DR Legal News: Money Laundering Schemes Using Real Estate Transactions

Feds Explain Potential Money Laundering Schemes Using Real Estate Transactions

by Lisa Harms Hartzler, Sorling Northrup Attorneys

This past August, the Financial Crimes Enforcement Network (FinCEN) issued an “Advisory to Financial Institutions and Real Estate Firms and Professionals” to explain how drug traffickers, corrupt officials, money launderers and other criminals hide illicit profits, conceal their identities, and launder funds through real estate transactions.  Although certain metropolitan areas in the country are targeted for this kind of activity more than what might be seen in most of Illinois, all real estate professionals should be aware of how a purchase and sale of real property can be exploited by criminals, what the warning signs are, and what they can or should do when they encounter a suspicious transaction. 

Money Laundering

Money laundering is the process by which illicit funds derived from criminal activities is “legitimized.”  Through a series of transactions, the origin of the money becomes obscured and useable without being traced back to the original illegal enterprise.  Shell companies that hide the true owners’ identities are especially useful in money laundering. 

High-end residential purchases (although commercial and other kinds of property may also be used) have become a particularly attractive way to launder money because they involve a lot of money and cash-only transactions are not that unusual.  Introducing illegal funds into the financial system in this way is called the initial or placement stage of money laundering.  

In the second or layering stage, illicit funds are further disguised and distanced from their source through a series of transactions through “shell” companies, such as when multiple pieces of real estate are bought and resold, exchanged, swapped or syndicated.  Complex arrangements involving real property are also not unusual and, therefore, provide an ideal way to make an illegal source of funds difficult to trace. 

When a money launderer who has purchased real estate sells it to a bona fide purchaser, that purchaser or his bank provides the money launderer with funds that appear to be derived from a legitimate business transaction.  This is the third, or integration, phase that completes the washing of illicit funds.  A criminal now has “clean” money. 

The Bank Secrecy Act

The U.S. Patriot Act, passed shortly after the 9/11 attacks in 2001, included a number of amendments to the Bank Secrecy Act intended to make it easier to prevent, detect, and prosecute international money laundering and the financing of terrorism.  Under the amendments, every covered financial institution is required to establish an anti-money laundering (AML) program, which must include developing policies, procedures and controls, designating a compliance officer, conducting employee training, and submitting to independent audits to test the AML program.  Covered financial institutions also are required to file Suspicious Activity Reports (SARs) with FinCEN and engage in adequate due diligence to understand their customers and their source of wealth.  Starting next year, many will have to collect beneficial ownership information on legal entities, like corporations, LLCs, and trusts, that open accounts.  

FinCEN has also placed additional reporting requirements on title insurance companies in Geographic Targeting Orders (GTOs).  The geographic areas include Miami and Palm Beach, New York, San Diego and Los Angeles, San Antonio, and Honolulu.  Title insurers in these targeted areas closing transactions on residential sales to legal entities with prices ranging from $500,000 to $3 million (depending on the location) must obtain and disclose to FinCEN the beneficial owners of those legal entities.  

Disclosure of beneficial owners helps FinCEN discover and compare the real people behind shell companies.  The first data collected under the initial GTOs revealed about 30 percent of the reported transactions were linked to possible criminal activity by the individuals revealed to be the beneficial owners of shell company purchasers.  FinCEN has found this process to be so effective in locating criminals involved in money laundering through shell companies that it recently extended and expanded the geographical target areas subject to the heightened disclosures. 

The Bank Secrecy Act applies to real estate professionals

The Bank Secrecy Act defines “financial institution” as including persons involved in real estate closings and settlements.  FinCEN clearly considers real estate brokers, escrow agents, title insurers, and other real estate professionals to be persons involved in real estate closings and settlements and, therefore, within the Bank Secrecy Act’s definition of a financial institution.  FinCEN’s Advisory notes, however, that real estate professionals are currently exempted from the broad AML compliance obligations imposed on banks, loan or finance companies, and housing government-sponsored enterprises like Fannie Mae and Freddie Mac.  Nevertheless, real estate professionals, “like all U.S. persons engaged in trade and business, must file reports on transactions in currency and certain monetary instruments involving more than $10,000.”  Such a currency transaction report is commonly referred to as Form 8300. 

In the Advisory, FinCEN also encourages real estate professionals to voluntarily file a SAR to report any suspicious real estate transactions. FinCEN believes that real estate professionals know the usual course of a transaction, how typical buyers and sellers act, and what the common methods of financing a transaction in the area are. Real estate brokers may often have a good idea as to the potential of purpose for which a property is being bought and the possible origin of a purchaser’s funds. In other words, based on their experience, real estate brokers may be able to smell something fishy about a buyer, a seller, or a deal. 

