Not Your Average Neighbor
On Christmas Eve of 2007, a Moscow-based network of corrupt officials and Russian organized crime fabricated and filed a US$230 million tax refund using the stolen identity of three companies managed by Hermitage Capital. According to allegations from the top federal prosecutor in Manhattan, auditor Sergei Magnitsky uncovered this brazen fraud while researching the case for Hermitage, and his investigation and testimony implicated police, the judiciary, tax officials, and Russian organized crime. However, some of the very individuals involved in this criminal enterprise were allegedly assigned to investigate Magnitsky’s complaint, and he was soon arrested. Magnitsky died in pretrial detention in Moscow nearly a year later under suspicious circumstances, and by then, the fraudsters had used a complex series of shell companies and nominees to extract much of the proceeds of the fraud scheme from Russia. Some of this money made its way through the coffers of a shell company in Cyprus before eventually being used to purchase residential and commercial property in Manhattan. Following the passage of the Magnitsky Act by the US Congress in 2012, law enforcement took action and the properties were part of an ongoing civil forfeiture complaint filed in 2013.
The case of these alleged Russian conspirators, the Magnitsky fraudsters, is particularly egregious, but it is far from unique. For example, Spaniard Álvaro López Tardón was convicted in 2014 as a drug kingpin and sentenced to 150 years in prison for laundering the millions of dollars he obtained leading a Spanish cocaine smuggling operation that had terrorized Madrid since the 1990s. Before his arrest and conviction, Tardón purchased 13 condos, including a luxury penthouse worth over US$1 million in South Beach, Miami. And just like the Magnitsky fraudsters who fleeced Hermitage Capital, Tardón paid cash for these properties using shell companies like “Miamark LLC” to hide his role in the transactions.
Both of these examples are drawn from major coastal cities, but money laundering in the US real estate sector is not limited to the coasts. As the Secretary of Finance of the Mexican border state of Coahuila from 2008 to 2011, Héctor Javier Villarreal Hernández took out hundreds of millions of dollars in fraudulent loans on the state’s credit, keeping some of the illicit funds for himself. Villarreal used a series of accounts in Brownsville, Texas, and Bermuda to move portions of these criminal proceeds out of Mexico, and eventually invested tens of millions of dollars in the Texas real estate market. In 2014, he pleaded guilty to a conspiracy to launder money, and in San Antonio alone, federal prosecutors filed suit to forfeit commercial and residential properties valued at over US$31 million from him and his accomplices. These properties included a CVS pharmacy, a strip mall, and a US$1.3 million home purchased in the name of a shell company called “Alpes Group LLC.”
In these cases, law enforcement was able to pierce the veil of secrecy and shell companies hiding the bad actors behind the purchase of US real estate. Regrettably, officials are not always so fortunate.
Tools of the Trade: Shell Companies and the All-Cash Market
Drug traffickers and fraudsters do not simply want to hide their dirty cash. They also want to conceal the origins of their funds in a way that grows as an investment, cleans as much money as possible in a single transaction, and allows them to enjoy the fruits of their illicit activity without worrying about market instability and exchange rates causing future losses. In that sense, real property — especially residential property in desirable cities in a relatively stable market like the United States — is a natural choice. In the example above, when Tardón was operating from Miami, he could stay in any one of the oceanfront condos that he owned there, living the high life while confident that most of his properties would appreciate in value without any connection to his name. Ultimately, it is this final characteristic of real estate — its potential for exchange in opaque transactions — which makes it so vulnerable to money laundering.
Shell companies make it possible to conceal the true owner of a mansion or even a convenience store in a real estate transaction more easily than a mainstream participant in the market might realize. This is done every day in perfectly legal circumstances when buyers use a limited liability company or other structure to shield themselves and their other assets from liability related to the purchase. Less commonly, celebrities may use the name of a legal entity when buying a home to maintain some privacy from overzealous fans or paparazzi who might try to track them down. These are legitimate practices, but unfortunately, bad actors do the same thing to obfuscate their injection of criminal proceeds into the US financial system by purchasing real property.
