Tag: FinCEN

A Focus on Residential Real Estate and Money Laundering

The Financial Crimes Enforcement Network announced the issuance of revised Geographic Targeting Orders. The threshold for reporting has been reduced down to $300,000 for all-cash purchases of residential real estate. The geographic scope has been expanded to now include nine cities: Boston; Chicago; Dallas-Fort Worth; Honolulu; Las Vegas; Los Angeles; Miami; New York City; San Antonio; San Diego; San Francisco; and Seattle.

The GTO requires U.S. title insurance companies to identify the natural persons behind all-cash purchases of residential real estate over that dollar threshold in those markets.

“All cash” means “[s]uch purchase is made, at least in part, using currency or a cashier’s check, a certified check, a traveler’s check, a personal check, a business check, or a money order in any form, a funds transfer, or virtual currency.”

I have no problem with virtual currency purchases having to be reported when used by a company buying residential real estate.

I think that threshold is going to be too low for those jurisdictions and overwhelm the FinCEN reporting structure.

I’m speaking a bit from personal experience. The GTO now covers my town. The definition of “Boston” includes all of Middlesex and Suffolk County. Suffolk is Boston proper and its various neighborhoods. Middlesex County, I assume, is targeted to Cambridge. But Middlesex county includes over fifty towns, stretching from Hopkinton, to Newton, to Ashby to Lowell.

There are lots of old houses and lots of developers buying those old houses and fixing them up. Like any good business, they use entities to limit liability and to meet lender single-purpose entity requirements.

Almost any residential purchase ends up using a check to cover part of the final purchase price. I expect the GTO will sharply increase the reports flowing into FinCEN. More so than expected.

I just think the GTO is too broad geographically and the dollar amount is too low. That can be fixed.

The GTO is effective. A study found a 95 percent drop in how much cash shell companies and other corporate entities spent on homes. The decline began immediately after the fist GTO rule took effect in March 2016. Before the rule, corporate entities bought an average of $111 million worth of homes with cash in Miami-Dade per week, or 29 percent of all residential transactions, according to the study. But almost immediately after the reporting requirement began, that number plummeted to $5 million per week, or 2 percent of all transactions.

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More Targeting of Real Estate Transactions by FinCEN

The US Financial Crimes Enforcement Network has started to look closely at cash purchases of expensive real estate as a possible source of money laundering. In January, FinCEN issued two Geographic Targeting Orders, one for New York and one for Miami. Now more metropolitan areas are in FinCEN’s sights.

Alamo

According to the press release, FinCEN has been gathering some good data from the small step it took earlier this year. Apparently it thinks there are other jurisdictions that are likely places for money laundering.

The new order targets all of New York City, more of the greater metropolitan Miami area, and adds in metropolitan areas in California and the area around San Antonio.

The covered transactions must meet the following criteria:

  1. An entity is the purchaser .
  2. It’s purchasing residential real estate.
  3. It’s for a large purchase price (see below).
  4. There is no bank loan or similar external financing.
  5. The purchased in made in part with cash or check or or certified check or cashier’s check.

One problem is the inclusion of a certified check or cashier’s check in the included transactions. If you’ve ever bought a home, you usually come to the closing with a certified check or cashier’s check. The closing needs cash equivalents at the closing to make sure it can send the money back out to the seller. In Massachusetts, its mandated by law.

I would guess that the FinCEN targeting order is generating mostly reports of ordinary, legal transactions.

That’s not to say that the efforts should not be applauded. Legitimate parties in real estate transactions do not want to be engaged in money laundering.

I would guess that most people engaged in this type of residential real estate money laundering have stopped using title companies in the transaction. That moves it out of the reporting requirements of the order. Title companies provide a great service, but not a required part of the transaction. It seems easy to structure around.

The purchase price guidelines in the targeted areas:

New York:

  • The Borough of Manhattan $3,000,000
  • The Borough of Brooklyn $1,500,000
  • The Borough of Queens $1,500,000
  • The Borough of Bronx $1,500,000
  • The Borough of Staten Island $1,500,000

Florida:

  • Miami-Dade County $1,000,000
  • Broward County $1,000,000
  • Palm Beach County $1,000,000

California:

  • San Diego County $2,000,000
  • Los Angeles County $2,000,000
  • San Francisco County $2,000,000
  • San Mateo County $2,000,000
  • Santa Clara County $2,000,000

Texas:

  • Bexar County $500,000

FinCEN is using title insurance companies as the gatekeeper because title insurance is a common feature in real estate transactions. FinCEN is quick to note that the title insurance companies themselves are not being implicated in the money laundering. “To the contrary, FinCEN appreciates the continued assistance and cooperation of the title insurance companies and the American Land Title Association in protecting the real estate markets from abuse by illicit actors.”

