanctions for noncompliance, and vest too much interpretive discretion in the federal government.

How is Treasury Going to Defend the Constitutionality of the CTA?

Treasury will likely argue that NSBU's arguments are political, and not constitutional.

NSBU asserts that it is unfair for the burden of reporting to fall on the shoulders of small business and that there would have been better ways for Congress to stem the tide of money laundering. These arguments, Treasury will argue, were considered and rejected by Congress. The constitutionality of the Corporate Transparency Act will not hinge on whether it is a "good" law or even a "fair" law. It will not hinge on whether there might have been a better way to achieve the same outcome. Instead, Treasury will argue, the constitutional question is whether Congress was within its authority under the Constitution's commerce clause it adopted the CTA's blanket reporting obligations.

The "commerce clause" refers to Article 1, Section 8, Clause 3 of the U.S. Constitution, which gives Congress the power "to regulate commerce with foreign nations, and among the several states, and with the Indian tribes." Courts interpret the grant of authority to regulate commerce "among the several states" to mean that Congress has the authority to adopt laws that govern commercial activities on an interstate basis.

The CTA requires all non-exempt reporting companies to file a beneficial ownership report with FinCEN. The CTA, and the regulations adopted by FinCEN to implement the CTA, provide for 23 categories of exemption. Most of the exempt categories describes companies whose ownership is already collected by a government regulator. (By way of example, FinCEN's regulations exempt from reporting certain issuers of publicly-traded securities, banks, bank holding companies and Section 501(c) tax-exempt entities.)

There is also a statutory exemption for large operating companies that have (a) a physical office in the U.S., (b) more than $5 million in gross income, and (c) more than 20 full-time employees. The exemption is intended to exempt from filing obligations those companies that are large enough to be easily identified in connection with a law enforcement inquiry. NSBU turns this rationale on its head when it claims in its lobbying materials that the CTA will require "only" businesses below this size threshold to file.

Treasury will focus its argument on the constitutional question of whether Congress' constitutional power to regulate commerce between the states authorizes it to require companies to file beneficial ownership reports with FinCEN. On this constitutional question, Treasury will likely recite a litany of prior cases where courts held that the Constitutional interstate commerce clause confers a wide grant of authority.

Congress Has Broad Authority through the Interstate Commerce Clause

For more than a century, the U.S. Supreme Court has tended to side with Congress in cases that have challenged Congress' power to adopt laws affecting interstate commerce. Arguments that claim Congress exceeded its authority under the interstate commerce clause usually fail.

In Swift & Co. v. United States (1905), the Supreme Court held that a price-fixing scheme among Chicago meat-packers constituted a restraint of interstate commerce—and was therefore illegal under the federal Sherman Antitrust Act (1890). The price-fixing activities took place entirely within the State of Illinois. But, because the intrastate meatpacking industry was part of a larger "current of commerce among the States" the Supreme Court held that Congress could regulate the anti-competitive behavior.

In the Heart of Atlanta hotel case, the Supreme Court ruled that the 1964 Civil Rights Act, which prohibited racial discrimination in housing, was constitutional even when applied to purely intrastate transactions.

The hotel owner in that case had argued that its racially discriminatory policies were outside the reach of Congress because the act of renting a hotel room was an intrastate activity. The Supreme Court reasoned that the ability to rent a hotel room is a key activity required for individuals to engage in interstate commerce. As a consequence, a federal law that prohibited discrimination in housing could constitutionally prohibit discrimination in hotel policies, even where the hotel owner and the affected renter lived within the same state.

In Gonzales v. Raich the Supreme Court upheld the federal Controlled Substances Act (1970) even though it conflicted with a contrary California state law. California state law permitted the intrastate noncommercial possession, production, and use of medical cannabis (medical marijuana). The federal law, however, prohibited any possession, production or use of cannabis (medical or otherwise) even if the activities involved were purely intrastate. On appeal, the Supreme Court upheld the federal law. The Court reasoned that Congressional authority under the interstate commerce clause could reach the intrastate cultivation and possession of cannabis because those intrastate activities could affect the supply of and demand for marijuana in the illicit interstate market.

Applying these rationales to the arguments made by NSBU, we would expect Treasury to argue that Congress was well within its authority when it adopted the Corporate Transparency Act. The ability of illicit actors to form shell companies to facilitate money laundering has a massive impact on illicit activity. In the same way that that Congress has the power to prohibit cannabis production and use on an intrastate basis because of its potential impact on the illicit interstate market, Congressional power would seem to extend to the formation of legal entities under state law because of the potential impact such entities may have on interstate illicit activity (in this case, money laundering).

NSBU's arguments that beneficial ownership information is available from other sources (like IRS records) or that the burden of compliance will fall unfairly on small business, might be persuasive to policy makers, but do not bear on the constitutional questions involved.

About The Author

Jonathan Wilson is the co-founder of FinCEN Report Company with 31 years of experience in corporate, M&A and securities matters. He is the author of The Corporate Transparency Act Compliance Guide (to be published by Lexis Nexis in the summer of 2023) and the Lexis Practical Guidance Practice Note on the Corporate Transparency Act.

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