Money Laundering In Real Estate

The Pandora Papers

Release of the Pandora Papers in 2021 (11.9 million documents published by the International Consortium of Investigative Journalists) exposed an international financial system awash in dirty money. Prime ministers, dictators, celebrities, arms dealers, oligarchs, and billionaires remain as determined as ever to move cash to places where the origin of funds is not questioned, taxes are low or non-existent, and one’s identity can be effectively concealed.

The Pandora Papers came five years after a previous and similar report, the Pulitzer-prize winning Panama Papers. These, however, exposed the files of just one law firm in Panama. The Pandora Papers were a much bigger story, encompassing 14 offshore providers, thousands of beneficial owners of shell companies and trusts, and spanning the period from 1996 through 2020. The finance ministers of Pakistan and Brazil were (and perhaps still are) siphoning money out of their countries and parking it offshore, often in the United States.

Acquiring American real estate, along with purchase of art and antiquities, are the preferred destinations for much of this international cash. Baker McKenzie, the largest law firm in the U.S., has been instrumental in creating vehicles (shell companies and trusts) to move this money. In 2016, the New York Times claimed that nearly half of the luxury real estate in the city was purchased by anonymous shell companies, many of which are used by money launderers, terrorists, and criminals to conceal profits by investing in U.S. real estate.

Reverberations of the Pandora Papers and the Panama Papers will continue to be felt in legislation and government enforcement for years to come. The Corporate Transparency Act and FinCEN regulations are a direct result of this investigative journalism.

White House Strategy on Countering Corruption

In 2021, the Biden White House issued the “United States Strategy on Countering Corruption” (www.whitehouse.gov) which provides for a whole-of-government approach to opposing financial corruption both within the U.S. and abroad. Along with FinCEN in the Treasury Department, other anti-corruption task forces are established within the State Department, USAID, and the Commerce Department. The theme is one of urgent national security and opposition to the “weaponization of corruption” and building resilience against this “evolving threat.”

While corruption and money laundering are undoubtedly both socially expensive and morally reprehensible, FinCEN’s declaration that these practices are weapons that threaten our national security is over the top. One has the impression that authors of both the White House Strategy and the new FinCEN regulations were aware of entering new and intrusive territory. The extreme language used may be an attempt to encourage Americans to accept the federalization of real estate transactions and state-based entity formation without a fight.

The Corporate Transparency Act

The Corporate Transparency Act (CTA, 31 U.S.C. Sec. 5336 passed in 2021) is Congress’ response to worldwide financial corruption. FinCEN, charged with the writing and implementation of rules and regulations to enforce the CTA, has declared that one of its ultimate goals “is to combat, to the broadest extent possible, the proliferation of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.”

While the goals of the CTA are laudable in broad strokes, the specific rules promulgated by FinCEN overreach in ways that invade individual privacy and civil liberties. Several questions arise. Since when is it the federal government’s role to achieve transparency in real estate transactions? And why is transparency now an absolute good? Do legitimate privacy concerns of law-abiding citizens make them presumptive money launderers?

FinCEN Reporting of State Entity Formations

Both new and existing stated-based registered entities are now required to report personal identifying information on their beneficial owners. Beneficial ownership information (BOI) reporting requirements for entity formations are found in 31 CFR Part 1010 et. seq. FinCEN states the following:

Illicit actors frequently use corporate structures such as shell and front companies to obfuscate their identities and launder their ill-gotten gains through the U.S. financial system. Not only do such acts undermine U.S. national security, but they also threaten U.S. economic prosperity: shell and front companies can shield beneficial owners’ identities and allow criminals to illegally access and transact in the U.S. economy, while creating an uneven playing for small U.S. business engaged in legitimate activity. . . .

Few jurisdictions in the United States, however, require legal entities to disclose information about their beneficial owners or individuals who take the steps to create an entity. . . . This lack of transparency creates opportunities for criminals, terrorists, and other illicit actors to remain anonymous while facilitating fraud, drug trafficking, corruption, tax evasion, organized crime, or other illicit activity through legal entities in the United States.

