By: Stephanie Thomas
April 25, 2019
Money laundering through United States real estate purchases is not a new phenomenon, yet Federal regulation of anonymous, all-cash transactions is only in its infancy. The real estate industry, particularly in the U.S. because of the market’s stability relative to that of other countries, provides criminals with opportunities to repatriate and legitimize proceeds from or intended to support illegal activity. A number of investigations have highlighted the lucrative real estate purchases by money launderers, and notably an in-depth series by the New York Times spurred Department of Justice investigations and increased attention to the industry. Reports revealed a pattern of brokers who did not know much about buyers, numerous examples of properties purchased by persons under government investigations, and exorbitant cases such as one related to the prime minister of Malaysia, resulting in $1 billion of asset forfeiture.
In general, money laundering operations have three stages: placement, layering, and integration. Criminals can place their illegal proceeds into the legitimate real estate industry by making a large down-payment or full purchase (the placement stage). Next, they can conduct a series of real estate transactions, resales, and exchanges to obscure law enforcement’s ability to trace the illegal proceeds (the layering stage). Finally, criminals can integrate their illegal proceeds into the legitimate market and come out with clean money when they sell their real estate to a bona fide purchaser and receive payment in legitimate funds (the integration stage). So while the entry and exit points of laundered money are easily identifiable, the Federal government has not historically taken a strong interest in targeting anonymous, all-cash real estate transactions through anti-money laundering (“AML”) regulations.
The Financial Crimes Enforcement Network (“FinCEN”), situated under the Treasury Department, has long had the authority to regulate the industry as part of its mandate to regulate financial institutions. It was only in January 2016, however, that FinCEN began a six-month temporary program using Geographic Targeting Orders (“GTOs”), which apply to residential real estate purchases with a designated minimum purchase price in certain major metropolitan areas where the purchaser is a corporation, LLC, partnership, or similar business entity and the transaction is being done without a bank loan or similar external financing. GTOs require U.S. title insurance companies involved in these transactions to conduct due diligence in determining the beneficial owners (i.e. the natural persons) behind the entities and file a transaction report to FinCEN. FinCEN can then investigate suspicious reports and coordinate with other agencies to pursue or aid in investigations, enforcement actions, or prosecutions.
Since 2016 the program has been renewed and expanded, suggesting law enforcement and lawmakers are finding it successful. Commentators noted a 2017 report stating that over 30 percent of beneficial owners identified by the program had been previously cited in Suspicious Activity Reports, reports that financial institutions file with FinCEN for potentially suspicious transactions. Meanwhile, another report “found that the number of companies using all cash to buy homes in Miami had fallen 95 percent since the program was introduced.” In November 2018, FinCEN issued a GTO renewal that expanded the means of purchase to include virtual currency, reduced the minimum purchase price to $300,000, and expanded the counties subject to the reporting requirement. The expansion to cover virtual currency payments is particularly important as its popularity rises with buyers because it brings additional layers of anonymity for those buyers.
The continued expansion of the GTO program is indicative of FinCEN’s interest in making the GTO program permanent, either through rulemaking or Congressional legislation. Back in 2003, FinCEN issued a notice of proposed rulemaking for AML program requirements for “persons involved in real estate closings and settlements” to determine which “persons” would be covered by regulations, the money laundering risks these persons posed, and whether any persons should be exempted from requirements. The proposed rulemaking recognized that the nature of real estate transactions varies by location and a number of other factors, affecting which persons are in the best position to obtain the identity of the beneficial owner(s).
FinCEN ultimately never actually issued any rules on this subject; however its description of the issues in the notice of proposed rulemaking may be helpful in predicting what an expanded GTO reporting program would or could look like. FinCEN identified a number of actors involved in real estate transactions besides title insurance companies that could be subject to reporting requirements, including the brokers, attorneys representing buyer or seller, banks, mortgage brokers, other financing entities, escrow agents, appraisers, and other inspectors. These actors range from those structuring the deal (who are thus are in a position to learn of its purpose and nature) to real estate inspectors.
