Podcast - Breaking Down the Decision to Declare the Corporate Transparency Act Unconstitutional

Eddie Jauregui: Thank you so much for joining us for today's podcast. My name is Eddie Jauregui. I'm a partner at Holland & Knight's Los Angeles office. My practice is White Collar Defense and Investigations. And I'm here today joined by my Partner Michael Titens. And we're going to be discussing the federal district court decision in which the district court found that the Corporate Transparency Act exceeded the Congress' constitutional powers. Michael, why don't you introduce yourself?

Michael Titens: Hello everybody, I'm Michael Titens, a corporate transactional partner with Holland & Knight in the Dallas office and a member of our Corporate Transparency Act Team.

Eddie Jauregui: Why don't we jump right into it? The case we're here to discuss today is National Small Business United v. Yellen. That's out of the United States District Court for the Northern District of Alabama. It made quite a few headlines because the district judge in that case found that the Corporate Transparency Act was unconstitutional. Can you tell us a little bit about the case?

Michael Titens: This case is about the Corporate Transparency Act. The Corporate Transparency Act entered into effect in January of this year, and will require millions of businesses in the United States to make filings with the government, reporting their ownership and information about each of their beneficial owners and control people. The law has been the subject of quite a bit of commentary, both because of the compliance burden it imposes and because of some of the ambiguities in the law itself. This case was brought last fall by a business association of small businesses and an individual as well, who owned several small businesses. The plaintiffs alleged that the law places undue burdens on these businesses. There were concerns about privacy and being compelled to share personal information with the government. From a legal perspective, the theory of the case was that Congress did not have the power to enact this sweeping of a statute requiring every business to provide information to the government, and therefore the entire law should be declared unconstitutional. The court, for reasons we will explain, agreed with the plaintiffs and held the law to be unconstitutional.

Eddie Jauregui: The government had three main arguments in support of the CTA and its constitutionality. Can you tell us what those were?

Michael Titens: The government argued that this law is well within the scope of Congress' authority to enact legislation on three grounds. First, it's within the Congress' authority to regulate and legislate with respect to national security. Second, it's within the federal Congress' powers to regulate interstate commerce. And finally, it is within the Congress' power to make laws and regulations relating to tax administration and the tax system of the United States.

Eddie Jauregui: Let's jump into that first one. Michael, there's a lot of talk, obviously, about, leading up to the CTA, about why something like the CTA was necessary in order for the United States to come into compliance, basically with world standards and international policies on money laundering, and also to prevent things like drug trafficking, human trafficking, arms trafficking and to prevent foreign powers from basically using the United States financial system for illicit gains. In other words, there were a number of ties between the CTA and things having to do with foreign powers. But tell us how that discussion played out in this court decision.

Michael Titens: Well, you're exactly right that the United States had started to be described as a leading tax haven, both for illicit actors and just for people who wanted accounts that were not traceable to themselves personally. And based on that, the purpose of this law is to require disclosure that can be used by government authorities to help them and stem illicit activities and prosecute illicit actors. This was one of the grounds that the government used to justify the law itself, was that the government has the power to regulate national security, the protection against illicit activity, whether it be trafficking, money laundering, etc., is a vital fundamental interest of the United States with respect to national security. And therefore, Congress had the power to enact this law. The court rejected that claim, despite the fact that this law is similar to laws in many other nations. The court said that regulating every single newly formed entity in this manner goes beyond any national security interest that the Congress or federal government might have. The court went on to say that just because some entities may be formed and engaged in illicit activity, there's not justification for regulating every single entity in this fashion. For that reason, the law itself goes beyond Congress' power to regulate national security and foreign affairs.

Eddie Jauregui: And one of the things that I found so interesting about the court's discussion in this section of its opinion is that what the court ultimately says is yes, Congress does have quite considerable powers to do foreign policy, oversee foreign affairs. But what you're doing here, Congress, is neither one of those things. What you're doing here is interfering with "purely internal affairs." Or I think the way the court worded it was "regulating creatures of state law." Did you also find that part of the discussion interesting?

Michael Titens: It was interesting to me that the court didn't criticize the, the purpose of the law or the aims of the law. The court acknowledged that regulating illicit international activity might be a good thing, but went on to say that the way in which Congress did it exceeded the congressional authority that even though it might be a wise law, it's an unconstitutional law. We saw that theme also play out in the court's analysis of the second justification proposed by the government, that this law is within the government's right to regulate interstate commerce. Do you want to tell us a little bit more about how the government argued that point and the court responded?

