Court Ruling Deems CTA ‘Unconstitutional’, Leaving Small Businesses Off the Hook – For Now

Millions of international corporate entities and their governing bodies were left unsettled over the last week as the final decision on a critical piece of new and highly-anticipated anti-money laundering (AML) legislation came to a head, with these latest developments testing the integrity of American judiciary process. The primary component of the much-heralded Corporate Transparency Act (CTA) that would establish beneficial ownership reporting requirements (i.e. reporting on the true identities of individuals who own or control >25% of a company) for both domestic and foreign firms has hung in the balance of the federal court system for the better part of 2024, with a contentious, back-and-forth series of judicial actions playing out in front of the American public over the month of December. All told, the results of these actions – should the latest ruling stand – are expected to shift the landscape of AML/CFT for years to come.

The U.S. Corporate Transparency Act – a measure which passed in 2020 and officially came into effect on January 1^st, 2024 – required U.S. small business owners to file corporate transparency reports with beneficial ownership information to bring these entities in line with larger corporations and financial institutions that had been completing similar requirements for many years to this point. The goal of the CTA was to combat illicit financial activity such as money laundering, tax fraud, and terror financing that had proliferated both domestically and abroad via the abuse of shell companies and complex layers of beneficial ownership structuring that had allowed sanctioned individuals, politically exposed persons, and criminals to exploit the American financial system for personal gain. Given the fact that larger corporations, while more lucrative, had stricter guidelines when it came to these regulations, criminals had begun to pivot their operations towards targeting smaller businesses not subjected to these same standards to better avoid detection. By requiring more businesses to provide beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN), the American government surmised that more illicit financial activity would be snuffed out, much to the benefit of the of global financial system. Given this unprecedented increase in reporting, and the costs that were expected to follow for small businesses, the measure quickly became highly controversial. Some opponents also argued that the measure would infringe on anonymous owners’ First Amendment rights to free association and Fourth Amendment rights to keep their information private, with others adding that the CTA infringed on the rights of states, where the companies are registered.³

Given the contentious nature of the measure, on December 3^rd, a federal judge operating on behalf of the U.S. District Court for the Eastern District of Texas issued a preliminary injunction which prohibited the enforcement of the CTA and its implementing regulations. The injunction was made on the grounds that the measure was “unconstitutional” in that it forced a wide variety of previously uncovered businesses to comply with highly-invasive reporting requirements that included the disclosure of a significant degree of personal identifiable information. In line with the original sentiments of small business owners with respect to the CTA, the initial reaction to this injunction was highly positive as those affected felt the law placed far too heavy a burden on them. Some of these disgruntled business owners had already banded together in a joint lawsuit further challenging the constitutionality of the CTA on various grounds. Judge Amos Mazzant – the Texas-based federal circuit judge who levied the injunction – ultimately sided with the plaintiffs, referring to the CTA as a “quasi-Orwellian statute” that violated states’ rights.

In a 79-page opinion, Judge Mazzant ruled that it was likely that the plaintiffs would be able to prove that:

• The CTA is not a proper exercise of Commerce Clause power because it does not regulate a channel or instrumentality of interstate commerce or any activity that substantially affects commerce;¹ and
• The CTA cannot be justified under the Necessary and Proper Clause because, contrary to the government’s assertions, it is not rationally related to any enumerated power to regulate commerce, conduct foreign affairs, or collect taxes.¹

The aftermath of this initial move is where things became interesting – if not dizzying. On Monday, December 23^rd, a three-judge panel of the New Orleans-based 5^th Circuit Court of Appeals ruled in favor of lifting the previously-imposed order that effectively blocked the nationwide enforcement of the CTA.  At the time of this decision, the appeals court that moved to overturn the injunction said the U.S. Department of Justice in defending the statute “made a strong showing that it is likely to succeed on the merits in defending CTA’s constitutionality.”² After that, it appeared that enforcement of the CTA was back on. However, just four days later, the appeals court changed its decision in a stunning reversal that left many onlookers baffled. The appeals court ultimately decided that it would be better to leave the injunction in place to keep the enforcement of the CTA paused while the arguments of its opponents are weighed and its constitutionality further sorted out. The primary basis of the opposing argument centered on tens of millions of Americans now being forced to incur unrecoverable costs for paperwork filing and record-keeping in managing their new compliance requirements.  

Most affected businesses had a January 13 deadline to submit their initial reports to FinCEN. Due to the decision of the court, this requirement has been lifted while the applicable order remains in force. FinCEN – which is unable to enforce the CTA’s reporting requirements against anyone for as long as the injunction remains in place – has however lobbied for reporting companies to continue voluntarily submitting beneficial ownership information reports for the time being, though the chances of this appear slim-to-none.

Where matters stand currently, following their reversal, the Fifth Circuit court issued an order requiring a merit briefing to be completed by February 28, 2025, with a subsequent oral argument set for March 25, 2025.

Global RADAR will provide additional information on these developments as they become available.

Citations

1. Mitchell, Stacy. “Corporate Transparency Act Enforcement Preliminarily Enjoined Nationwide.” Gibson Dunn, 5 Dec. 2024. 
2. Raymond, Nate. “US Appeals Court Allows Anti-Money Laundering Law to Be Enforced | Reuters.” Reuters, Thomson Reuters, 24 Dec. 2024.
3. Schwartz, Mattathias. “Enforcement of Anti-Money-Laundering Law Blocked after Court Reversal.” The New York Times, The New York Times, 27 Dec. 2024.