Imagine this scenario: You are in the business of seeking investors in real estate transactions. You realize that one of the investors has arranged to transfer its earnings from a transaction to accounts in countries that have been identified as “high risk” for money laundering by the Treasury Department. Should this raise a red flag? Should your company have procedures in place to spot such a red flag?

Under rules proposed by the Treasury Department's Financial Crimes Enforcement Network (FinCEN), real estate professionals will need to confront such questions. In response to the terrorist attacks of 9-11, President George W. Bush signed into law the USA Patriot Act on Oct. 26, 2001, which includes a broad array of measures designed to prevent, detect and prosecute international money laundering. The USA Patriot Act applies to financial institutions as defined under the Bank Secrecy Act, and includes a requirement that these institutions implement an anti-money laundering program. This article discusses two FinCEN releases that could affect real estate professionals.

Proposed Anti-Money Laundering Programs

Late last year, FinCEN proposed an expansion of the definition of financial institution under the Bank Secrecy Act to include any “unregistered investment company,” which was further defined to include any “company that invests primarily in real estate and/or interests therein.” FinCEN explained that the definition would include real estate investment trusts (REITs), but would exclude entities with interests that are not redeemable within two years of purchase and those with less than $1 million in assets.

The National Association of Real Estate Investment Trusts (NAREIT) has commented on this proposal. While it appreciates that the redeemability requirement would exempt most REITs, NAREIT says that virtually all public REITs that employ an “umbrella partnership” structure, commonly referred to as UPREITs, would be required to comply with the proposed anti-money laundering regulation. NAREIT argues that neither REITS nor UPREITs should be subject to the Bank Secrecy Act, and that they pose low money laundering risk.

FinCEN's proposal would require that a real estate company — at a minimum — establish and implement internal controls designed to prevent the company from being used for money laundering or the financing of terrorist activities, provide for independent compliance testing by a real estate company's personnel or by a qualified outside party, designate a compliance monitor, and provide ongoing training.

Comments Sought

Separately, FinCEN on April 10 published a release seeking public comment on another type of financial institution under the Bank Secrecy Act, namely persons involved in real estate closings and settlements.

FinCEN posed four questions for public comment: What are the money laundering risks in real estate closings and settlements? How should persons involved in real estate closings and settlements be defined? Should any persons involved in real estate closings or settlements be exempted from coverage? Lastly, how should the anti-money laundering program requirement for persons involved in real estate closings and settlements be structured?

In seeking comment, FinCEN explains that the real estate industry can be vulnerable in all three stages of the money laundering process.

• Placement stage — Funds from, or intended to support, illegal activity are introduced into the financial system. For example, this may occur when payment for real estate is made with a cash down payment.

• Layering stage — Illicit funds are disguised/distanced from their illegal source through a series of complex transactions. For instance, when multiple pieces of real estate are bought and resold, exchanged, swapped or syndicated, it becomes difficult to trace the origin of funds.

• Integration stage — Illegal funds appear to have been derived from a legitimate source. For example, when a money launderer sells real estate to a bona fide purchaser, the purchaser could provide a check that the money launderer can represent as the proceeds of a legitimate business transaction.

FinCEN notes that the American Land Title Association has identified several red-flag situations involving real estate transactions, including instances when a prospective buyer is paying for real estate with funds from a country designated by the Treasury Department as a “primary money laundering concern.”

While it is too early to predict the ultimate outcome of FinCEN's focus on the real estate industry, real estate professionals must continue to monitor this developing area, and may want to begin thinking about their own compliance responsibilities, and those of their clients and other industry participants.

Joan Ohlbaum Swirsky is counsel at Drinker Biddle & Reath LLP. Partners Michael E. Rothpletz and Kenneth L. Greenberg also provided input for this article. For more information, see www.drinkerbiddle.com.