FinCEN requires disclosure of personal identifying information on the beneficial owners of all state-registered entities such as corporations, LLCs, and limited partnerships. These beneficial ownership reporting rules require federal self-reporting by everyone who forms an LLC, corporation, or other registered entity in any state, which is a huge change to the practice of entity formation in the United States.

Who must report and what must be reported?

Company applicants and persons including senior officers who are part of reporting companies are required to report beneficial owner information (including those having substantial control) to FinCEN (31 CFR Sec. 1010.380). These are all defined terms in the rule.

Reporting companies are corporations, limited liability companies, or similar entities that are created by the filing of a document with a secretary of state or a similar office (31 U.S. Code Sec. 5336 (a)(11)). There is now a distinctly federal component to state-based entity formation, an area that has long been the preserve of the states. Registered entities formed both in the U.S. and abroad (regardless of their date of formation) are considered to be reporting companies with reporting obligations.

A beneficial owner is defined as any individual who directly or indirectly exercises substantial control over an entity or owns at least a 25% interest. A reporting company will always have at least one owner who has substantial control even if no individual holds a 25% or greater ownership interest. There are five exceptions: (1) a minor so long as the reporting company provides information about the minor’s parent or legal guardian; (2) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual (perhaps exercising a power of attorney); (3) an employee, acting solely in an employee capacity and not as a senior officer (defined below) whose substantial control over or economic benefits from such entity are derived solely from his or her employment status (effectively an exception for clerical and support personnel); (4) an individual whose only interest is an inheritance-based future interest; and (5) a creditor (31 C.F.R. Sec. 1010.380(d)(3)).

The definition of substantial control is broad enough to encompass direct and indirect de facto control and cannot be circumvented by manipulation of job titles or descriptions of corporate function. In other words, being overly-clever with the documentation (and who is named as what) in order to conceal substantial control from FinCEN or avoid reporting would be a violation.

FinCEN and Trusts

FinCEN’s beneficial ownership rules apply broadly to individuals and legal entities such as LLCs, corporations, limited partnerships, and the like. Trusts do not fall within the category of registered entities such as LLCs or corporations. In fact, a trust is not an entity at all, it is a contract. A trust agreement is a private document that need not be filed or recorded anywhere.

Trusts, including those that hold real estate, have traditionally enjoyed a high degree of confidentiality. Under present FinCEN rules, a trust must be reported as a beneficial owner if it exercises substantial control or own 25% or more of a registered entity such as an LLC. However, beginning December 1, 2025. FinCEN’s residential rule will take effect. As to details of the rule, FinCEN will be including a new sub-part to Chapter X of the Code of Federal Regulations for this purpose. Until then, much of the best information on the residential rule is available is on the FinCEN website.

FinCEN’s residential rule is focused on non-financed (including all cash) transactions and expressly mentions trusts: “Illicit actors . . . often hold residential real estate in the name of a legal entity or trust, in an effort to obscure their identities and their ownership interests in the property. Transfers that are both non-financed and involve a transferee that is a legal entity or trust are of higher risk for money laundering. . . .”

Under the residential rule, reportable transfers must be reported to FinCEN by a reporting person when they meet the following criteria: (1) the property is residential real property including unimproved land; (2) the transfer is non-financed; (3) the property is transferred to a legal entity or trust, and (4) an exemption does not apply. Transfers meeting the rule’s requirements must be reported regardless of purchase price or the value of the property. Cash and gift transfers are therefore clearly subject to the rule. However, transfers made directly to an individual are not covered.

Personal identifying information on both transferor and transferee (sellers and buyers) must be reported along with a description of the property and the consideration paid. FinCEN’s intention is to include as reporting persons all settlement agents, title insurance agents, escrow agents, and attorneys who do real estate closings. However, there is only one reporting person for any given reportable transfer. In most cases in Texas this will be the title company that closes the transaction. If an attorney closes the transaction in the office, then the attorney will be responsible for reporting to FinCEN.

FinCEN’s expansion into the realm of trusts is significant. However, the FinCEN reporting requirement applies only to the federal law-enforcement database. State-based filing requirements and the recording of dees and other documents in the county real property records are not affected by the residential rule.