Eddie Jauregui: The government's second argument was that the CTA was justified under the Congress' Commerce Clause authority because the common sense and the record, the government argued, indicated that the entities that constituted CTA reporting companies frequently utilize the channels of interstate commerce. The more sort of basic argument is, look, what we're doing here is regulating economic entities, and all of this area is going to have a substantial effect on interstate commerce. These are business entities. They tend to operate both in interstate and foreign commerce, etc. The court rejected that argument, as you said, Michael. It said, you know, there are three ways to do a Commerce Clause analysis. Number one, are you regulating the channels of interstate and foreign commerce? Number two, are you regulating the instrumentalities of and things and persons and interstate and foreign commerce? And number three, are you regulating activities that have a substantial effect on interstate and foreign commerce? The court did a thorough analysis of each one of these arguments, and it said that the regulation at issue does not fall in any one of these categories. For starters, it says, number one, you're not regulating the channels of interstate and foreign commerce. In other words, you're not doing things like regulating highways, train tracks, the things that allow interstate and foreign commerce to happen. Number two, you're not regulating instrumentalities of those things. So you're not regulating the computers or telephones that things that help make interstate and foreign commerce happen. What you're doing is regulating business entities at the moment that they incorporate with the state. And so what it said is the fundamental question in this case is, does Congress have authority under the Commerce Clause to regulate noncommercial intrastate activity? So noncommercial intrastate activity, meaning regulate business entities at the time that they incorporate with a state. When certain entities, which have availed themselves of the states' and corporations' laws, use the channels of commerce and their anonymous operations substantially affect interstate and foreign commerce. That is a long setup, but that's the way the court framed the question. And it said, the answer here is no. No, because what you're really doing, to get back to our theme that we discussed about in the foreign affairs section, is you're regulating entities just because they incorporate with a state. And that is purely non-economic. It doesn't have anything to do with interstate or foreign commerce, and it cannot be justified under the substantial effects part of the Commerce Clause analysis, because the tie between incorporation with a state or an Indian tribe, as allowed under the CTA and commerce, is far too attenuated. And so it said that this was not a proper exercise of Congress' authority under the Commerce Clause.

Michael Titens: Even though most of the entities and nearly all entities that are being created will engage in some sort of economic activity, and the formation of entities often does involve interstate commerce. When a group of people in one state forms their corporation in Delaware or some other state, when people even within a state form their corporation by making a filing online, there are arguably channels and instrumentalities of interstate commerce being used. And this court was a little bit more specific, as in the, the national security claim of saying that just because there may be some corporate formations or some, some entities that will engage in interstate commerce, it's not appropriate to regulate every single entity from the time it is formed. And further went on to point out that the government was not challenging the argument that merely forming an entity is not interstate commerce. The court then went from there to say, well, if just merely forming, it is not necessarily interstate commerce, and this law is triggered by the formation alone, then this law is not closely related to interstate commerce in a way that would justify this regulation.

Eddie Jauregui: Couple more points, Michael, on this section that I thought were very interesting. Number one, the court said, look, we don't think that what Congress was doing here was Commerce Clause stuff because nowhere in the statute does the Congress say that they're regulating commerce. Very fascinating discussion for those people out there who are into constitutional law. It says the court finds that when Congress is trying to justify its authority under the Commerce Clause, it knows how to do that. It usually includes something that the court calls a jurisdictional hook, and says that it is pursuant to the Congress' Commerce Clause authority. And nowhere in the CTA does the Congress say that. So it found that part to be very interesting and very powerful, because the Congress never said that it was exercising its Commerce Clause authority. And then the other thing that I thought was interesting, the government had made this argument that the CTA is necessary and proper to carry out a legitimate exercise of Congress' Commerce Clause powers. And the court rejected that argument and said that we don't think that the CTA is necessary. In fact, in the court's view, it's far from essential. And the reason it found that is because, as the court detailed in its memorandum in opinion, FinCEN already has something called the Customer Due Diligence rule, and the CTA and the CDD substantially overlap. And the court found that it was hard to justify a conclusion that failure to regulate corporate entities the way the CTA would, would leave a hole in Congress' fight against illicit corporate activity and money laundering. In other words, the government is saying this act is important and it's necessary to our fight against illicit corporate activity and money laundering. And the court rejected that argument, saying, no, it isn't. You already have another law on the books that does this very thing, so that argument is not compelling.

Michael Titens: After a rather lengthy discussion of the Commerce Clause and the government's arguments why Congress has the power under its rights to regulate interstate commerce to adopt this law and, furthermore, why the court disagreed with that argument, the court then went on to address the third justification proposed by the government, that being that the federal government has the power to regulate the tax system and, and tax administration in the United States. The court addressed this argument rather more briefly. The court did not find this law to be sufficiently related to taxing authority or tax administration. The court admitted that yes, there are provisions in here that allow the sharing of information submitted under the CTA with tax authorities in the United States and in other countries. However, the court pointed out that, in its view, merely putting a statement into a law the tax authorities have access to the information is not sufficient to create a tax law or a law under the Congress' taxing powers. The court argued that if all it took was to say in a regulation that the IRS can have access to this information, it would undermine any limitation on Congress' authority. It's just too big of what it viewed as a loophole in the limitations on the federal government's powers. And so, for those reasons, the court also disagreed with the government on their third purported justification, and without any justification being found to be justified by the court, the court ruled that this law is unconstitutional, and further ordered that because it's unconstitutional, the plaintiffs in the case, the individual as well as the members of the National Small Business Association, would not be subject to this law.