Transaction red flags

Every transaction is different, and no one fact or circumstance makes a transaction suspicious.  However, the National Association of REALTORS®, the American Land Title Association, and FinCEN have all provided tips for evaluating potential suspicious activity.  “Red flags” that could indicate money laundering include: 

  • The purchase money is coming from or going to a “high risk country” (one that has a weak anti-money laundering regime, supports or funds terrorism, or has a high degree of political corruption) or is a person or entity on the sanctions list compiled by the Office of Foreign Assets Control (OFAC) of the U.S. Treasury Department. 
  • The purchaser seeks to buy residential property in the name of a nominee (third person, relative, business entity, etc.), has no legitimate explanation for the use of a nominee, and/or is reluctant to disclose the identity of the person for whom the buyer is acting. 
  • The buyer or seller provides suspicious documentation to verify his or her identity.  
  • The purchase price far exceeds the buyer’s wealth, comes from an unknown origin, or is coming from or going to unrelated individuals or companies. 
  • The buyer does not mortgage the property where a cash-only payment does not match what is known about the buyer (occupation and income). 
  • The buyer brings actual cash to the closing. 
  • The buyer appears to lack sufficient knowledge about the purpose or use for the property. 
  • The purchase seems to lack economic sense, has no apparent lawful business purpose, will generate little to no revenue, or will incur high fees or monetary penalties. 
  • The buyer has little regard for the property’s condition, location, assessed value or sales price, and/or has not viewed the property. 
  • The seller is selling the property for significantly less than he purchased it for and/or is disinterested in seeking a better or the best price. 
  • The buyer/seller is buying and selling the same property within a short time or multiple parcels without an apparent legitimate purpose. 
  • The buyer/seller seeks to have closing documents reflect something other than the true nature of the transaction or to conduct the transaction in an irregular manner. 
  • Any other factors that do not make commercial sense or are outside the normal course of business. 

Of course, none of these red flags, either separately or even together, proves that a buyer or seller is using a real estate transaction to engage in money laundering.  They are simply factors that a real estate professional should consider and, based on his or her experience and knowledge of the real estate market, apply to determine when a transaction “smells fishy.” 

Filing a voluntary SAR

It is important to remember that real estate brokers and licensees are not required to file a Suspicious Activity Report when they suspect a transaction could be involved in a money laundering scheme.  As the National Association of REALTORS® has noted, most real estate transactions involve highly regulated entities, like banks and mortgage companies, which have existing Bank Security Act obligations to have AML programs and to file SARs.  However, according to the Advisory, FinCEN believes that real estate professionals “are well-positioned to identify potentially illicit activity as they have access to a more complete view and understanding of the real estate transaction and of those involved in the transaction.”  SARs are very helpful to FinCEN and law enforcement in making connections between criminals, their criminal activities, and their attempts to launder money gained from those activities. 

SARs are submitted electronically through FinCEN’s Bank Security Act E‑Filing System.  Its website contains a tutorial on how to file a SAR.  The Advisory also notes that when submitting a SAR involving a real estate transaction, the filer should reference the FinCEN Advisory, FIN‑2017‑A003, and include the key term “ADVISORY REAL ESTATE” in a narrative description of the transaction and in SAR field 33(z) (Money Laundering-Other).  These key terms assist FinCEN in cross-referencing real estate transactions and making connections among people and the shell companies they use to launder illegal funds. 

Safe harbors for SAR filers

The Advisory makes clear that FinCEN protects the confidentiality of all SARS.  Under the Bank Secrecy Act, neither any government employee nor any person filing a SAR may disclose to anyone involved in a transaction that the transaction was reported to FinCEN.  SARs are not subject to FOIA requests.  In addition, the statute provides that no person reporting a suspicious activity can be held liable to anyone for filing a SAR.  The process is about as confidential as it can get. 

Still, FinCEN is essentially asking real estate professionals to help fight large-scale criminal activity, including narcotics trafficking and terrorist financing, which is scary stuff.  And no one can guarantee that confidential information will not be hacked and released, even if such unauthorized release violates federal law.  Anyone filing a SAR that names persons potentially engaged in such criminal activity could legitimately perceive some danger in cooperating with the government. 

Being too “nosey” about a transaction could tip off clients engaged in illegal activity, while being oblivious to a possible money laundering scheme enables serious crime to flourish.  Real estate professionals will need to balance their patriotic duty with any real threat to safety they perceive.