States Pushing Back Against Transparency

Certain U.S. states (Delaware, South Dakota, Wyoming, and Nevada among others), are resisting the trend toward increased regulation and transparency by re-writing their trust and judgment-execution laws. South Dakota is now probably the leader in the effort to solicit the importation of world cash regardless of origin, having brought billions in deposits to the state in recent years.

There are several reasons for South Dakota’s lead in asset protection: first, there are no income or death taxes, a prerequisite for a state to become an asset protection haven; second, there is only a two-year “lookback” (statute of limitations) for fraudulent conveyances rather than the usual four or more; third, the rule against perpetuities (a limitation on generational trusts) has been abolished and trusts established in South Dakota can now be perpetual; fourth, trusts in South Dakota can be self-settled, which means that one can be both a trustor/grantor/settlor and a beneficiary of the trust.

In South Dakota one can put your money into a trust and direct its management for one’s own benefit. In Texas, which adheres to the common law doctrine of merger when it comes to trusts, this arrangement would fail because it would not be considered a trust at all. It would be viewed as the equivalent of fee-simple ownership.

Most revolutionary of all, South Dakota declares that a trust beneficial interest is not personal property (S.D. Codified Laws Sec. 55-1-43). The result is an extraordinary level of protection for cash that is held in a South Dakota trust. The word “extraordinary” is justified here because cash is always the hardest item to protect in any asset protection regime. But in South Dakota, as long as funds were not transferred into the trust with the intent to hinder, delay, or defraud creditors (or even if they were but more than two years has elapsed), cash assets in a trust are unreachable by a judgment creditor. This is a departure from common law and prevailing statutory law across the U.S. No wonder this tiny state is a bright spot on the international map of asset protection havens.

Money Laundering with Crypto Currency

A discussion of money laundering would not be complete without mentioning the rising role of crypto currency. Chainalysis, a crypto consulting and compliance firm, estimates that nearly $9 billion dollars was laundered last year using crypto. In the case of the Spartan Protocol hack in 2021, hackers found a vulnerability in the sparta code (a flawed liquidity-share calculation in the smart contract code) and utilized it to steal $30 million in sparta tokens. These tokens were then moved into etherium and bitcoin and finally into Tornado Cash, a process known as “chain hopping.”

Funds that are laundered in this manner are then ready to invest in real estate, where no rules regulate how consideration is tendered. If a seller of property is willing to accept it, then crypto is as good as cash.

In the world of “DeFi” (decentralized, blockchain-based finance) there is no central institution (a bank or regulatory authority) to monitor transactions for fraud; and once money is moved, whether for legitimate or illegitimate purposes, there is no reversing the process even if the funds can be traced through a multi-layered laundering process that may involve international shell entities. In most such cases, as a practical matter, the money is simply gone.

The Proposed “Enablers Act”

Not yet law as of this writing, the Enablers Act is a bipartisan measure introduced in the House of Representatives as a response to the Pandora Papers. It would amend the Bank Secrecy Act’s definition of financial institutions to add: (1) investment advisors; (2) art and antiquities dealers; (3) attorneys and notaries involved in financial activity or related administrative activity on behalf of another person (e.g., a client); (4) a trust company or service provider including persons who assist in forming business entities or providing such entities with a registered office or address (this clearly includes business and corporate attorneys and anyone acting as a registered agent); (5) CPAs; (6) public relations firms; and (7) third-party payment services, including payment processors, check consolidators, and cash vault service providers.

The proposed law would impose due diligence “know your customer” obligations and other compliance requirements on “gatekeepers” which would include establishing BSA/AML compliance programs and filing of SARS in suspicious cases.

If passed, the Enablers Act will forever change the life of an individual real estate practitioner. Every professional involved in real estate transactions, likely including real estate investors, would be made unofficial agents of federal law enforcement. This profound shift would be carried out in the name of achieving transparent and open markets worldwide. Problem, in business (as in diplomacy) not everyone wants the details of their transactions to be public. Legitimate concerns as to confidentiality in real estate transactions (supported by centuries of legal precedent) would go by the wayside.