The term “shell company” generally refers to limited liability companies and other legal entities with no significant legally derived assets or actual ongoing business activities. Shell companies, whether formed for illicit or legitimate purposes, usually have no physical presence other than a mailing address, have no employees, and create little if any independent economic value. Many Americans associate shell company activity and corporate secrecy with offshore financial centers like Panama or the British Virgin Islands. The revelation of the “Panama Papers” and the uproar over potentially illicit activity by shell companies incorporated for customers of Panamanian law firm Mossack Fonseca gives a small glimpse into the workings of an industry that caters to clients seeking total anonymity. However, the United States itself has a poor track record for the transparency of its legal entities. This marks a role reversal for the United States, which historically has led by example when it comes to the implementation of rigorous anti-money laundering standards.
The efficiency and ease of using the US banking system to obtain anonymous shell companies contributes to the high incidence of money laundering in the country. Tardón, Villarreal, and the Magnitsky fraudsters all made use of shell companies incorporated in the United States to launder their money via the real estate market. Given the difficulty of finding records about the true owners of legal entities such as limited liability companies in the United States, it is extremely difficult for law enforcement to identify the individuals behind illicit activity conducted in the name of a shell company.
The ability to conceal the identity of the purchaser of real estate is especially important to illicit actors who would otherwise attract suspicion for their involvement in a transaction, such as corrupt senior officials of foreign governments. In one famous example, the Second Vice President of Equatorial Guinea, Teodoro Nguema Obiang Mangue, allegedly enriched himself through his oversight of the forestry industry and abused his authority as the son of the country’s president. Revealingly, between July 2004 and June 2006, five different banks in the Los Angeles area had closed nine bank accounts held by shell companies under Nguema’s control after learning of his association with the accounts. In spite of this, with the help of his attorney, Nguema was able to purchase a US$30 million Malibu estate in early 2006 through a wire transfer from an entity called “Sweetwater Malibu LLC.” This effectively obscured his involvement in the real estate transaction from the view of all other parties directly involved. As will become clear, the fact that he also made this purchase without financing is significant from a transparency standpoint.
The misuse of shell companies to launder money is a systemic concern for law enforcement and regulators across the financial system, but it is particularly problematic in the real estate market because a portion of that market has relatively few anti-money laundering regulatory protections. The Financial Crimes Enforcement Network (FinCEN) is the part of the US Treasury responsible for such regulations. FinCEN collects information useful in fighting money laundering and terrorist financing and sets regulatory safeguards to make the US financial system more resilient to this illicit activity in the first place. The real estate industry is of structural importance to the US economy, and its vulnerability to money laundering has been a focus of the US Congress and FinCEN for years.
Calvery, former director of FinCEN, attends a Congressional hearing. Part of FinCEN is also responsible for regulations protecting against money laundering. AP Images.
Congress has provided FinCEN with the authority to issue regulations to protect US financial institutions, including the real estate industry, from money laundering and terrorist financing. To implement this policy, FinCEN has taken an incremental approach to addressing the money laundering vulnerabilities in the real estate industry, beginning by covering banks and non-bank mortgage lenders and originators. According to August 2015 figures for existing home sales from the National Association of Realtors, through its coverage of lenders, FinCEN currently has regulatory oversight over the approximately 78 percent of the real estate market that involves a mortgage. However, this leaves the remaining 22 percent of the real estate market without the same anti-money laundering protections and safeguards as those required for banks, casinos, or other financial institutions covered by FinCEN’s anti-money laundering regulations. Many of these non-mortgage transactions are routine and legitimate; for example, think of aging parents selling their large home and buying a small condo with the proceeds. It is this all-cash portion of the market that many crooks seek to exploit.
What exactly is a criminal sidestepping by using a cashier’s check or a wire transfer instead of a mortgage to buy property? When banks and other mortgage lenders provide financing in a real estate transaction, they typically conduct a due diligence investigation to make sure that they will get their money back from the borrower. In the course of this investigation, the financial institution has an opportunity to identify the source of funds used for repayment and even the individual operating behind a limited liability company obtaining a mortgage for a home or a commercial property. Knowing your customer is good business, but it is also an important part of preventing money laundering. If the financial institution identifies some kind of suspicious activity, such as a customer structuring transactions to avoid FinCEN reporting requirements, it is required to report it to FinCEN. Such disclosures are so important to transparency that financial institutions are given a safe harbor from liability to customers related to them. However, when there is no financing for a real estate transaction, no party directly involved in the transaction has any anti-money laundering regulatory obligation to report any possible suspicious financial activity to FinCEN. Because of this, there is no requirement, and little business incentive, for real estate agents, title agents, attorneys, and others to conduct due diligence on a potential client in a transaction to help identify possible money laundering.