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Upcoming Anti-Money Laundering Rules for Private Funds

The Treasury’s Financial Crimes Enforcement Network has been toying with how to impose anti-money laundering standards on private funds and investment advisers for years. There is rumbling from the White House Office of Management and Budget that it approved proposed new regulation.

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A notice of rulemaking was dropped a few years ago. The thought then was that the underlying custodian has AML standards in place to keep things in line for investment advisers.

The posting at the OMB states that a proposal is moving along. According to the entry, the rule would “prescribe minimum standards for anti-money laundering programs to be established by certain investment advisers and to require such investment advisers to report suspicious activity to FinCEN.”

A few months ago U.S. Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen gave speech to to the ABA/ABA Money Laundering Enforcement Conference and said changes are underway.

It looks like changes are coming.

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Laundering Dollar Bills is by  TaxRebate.org.uk

Proposed Regulations on Customer Due Diligence Requirements

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The U.S. Treasury Department’s Financial Crimes Enforcement Network has proposed revisions to its customer due diligence rules. Of course, the proposed rule would affect financial institutions that are currently subject to FinCEN’s customer identification program requirement: banks, brokers-dealers, and mutual funds. However, FinCEN suggested that it may be considering expanding these customer due diligence requirements to other types of financial institutions. FinCEN names money services business, casinos and insurance companies. Investment advisers and private fund managers are not specifically mentioned.

According to FinCEN, an Anti-Money Laundering program should have four elements:

  1. Identify and verify the identity of customers;
  2. Identify and verify the identity of beneficial owners of legal entity customers
  3. Understand the nature and purpose of customer relationships; and
  4. Conduct ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.

Please notice number 2. The definition of “beneficial owner” is proposed as have two prongs:

  • Ownership Prong: each individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer, and
  • Control Prong: An individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer); or (ii) any other individual who regularly performs similar functions.

For identifying ownership of an entity, FinCEN has proposed a form of certification. I find the certification to be overly simplistic. It only asks for individuals with ownership in the entity. This would clearly miss ownership of the account holder by other entities who could be “bad guys.” The certification also only requires one senior officer.  That makes it too easy to appoint a straw man as executive officer to hide the underlying control by a “bad guy.”

On the other hand, it makes it really easy for the financial institution to check the boxes with requirements and confirm compliance.

The rule does not specifically contemplate investment advisers or private fund managers. For many investment advisers, the underlying broker-dealer or custodian will end up with KYC responsibilities. The investment adviser will have to be a conduit for that information.

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FinCEN Emphasizes a Culture of Compliance

Compliance Secrets Advice Following Rules Yellow Envelope

The US Financial Crimes Enforcement Network has finally come around to realizing that US financial institutions should promote a culture of compliance. FinCEN does not point to any specific problem, but mere notes that “Shortcomings identified in recent Anti-Money Laundering enforcement actions confirm that the culture of an organization is critical to its compliance.”

FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis and dissemination of financial intelligence and strategic use of financial authorities.

I don’t think that that anyone believes that these roadblocks in the financial system will prevent terrorism, drug sales or other illegal activities. But it should prevent law-abiding financial institutions from helping illegal activities.

The FinCEN’s advisory (.pdf) comes off as a bit stale since the culture of compliance mantra has been echoing throughout financial institutions for many years.

One piece of the FinCEN guidance did catch my eye:

Compliance should not be compromised by revenue interests

Again, this guidance is not novel, but rarely have I seen it so specific. AML compliance should operate independently and be able to take appropriate actions to mitigate risk and investigate possible inappropriate activity.

When BNP Paribas SA, compliance staff gave warnings but then assisted with misconduct, you understand the need for FinCEN to be more explicit about compliance culture.

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J.P. Morgan’s Madoff Failure

jp morgan and compliance

Yesterday J.P. Morgan agreed to forfeit $1.7 billion for its failure related to the Bernie Madoff fraud, plus several hundred million in fines. As part its deferred prosecution agreement, the bank agreed that it did not have the proper systems in place to catch Madoff. It’s easy to target the bank for compliance failures but I wanted to dig a little deeper to see what went wrong. The picture is not very clear and I’m not sure why the bank forfeited so much cash.

J.P. Morgan was the main bank for Madoff from 1986 until the fraud collapsed. With money moving in an out of the accounts, J.P. Morgan could presumably have noticed something wrong with the flow of money. But that would likely be difficult. Madoff would have moved money around through several accounts. It would not be a simple task to track the flow of cash and see the fraud. If it were that simple, it would have been spotted much earlier. The agreement notes a few flags on the account and some inadequate diligence by the relationship personnel. None of that data seems to indicate a bigger problem with the flow of cash.

There was a mid 1990s transaction that looked like check kiting between an unnamed private bank client of Chemical Bank (which was eventually consumed by J.P. Morgan), Madoff and a second bank. The second bank ended up terminating the relationship and filing a suspicious activity report. J.P. Morgan did not. The private bank client did not terminate the relationship because Madoff had turned the investment from $183 million to $1.7 billion over 12 years. Madoff’s fake returns bought silence.

