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Cleaning House: Combatting Money Laundering

Money laundering, for the general public, is the stuff of gritty dramas like Ozark or the notorious dealings of Pablo Escobar and El Chapo. In popular culture, it is depicted as an activity to be done in the dark of night with neatly-stacked wads of cash deposited into duffel bags. The reality, however, is much more banal, with most money laundering occurring in the guise of an unremarkable series of transactions designed to obfuscate the trail for any who might be inclined to investigate.

The real estate sector has long been a favorite of money launderers, as the lack of regulation and use of shell companies have enabled them to “wash” a large quantity of cash through the system in one transaction. The truth is that nobody really knows how much money is laundered through real estate—not least because much of it currently goes undetected. This opacity might serve shady operators well, but it can have catastrophic effects on the rest of the economy, as the 2008 housing crisis demonstrated all too devastatingly.

Why Real Estate Is a Target
Because the United States, until recently, did not require company owners—including those of anonymous shell companies—to reveal their identities, they were able to operate as if legitimate businesses, even if their dealings were anything but. Consequently, criminals and money laundering networks often use shell companies to purchase property without raising suspicion from authorities. Global Witness, an NGO that has conducted multiple investigations into money laundering, noted that “all too often, the proceeds of crime and corruption [are] used to purchase homes” which, once resold, make any capital involved legally acquired.

In 2018, three people in California—Surjit Singh, Rajeshwar Singh, and Anita Sharma—were sentenced to prison and ordered to pay hefty fines and restitution for their participation in a mortgage fraud scheme. The scheme entailed recruiting individuals with good credit to act as “straw buyers”—that is, someone who purchases a property on someone else’s behalf—for properties owned by Surjit Singh’s family members and associates. Because many of those straw buyers lacked the income to be able to afford those properties, Rajeshwar Singh, an accredited real estate agent, submitted falsified loan applications on their behalf to improve their chances of being approved.

In total, the Singhs and their accomplices were involved in the sale or refinancing of at least 14 different properties and were responsible for the origination of over $9.3 million worth of residential mortgage loans. As the broker responsible for the “sales," Rajeshwar Singh received commissions on each transaction—while also being listed as the seller for half of the aforementioned properties. Meanwhile, Surjit Singh directed payments for “contracting services” (which never took place) to shell companies linked to his daughter and her partner out of escrow. In addition, he received rent from the inhabitants of the houses purchased by the straw buyers, despite the fact that the straw buyers claimed they would be the primary inhabitants of the property on their loan applications. Many of his family members also received some sort of financial benefit, either by selling their property as part of the scheme or receiving money directed out of escrow.

In this case, the real estate transactions were the means for both committing fraud (by submitting fraudulent loan applications) as well as for moving around the misbegotten gains so as to make them untraceable. The use of shell companies helped to further obscure where the money was going while also enabling funds to be distributed to multiple parties.

While the Singhs were eventually discovered, their example is, sadly, not as rare as one would like. In fact, in the second quarter of last year, it is estimated that one in 164 mortgage applications had some indication of fraud. Applications for investment properties were even riskier, with one in 28 applications estimated to contain indications of fraud. Of course, not all mortgage fraud is money laundering, but mortgage fraud for-profit schemes are often linked to other illegal activities such as organized crime, drug trafficking, and terrorism, where money to be laundered often originates.

The Scope of the Problem
In a 2018 statement before the Senate Banking, Housing, and Urban Affairs Committee, Steven D’Antuono, Section Chief for the FBI’s Criminal Investigative Division, noted that the flow of illicit proceeds into luxury real estate, hotels, and other assets “threatens the transparency and integrity of our financial system” by preventing legitimate operators from buying or investing into those same properties, thus limiting their ability to participate in a free and open market. In other words, properties that might otherwise have been put to legitimate, beneficial use as homes or investments are taken beyond the reach of law-abiding citizens.