This is why the use of a legal entity to purchase real estate without financing is such an important money laundering vulnerability in the United States. By paying all-cash through a limited liability company, the Magnitsky fraudsters, Villarreal, and domestic criminals like Ponzi scheme operator Scott Rothstein are able to launder their money with a low risk of being identified by law enforcement or regulators in the process. Of course, aside from the direct negative impact of the crimes involved, it is fair to ask whether the benefit of increased investment in the local economy outweighs any damage done by allowing illicit money into the market. Unfortunately, the answer is no.
Taking as a given that the drug trafficking, fraud, corruption, human trafficking, and other crimes that fuel money laundering have a harmful impact on society, the dirty money produced by these crimes is damaging in its own right. The source of the money coming into the real estate market matters because illicit funds have a distorting effect on the financial ecosystem. At a local level, a major influx of illicit money can push law-abiding homebuyers and business owners out of the market. All other things being equal, someone hoping to launder large quantities of dirty money by purchasing real estate can outcompete an ordinary homebuyer, who often needs a mortgage, by paying cash and being far more flexible about price.
The impact of an increase in cash purchases through legal entities on a market is not theoretical. As noted in February 2016 by CBS Boston’s Lauren Leamanczyk, the increase in all-cash purchases of homes in the Boston area by limited liability companies, whether for money laundering purposes or not, has created great difficulties for locals looking to buy a home. According to a November 2015 New York Times article, a similar trend has begun to impact American home buyers in San Francisco as purchasers from overseas, often paying cash, increasingly compete for a limited supply of homes in a densely populated area. FinCEN is concerned that some of this influx of cash may be derived from illicit sources.
Flows of illicit funds are often unstable, as illustrated by the losses in the Swiss watch industry following a sustained crackdown on official corruption in China since 2012. Dirty money is subject to major shifts based on the behavior of law enforcement and regulators as well as criminals and corrupt officials around the world. Because of this, a market that has become accustomed to an influx of dirty money is at risk of sudden disruption. But even a sustained gradual increase in the proportion of real estate in a city purchased with the proceeds of illicit activity can be damaging as this shift could allow organized crime to begin to crowd out legitimate businesses and influence local politics in both subtle and not-so-subtle ways.
The assistance of local partners such as attorneys and company formation agents was crucial in the cases of Nguema and Villarreal. Rothstein went so far as to make numerous political contributions with the proceeds of his US$1.2 billion fraud while enjoying his status as the only person in history to receive around the clock protection from off-duty officers of the Fort Lauderdale police department. Clearly, illicit money is not a welcome economic boon, but a corrupting agent that distorts local markets and makes it more difficult for honest people to succeed.
FinCEN’s Next Steps: The Path to Transparency
As the US government’s financial intelligence unit, FinCEN is the custodian of sensitive financial information used for regulatory and law enforcement investigations. FinCEN analyzes this information, especially reports relating to suspicious activity, to find leads for investigations and identify trends in illicit behavior by criminals and other potential bad actors. This analysis feeds into FinCEN’s current regulatory enforcement cases and is shared with appropriate law enforcement partners to further their investigations. In turn, the experiences that FinCEN gains from these cases support the agency’s broader rulemaking and policy plan.
“U.S. hundred dollar bill, 1999”. CC BY-SA 2.0, accessed
via Wikimedia Commons.