Eddie Jauregui: There were a lot of questions about what is the impact of this case. If a federal district court has found the CTA to be unconstitutional, does that mean that all entities across the nation can stop complying with it?

Michael Titens: This judge did not issue a ruling that applied nationwide. There are certainly some cases, some judges in the federal courts who, when they find a law to be unconstitutional, will immediately issue a nationwide order enjoining the enforcement of the law. This judge was somewhat more restrained in approach, and so the court’s order was applicable only to the plaintiffs in the case. We have already seen other similar lawsuits being filed in other jurisdictions. It is possible that in some of these other jurisdictions, if the court reaches the same conclusion as this Alabama court, that the law is unconstitutional, that in some of those other cases, there could be a nationwide order that would affect all businesses across the U.S. But for now, unless you are a member of the National Small Business Association and were on March 1 a member of that organization, you are still subject to the Corporate Transparency Act and still will be required to make filings for new entities within 90 days after formation and for entities that existed before January 1 of this year. The filing is due by the end of the year.

Eddie Jauregui: Can you tell us a little bit about what FinCEN has said about the court's ruling?

Michael Titens: FinCEN issued a statement, and it latched on to the court's ruling itself to say, we acknowledge the court made this ruling and we will not be enforcing the CTA against these particular plaintiffs. Furthermore, we will still require, and all other entities are still subject to this law. FinCEN also has appealed the Alabama decision to the circuit court, and will be arguing in that appeal that the Alabama judge got it wrong, and this case is, in fact, constitutional. We shouldn't expect any immediate easy answers, because an appeal to the Eleventh Circuit Court will take some time. Any copycat lawsuits that have been filed in other jurisdictions, and many have, will also take time to work their way through the system. And so it could easily be six months, nine months or even years before we get additional rulings on the constitutionality of this law.

Eddie Jauregui: You mentioned that there have been other suits. Michael, I know there's at least one other lawsuit that we're aware of. Federal district court in Ohio, in which the plaintiff is challenging the Corporate Transparency Act, both unconstitutional grounds and on Administrative Procedure Act grounds. I think you're right. You know, these cases are going to take time to make their way through the courts. I do think that having a lengthy, reasoned opinion out there may impact whether folks decide to file new challenges to the CTA throughout the country. Certainly, I think any judge weighing a constitutional challenge to the CTA is going to familiarize themselves with the arguments made by the parties and, of course, with the reasoning of the court in the Northern District of Alabama. So I think the case is going to be important for lots of reasons. Michael, there are these "mini-CTAs" that are percolating throughout the country, and we know one that passed in New York and California is presently contemplating one. What impact, if any, do you think this case may have on the passage of mini-CTAs?

Michael Titens: Well, let me answer that first by talking about the appeals in this case, in addition to the Ohio case you mentioned, I know of one that's been filed in Maine, and there may be others coming down the pipe, but it should be pointed out that this Alabama case challenged the law, not just on the limits of the federal government's authority to pass regulations, but also under the First, Fourth and Fifth Amendments to the Constitution. Those arguments relate more to the plaintiffs arguing that they're being forced to provide personal information, being put in a position of either providing personal information or subjecting themselves to potential criminal penalties. I mention that because these state laws that have similar disclosure requirements would not be subject to the same unconstitutionality argument as the one that was used in Alabama to rule the statute unconstitutional. The state laws are not reliant on federal government authority to regulate interstate commerce, for example. However, the other claims that were made against the CTA in Alabama and were not decided by the Alabama judge at this point could also form the basis for challenges to the state level CTA disclosure regimes that have been proposed in New York, California, and elsewhere.

Eddie Jauregui: Well, Michael, I think that covers our discussion on the Northern District of Alabama, a case that has made waves throughout the country. Anything else before we wrap up today?

Michael Titens: We will continue to monitor these cases, and we'll certainly continue to monitor the status of the CTA. Our clients are engaged in their efforts to comply with the CTA. In some cases, that becomes a very difficult endeavor. And as of now, there's no relief for these entities, and we will be continuing to advise our clients that the law is still applicable and compliance is still required and continue to be available to assist in any way we can.

Eddie Jauregui: Thank you so much, Michael, and thank you to all of those listening.