Nor is this the only impact that real estate money laundering has on society. The example of the Singhs is illustrative in this case, as we can see clearly the effect that it has on financial institutions, which are tricked into giving loans to people who either do not need them or view them as an opportunity to profit. This then reduces the amount of capital available for people who genuinely need financial assistance to purchase a property, which in turn can have a profound effect on their quality of life.

There are other, more insidious effects as well. By shielding their identities behind LLCs, bad actors can use their anonymous position to create a phony bidding war that raises property prices, then purchase those expensive properties without revealing where they got the money from. As Global Witness notes, the anonymity of these owners “can mean that tenants struggle to hold landlords accountable, cities fail to fight graft, and that researchers can’t answer basic questions about the housing market”—all of which further erode people’s basic rights.

In recognition of the outsize threat that money laundering in real estate poses to the United States, the government has, in recent years, beefed up its enforcement of existing anti-money laundering measures. In addition, the U.S. Treasury Department and the Financial Crimes Enforcement Network (FinCEN) have recently identified loopholes in the current AML regime pertaining to real estate and are committed to remedying them, so it is to be expected that even tighter regulation is on the way.

Currently, there is a requirement that firms raise a “Suspicious Activity Report” (SAR) when they suspect a transaction may be fraudulent. The number of these SARs filed by loan and finance companies has been growing steadily, from just 1,500 in 2015 to nearly 26,000 in 2019. On the one hand, this reflects growing awareness of the problem, but it also shows just how prevalent money laundering remains, and how difficult it is for authorities to curtail it entirely.

One issue is that not all real estate transactions are required to comply with the strict anti-money laundering requirements laid out in the Banking Secrecy Act (BSA). If the purchaser does not require a mortgage nor any other type of involvement from a regulated financial institution, then none of the parties involved in the transaction are obligated to be compliant with the BSA. FinCEN estimates that about 22% of real estate transactions for residential properties fall under this category. While financial institutions are kept under increasing levels of scrutiny, cash deals are a huge blind spot that money launderers take full advantage of.

However, the passage of the Anti-Money Laundering Act of 2020 (AML) shows that regulators are committed to closing the loopholes within U.S. financial law. One of the most important provisions of the AML is that it requires all companies, including LLCs, to disclose information about their beneficial owners (i.e., anyone who either owns or controls a significant portion of that company) to FinCEN, thus depriving would-be money launderers of anonymity. These new requirements, coupled with new technologies that make performing background checks faster and simpler, will hopefully enable regulators and financial institutions to reduce the prevalence of money laundering in the United States. 2021 has already proven to be a new era for financial crimes. In January, the Financial Crimes Enforcement Network (FinCEN) penalized Capital One to the tune of $390,000,000 for “willfully failing to implement and maintain an effective Anti-Money Laundering (AML) program to guard against money laundering.”

Identity verification is the first step in combating money laundering, as it is imperative to know that the person you’re dealing with is who they say they are—and has not been involved with any criminal operations in the past. However, in order to effectively prevent money launderers from continuing to find ways around existing laws, there need to be tools available to real estate agents, mortgage brokers, and anyone else involved in a transaction to be able to perform the necessary background checks to identify them. Automated anti-money laundering solutions can help perform this function by confirming (or flagging) someone’s identity in minutes, while simultaneously screening them against existing sanctions lists. These solutions will not only allow brokers and firms to fulfill their moral obligations to reporting potential money launderers, but also protect them from inadvertently becoming involved in an illegal scheme.

After the Department of Treasury began requiring anyone using an LLC to purchase high-end real estate to identify themselves, all-cash purchases by corporations fell by around 70%, which suggests that the loss of anonymity is a powerful deterrent to money laundering in the real estate space (while also indicating how widespread it has been). All in all, however, in order to effectively prevent money launderers from operating and make it difficult for them to enjoy the fruits of their illegal labors, it is incumbent on all players within the real estate industry, from real estate agents to financial institutions to regulators, to better understand the processes that money launderers rely upon.

About Author: Martin Cheek

Martin Cheek is VP of SmartSearch, a provider of an anti-money-laundering verification service based in Lehi, Utah.
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