Federal law enforcement is evaluating a proposed rule to combat money laundering through shell companies. If adopted, the rule would dramatically expand and deepen the compliance and due diligence required from financial institutions to identify beneficial owners—as well as the legal owners—of accounts. Legal and real estate experts predict that high- profile investigations and enforcement actions may be imminent—and the real estate industry must prepare now.
The Big Picture: New Due Diligence Requirements
Currently, financial institutions exercise their own judgment in making risk-based assessments of whether to require beneficial owner information for legal entity accounts. Banks, broker-dealers, mutual funds, futures commission merchants and introducing brokers in commodities are already required to have robust policies and procedures to conduct customer due diligence and comply with recordkeeping and reporting requirements, such as the filing of suspicious activity reports.
In July 2014, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking that would expand and reset this compliance burden. The proposed rule would require banks, real estate professionals and others to identify and verify the identity of beneficial owners of entity customers.
The new rules could significantly affect real estate investment, where shell companies are sometimes used to obfuscate the ultimate owners of property. FinCEN Director Jennifer Shasky Calvery recently used her comments at an anti-money laundering forum in May 2015 to update attorneys and compliance professionals on the status of the proposed rule, especially as it relates to potential money laundering through real estate transactions.
“As far back as 10 years ago when I was working as a prosecutor, so many of my very own investigations were stalled by an inability to follow the money,” Calvery said. “And inevitably shell companies were involved. So when people ask ‘why beneficial ownership’ and ‘why now?’ what I really want to say is ‘why not 10 years ago?’”
Legal and real estate experts predict that high-profile investigations and enforcement actions may be imminent -- and the real estate industry must prepare now.
Who Is a “Beneficial Owner” for Purposes of Identification?
The proposed rule requires the identification of all individuals that meet either the “ownership test” or “control test”—either owning 25 percent or more of the equity interests of the legal entity customer or having significant responsibility to control, manage or direct the legal entity customer (such as an executive officer).
This requirement to identify natural persons will force banks and others to peel back multiple corporate layers during the identification process. Acknowledging the difficulties involved, FinCEN is nevertheless unambiguous on the requirement to identify actual individuals “regardless of how many corporate parents or holding companies removed the natural person is from the legal entity customer.”
Impact on the Real Estate Industry
FinCEN Director Calvery brought the proposed FinCEN rule into the field of real estate transactions when she further stated, “we need to ensure transparency in the area of real estate.” She referenced the February 2015 investigation by The New York Times, “Towers of Secrecy.”
It concerned the use of shell companies to purchase high-value condominiums and real estate in New York City. The series found that shell companies own significant percentages of units in high-profile New York buildings, including Trump International (57 percent), One57 (77 percent) and Time Warner Center (64 percent).
In the Time Warner Center alone, after piercing through the shell companies and identifying the actual beneficial owners, The Times found 37 percent of the units are owned by foreign nationals, including government officials and close associates of officials from Russia, China, Kazakhstan, Malaysia, Colombia and Mexico. At least 16 of the beneficial owners have been the subject of government inquiries into financial fraud, housing and/or environmental violations. Four owners had been arrested and another four owners had been penalized or fined for illegal activities.
The Times’ findings are consistent with what federal investigators have found. “FinCEN continues to see the use of shell companies by international corrupt politicians, drug traffickers, and other criminals to purchase luxury real estate in cash,” said Calvery. “Our information shows funds transfers in the form of wire transfers originating from banks in offshore havens at which accounts have been established in the name of the shell companies.”
What Do Real Estate Professionals Need to Do Now?
So, federal law enforcement and regulators are aware of the problem and poised to take action. What do banks, real estate professionals, developers and their attorneys need to do now to be ready for the inevitable?
Know Where to Start and What Is Required at Minimum.
The proposed FinCEN rule notes that covered financial institutions need not conduct the analysis themselves to identify the beneficial owners, but generally may rely on the representations of the legal entity customer. However once disclosed, the proposed rule requires that covered financial institutions actually verify the identity of all disclosed beneficial owners in the same manner as current customer identification requirements (e.g., by collecting a driver’s license).
Put in Place Services and Processes in the Event the Identity of the Beneficial Owners Cannot Be Verified.
The proposed rule explicitly states “[a] financial institution must also include procedures for responding to circumstances in which it cannot form a reasonable belief that it knows the true identity of the beneficial owner.” Institutions will want to retain standby due diligence and investigatory services, to be used as needed.
Organize and Prepare These Processes Sooner Rather Than Later.
Industry leaders agree that the real estate transaction deal flow can slow or freeze up entirely if counsel and developers do not have the requisite revised due diligence procedures and safeguards in place and ready.
While the proposed rule and FinCEN’s emboldened push for enforcement will motivate real estate dealmakers and banks to strengthen their in-house compliance departments, the industry is already struggling with a shortage of experts capable of untangling complicated shell-company deals in order to identify the actual beneficial owner. Thus, this stronger and more assertive push by federal law enforcement to fight money laundering and corruption in real estate transactions will also likely force dealmakers to factor in extra time to ensure compliance and take steps to ensure they have the expertise in place to provide the increased level of scrutiny FinCEN is prepared to require.
Learn more about fraud statistics and trends in Kroll’s annual Global Fraud Report.
1 This article is condensed from our Federal Rules Target Real Estate Deals white paper.