In the late 1990s and again in 2007 divisions of J.P. Morgan were considering having its private bank invest in Madoff. But Madoff was unwilling to help with the bank’s diligence efforts and the the bank expressed concerns when it was unable to reverse engineer Madoff’s returns.

In 2006 the London office of the bank had set up an exotic derivative that would provide clients with synthetic exposure to a hedge fund without making a direct investment in the fund itself. To cover the other side, J.P. Morgan invested in a Madoff feeder fund. Apparently, the derivative was wildly successful and hit the bank’s $100 million exposure limit. The traders went to an internal committee to get an exposure increase to $1 billion. The committee tabled approval because the bank couldn’t get the diligence it wanted. Madoff refused to allow the bank to conduct due diligence on his fund directly.

That triggered more diligence efforts and an increasing unease at the bank about having exposure to Madoff. J.P. Morgan began redeeming its interests in the Madoff feeder funds. This was 2008 and Lehman had just collapsed and the Madoff fraud would be exposed in a few months. J.P. Morgan also began unwinding those synthetic exposures. It looks like the bank was able to save $250 million before the Madoff collapse.

The key dagger seems to be when the London office of J.P. Morgan filed a report with the U.K. authorities as a result of its diligence. But J.P. Morgan did not file an equivalent report in the US. Under the Bank Secrecy Act, a bank needs to file Suspicious Activity Reports with FinCEN if the bank notes any suspicious transaction relevant to a possible violation of law or regulation.

The second big failure was that the suspicions were not transmitted from the investment side of the bank to the commercial banking side of the bank. The investment side wanted to limit its exposure and minimize its losses for being invested in a fraud. The banking side would have to take steps to prevent funds from leaving for improper purposes.

From the time the report was filed in London, the Madoff bank account at J.P. Morgan had fallen from $3 billion to $234 million. The $1.7 billion paid by J.P. Morgan is supposed to represent a portion of the money that the bank allowed to leave the Madoff account during that period.

What is boils down to is that in the Fall of 2008, just before the collapse of the Madoff fraud, J.P. Morgan took steps to protect its own business interests but failed to notify FinCEN of the same suspicious, potentially fraudulent, activities.

In the end I suspect J.P. Morgan thought it would not win the case if it went to trial. It has some bad facts on its side. One of the diligence emails joked that they should visit Madoff’s accountant’s office to make sure it wasn’t a car wash. The bank would never find a jury that would offer one iota of sympathy or understanding.

Then it was just a matter of how much cash the bank was willing to pay. It sounds like the initial government ask was about $3 billion: the $2.75 billion that left the Madoff bank account, plus the $250 million that the bank managed to avoid losing by redeeming out of the Madoff feeder funds. I assume the bank is looking to end as much of the regulatory actions from the 2008 financial crisis hanging over its heads as it can. Another one down.

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Suspicious Activity Reports and Private Funds

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Over the years, the Financial Crimes Enforcement Network (FinCEN) has required banks, brokers, and other financial entities to officially report suspicious activities of its customers. Investment advisers and private fund managers have managed to sty outside the requirements. In large part, that’s because a fund’s custodial accounts are already subject to the self-policing. since the account is with a broker subject to the FinCEN requirements.

But changes are coming. James H. Freis, Jr., Director of the FinCEN, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he raised the issue and mentioned that a new rule is in the works.

Reuters is reporting that a proposed rule is likely to come out in the first half of 2013. The rule would likely address anti-money laundering concerns. Although that may be an issue for some types of funds, it’s not a concern for most private funds. Once you limit redemption rights, you make the investment very unpalatable for drug kingpins and other bad guys trying to hide their money. They are not typically patient investors looking for long term returns.

Hedge funds were thrown into the bucket of “shadow banking” and private equity firms were labeled as “vulture funds” during Romney’s presidential campaign. It looks like the federal government will continue to pile regulatory requirements on private fund managers for the foreseeable future.

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Mortgage Fraud Rises in 2011

The Financial Crimes Enforcement Network released its full year 2011 update (.pdf) of mortgage loan fraud reported suspicious activity reports. It  reveals a 31% increase in submission.It also shows some of the trends that lead to the 2008 financial crisis.

Financial institutions submitted 92,028 MLF SARs in 2011, compared to 70,472 submitted in 2010. Financial institutions submitted 17,050 MLF SARs in the 2011 fourth quarter, a 9 percent decrease in filings over the same period in 2010 when financial institutions filed 18,759 MLF SARs. While too soon to call a trend, the fourth quarter of 2011 was the first time since the fourth quarter of 2010 when filings of MLF SARs had fallen from the previous year.