FinCEN issued Geographic Targeting Orders (GTOs) on January 13, 2016 that temporarily require specified title insurance companies to report the ownership information on legal entities, including shell companies, used to purchase certain luxury residential real estate in Manhattan and Miami-Dade County. FinCEN is seeking to understand the risk that corrupt foreign officials, transnational criminals, or domestic money launderers may be using premium US real estate to secretly invest millions in dirty money. These GTOs will produce valuable information that will assist law enforcement and inform FinCEN’s broader efforts to combat money laundering in the real estate sector by enhancing the transparency of some of the transactions that take place in the 22 percent of the real estate market that currently has relatively few anti-money laundering protections.
This action has been described as a “crackdown.” It is not. FinCEN does not expect to solve the complex problem of money laundering through the real estate industry in the United States with these temporary and limited GTOs in Manhattan and Miami-Dade County. Rather, these two jurisdictions were chosen because they are popular destinations for luxury buyers, have a higher than average percentage of all-cash purchases, and major law enforcement investigations have drawn attention to money laundering through real estate in both Manhattan and Miami-Dade County. This step is a pilot effort intended to gather information while advancing FinCEN’s incremental approach to regulating the real estate industry. Just as important, however, the GTOs also provide FinCEN an opportunity to refine the use of its authorities in the portion of the real estate market that currently does not have the same anti-money laundering regulatory safeguards that protect many other industries in the financial sector. The GTOs have already resulted in an earnest dialogue between FinCEN and members of the real estate industry on how to improve transparency, which is an important step in the right direction that will hopefully expand. Furthermore, title insurance companies have started submitting information about covered transactions, and banks are filing suspicious activity reports about potentially related activity.
FinCEN will analyze the information that the covered businesses report in response to the GTOs and share the results with our law enforcement partners in order to identify any potential illicit activity and develop appropriate regulatory responses. FinCEN will also look for any attempts at circumvention and signs of shifts in activity as a result of the temporary GTOs. As some have pointed out, the GTOs are limited in scope geographically and in terms of the kinds of transactions covered. In that context, it is noteworthy that various legal and real estate experts have rushed forward to provide suggestions about ways to get around our reporting requirements. Some might conclude that there is a healthy market for this kind of expertise. However, it must be noted that anyone who intentionally structures a transaction with the purpose of avoiding compliance with the GTOs could face serious legal consequences, and FinCEN will be on the lookout for such behavior.
But even if criminals find a way to evade the reporting requirement, FinCEN will still know more than it did previously about how money laundering works in all-cash real estate transactions. If market behavior changes in an effort to exploit loopholes, then that is good to know. For instance, consider a Driving Under the Influence (DUI) checkpoint on New Year’s Eve. The checkpoint is designed to catch drunk drivers, but cars that stop to turn around before the checkpoint — or choose a different road — are significant too. If activity shifts to areas neighboring Manhattan and Miami-Dade County, or transaction patterns otherwise adjust, FinCEN will take note. FinCEN’s analysis will take into account the information reported by covered businesses, responses from law enforcement partners, and any information about potential evasions. On the basis of this analysis, FinCEN will look at potential next steps, whether rulemaking or other regulatory tools, to address the problem of money laundering in the real estate sector.
Conclusion
As shown by the cases of the Magnitsky fraudsters, Tardón, and Villarreal, international illicit actors continue to exploit the intersection of corporate secrecy and all-cash transactions to move their dirty money into the US real estate market. An increase in the percentage of cash purchases at the top of the market by money launderers, whether foreign corrupt officials and drug traffickers, or domestic Ponzi scheme fraudsters like Scott Rothstein, can trickle down to cause financial pain for ordinary people. Crime obviously harms communities, but the proceeds of crime are also damaging. In short, when criminals move their dirty money into the real estate market, American consumers and businesses suffer.
Currently, about 22 percent of the US real estate sector has limited anti-money laundering protections. FinCEN has longstanding concerns about the vulnerability of this portion of the real estate market to abuse by money launderers, and is seeking to learn more about the best way to address the problem through enhanced information gathering tools like the GTOs. Anyone who has bought a home knows that real estate closings are complex. What many may not know is that the professionals represented at a closing table vary from state to state and even from county to county. Part of FinCEN’s goal is to determine which of these real estate professionals are best positioned to shed some light on the least transparent portion of the real estate industry. FinCEN is taking a deliberate approach to the issue and is determined to find the right way to confront money laundering in the US real estate sector, wherever it is found.
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