Congress is also interested in a permanent reporting program, particularly after revelations about U.S. real estate ownership by Russian oligarchs. The Senate sought to codify the program through a provision in a Russian sanctions bill introduced last year that includes several anti-money laundering updates, leaving the GTO program largely as it operates now by focusing on high-value residential transactions that use title insurance companies. This bill remains in committee, but more recently, the House passed a resolution acknowledging the need to increase transparency and close regulatory loopholes in this area. Despite Congress’ general gridlock, this appears to be an area with bipartisan support. Legislation codifying this program would provide more certainty and stability than a temporary, yet continuously renewed, program, and would clarify FinCEN’s authority in the space. However, codifying the program exactly as it operates now will be insufficient to adequately deter money laundering in the real estate market. To understand why, we need to understand the limitations posed by a reporting requirement that falls solely on title insurance companies.
Title insurance companies are the first actor subject to AML reporting requirements, likely because they are already a regulated industry involved in some aspect of many, if not most, real estate transactions; they even handle payment transfers in some regions. However, the present program’s focus solely on title insurance companies has several shortcomings. Any legislation should retain the flexibility needed to ensure the best-placed party to a transaction bears the reporting obligation, that all transactions are included regardless of whether title insurance is used, and consideration should be given to the elimination of anonymous entities altogether (e.g. mandatory disclosure of beneficial ownership).
First, unlike brokers, title insurance companies do not necessarily interact with the buyers, either directly or frequently, such that they are in a position to know or easily learn the identity of the true beneficial owners, nor do they always handle the purchasing funds. Title insurance companies operate differently around the country. In many Miami transactions, for example, they play a direct role as settlement agent and have the funds flow through the company, making them a logical reporter (if title insurance is obtained). In New York, however, this is typically not the case, meaning title insurance companies must seek out affidavits and other forms of proof from the parties, which they may not be in the best position to obtain.
Second, title insurance is often not required by states, so while institutional lenders require it to obtain financing, all-cash or privately financed transactions can avoid this process. All-cash buyers can forgo it, and will be incentivized to do so if it comes with reporting requirements, so long as they can free-ride off of the developer and non-cash buyers using financing. Where they are purchasing high-end, luxury real estate, a money launderer can trust that the title is clean because the developer and legitimate buyers have conducted in-depth title searches to secure their investments. Therefore, if the buyer avoids title insurance, there will not be a transaction report filed for the purchase, avoiding FinCEN monitoring altogether.
Instead, regulations should capture enough actors in the process to ensure that decisions such as forgoing title insurance do not create loopholes and opportunities to avoid a transaction report. Some party must be responsible to report in every transaction. In one scenario, title insurance companies would remain primarily responsible with escrow agents, brokers, lawyers, or other parties filling in gaps for transactions where the company is not involved at all. Alternatively, whoever functions as the escrow agent in a particular transaction could bear primary responsibility. This would leave title insurance companies responsible in markets where they handle payment directly but brokers, lawyers, or other actors taking on the role in other markets. Regulations should also capture cryptocurrency exchanges or whichever party handles the cryptocurrency payment to further ensure a transaction report is filed.
Another criticism of the existing program is that disclosure of the beneficial owner and the due diligence comes too late in the process and with excessive search costs, regardless of the party responsible. Currently, GTO reports reveal beneficial ownership only at the time of purchasing real estate. Instead, this disclosure could be made at the time of the entity’s formation. A transaction report could still be filed for real estate purchases, but without the costs of conducting initial due diligence on anonymous entities. Title insurance companies or other covered entities could confirm the beneficial ownership has not changed instead of starting from scratch. Moving the identification timeline up should also deter the use of these entities for non-real estate money laundering transactions.
Therefore, whether done by rulemaking or legislation, the GTO program must be comprehensive, and remain flexible to account for local transaction practices and potential changes in transaction norms, such as the potential rise of cryptocurrency payments. Further, Congress should address underlying problems posed by the use of anonymous shell entities. The attention on the real estate industry is welcome and long-overdue, but Federal regulators must not limit themselves to an incomplete solution.
Stephanie Thomas, J.D. Class of 2019, N.Y.U. School of Law.
Suggested Citation: Stephanie Thomas, Cracking Down on Money Laundering in U.S. Real Estate, N.Y.U. J. Legis. & Pub. Pol’y Quorum (2019).