Since 2001, the number of mortgage loan fraud SARs has grown each year.

The report pins the sharp increase in 2011 on mortgage repurchase demands. Those demands prompted a review of mortgage loan origination files where filers discovered fraud. In 2011 a majority of the SAR filings related to fraud that was more than 4 years old. So this is the fraud leading up to the bubble now being detected.

Simply redo the chart by focusing on the year of the fraudulent activity instead of the date of filing.

You can see the rise in fraud tracking the heights of the real estate bubble in 2005 through 2008.

Going back to the 2011 reports:

  • 21% involved occupancy fraud, when borrowers claim a property is their primary residence instead of a second home or investment property
  • 18% involved income fraud, either overstating income to qualify for a larger mortgage or understating to qualify for hardship concessions.
  • 12% involved employment fraud

The up and coming frauds are related to the repercussions of the housing bubble.

Short sales are a source of fraud. SAR filers noted red flags in short sale contracts, such as language indicating that the property could be resold promptly, or “common flip verbiage” in the sales contract, or discovered that the “buyer’s
agent” was not a licensed realtor.

Several SAR filers described borrowers who “stripped” or removed valuable items from their foreclosed homes before vacating the premises. In one SAR, borrowers removed $33,000 worth of fixtures from the home, including major appliances and fixtures.

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New Anti-Money Laundering Requirements for Non-Bank Mortgage Lenders and Originators

Private Equity has been siting on the fringes of Anti-money laundering regulation for many years. It’s still illegal to be involved in money laundering and fund managers should be taking some steps to protect themselves and to identify problems. There’s just no set script. FinCEN is supposedly working on a new rule.

In the meantime, FinCEn has issued a new rule setting out the requirements for Non-Bank Mortgage Lenders and Originators.

The rule starts with a simple principle based approach:

Each loan or finance company shall develop and implement a written anti-
money laundering program that is reasonably designed to prevent the loan or finance company from being used to facilitate money laundering or the  financing of terrorist activities.

What do you have to do to meet this standard? The rule goes on to set minimum requirements:

(1) Incorporate policies, procedures, and internal controls based upon the company’s assessment of the money laundering and terrorist financing risks associated with its products and services.
(2) Designate a compliance officer who will be responsible for ensuring that:
(i) The anti-money laundering program is implemented effectively
(ii) The anti-money laundering program is updated as necessary; and
(iii) Appropriate persons are educated and trained

(3) Provide for on-going training of appropriate persons concerning their responsibilities under the program.
(4) Provide for independent testing to monitor and maintain an adequate program, including testing to determine compliance of the company’s agents and brokers with their obligations under the program

 The mortgage company is also now explicitly required to file suspicious activity reports.

Obviously, private equity firms are not subject to this rule. However, I would guess that the proposed rule for private equity will end up having many of these same elements.

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Changes Coming With Anti-Money Laundering Requirements

James H. Freis, Jr., Director of the Financial Crimes Enforcement Network, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he highlighted many of the issues of money-laundering in the various financial sectors. FinCEN‘s rules currently apply to broker-dealers and to mutual funds, but not to investment advisers.

On May 5, 2003, FinCEN published a notice of proposed rulemaking in the Federal Register proposing that investment advisers establish anti-money laundering programs. But it never went anywhere. On November 4, 2008, FinCEN announced that it was withdrawing the proposed regulations and would not proceed with regulations for these entities without publishing new proposals and allowing for industry comments.

“FinCEN is currently revisiting the topic of investment advisers, building on the changes to that industry pursuant to the Dodd-Frank Act, the SEC rules implementing Dodd-Frank and other changes, and is working on a regulatory proposal that would require investment advisers to establish AML programs and report suspicious activity.”

The investment adviser line of business has lots of business models. Shortly, the ranks of investment advisers will be flooded with private fund managers. Fries cites these statistics:

“According to the Investment Advisers Association, the number of investment advisers registered with the SEC totaled 11,539 in 2011, and the total assets under management reported by all investment advisers increased 13.7% to $43.8 trillion in 2011, from $38.6 trillion in 2010.28 According to the SEC, there are more than 275,000 state-registered investment adviser representatives and more than 15,000 state-registered investment advisers.29 Approximately 5% of SEC-registered investment advisers are also registered as broker-dealers, and 22% have a related person that is a broker-dealer. Additionally, approximately 88% of investment adviser representatives are also registered representatives of broker-dealers.”

Clearly, it’s a big industry. Clearly, working with “bad guys” on any of the blocked persons lists would be a big problem.

However, the private equity fund vehicle is an unlikely choice for someone to launder money. The investment is highly illiquid, the subscription commitment requires you to contribute money infrequently over a long period of time, and the money is distributed back irregularly.

I welcome some clarity from FinCEN, but hope they are realistic about the burdens they will impose in contrast to the risk.