Money Laundering Through Commercial Real Estate and Our “Know Your Client” Obligations

by | 28 February 2018

If you have followed the story of former Trump campaign manager Paul Manafort, you may know that he has been charged with money laundering and tax evasion by means of real estate transactions. The alleged approach included opening bank accounts in Europe with ill-gotten money and using a direct funds wire sent from the European bank directly into a U.S. escrow account to close all cash purchases of property. He then subsequently placed a loan on those properties to obtain cash on a tax-free basis.

To those following international money laundering news however, this is no surprise. For many years, international bad actors have used an identical approach for purchases of commercial properties. This is because commercial property transactions are uniquely vulnerable to money laundering, for a number of reasons.

Most commercial real estate purchases are made through LLCs formed specifically to purchase and own the individual property. These LLCs can be formed by anyone but the actual owners may not be fully-disclosed in the operating agreements. Their domestic agents forming the LLCs may be cut-outs for the real owners, just like in practices used for illegal gun sales where a willing accomplice purchases a gun in their own name, on behalf of a shadow party. Commercial property is also ideal because the size of these transactions can move a significant amount of money, at one time.

At this moment, there are no regulatory obligations imposed on title or escrow providers (or on attorneys handling transactions in non-escrow states) to validate the origin of funds coming through a direct wire from an offshore banking account. There are also no regulatory obligations imposed on brokerage firms like Colliers International to conduct KYC (Know Your Client) or AML (Anti-Money Laundering) investigations of offshore buyers similar to the exhaustive process used by banks when dealing with offshore parties wishing to open a U.S. bank account.

For all these reasons, politicians and regulators are beginning to recognize this enormous gap in our money laundering defense network. Despite the level of regulation placed on banks and deposit transactions, there has been little effort thus far to close this massive loophole in commercial property transactions.

As a result of high-end residential real estate transactions in Florida that were determined to involve offshore funds from drug dealers, the U.S. Treasury finally enacted regulations in 2016 forcing title companies to disclose all cash transactions between $1,500,000 and $3,000,000 completed in New York, Florida, California and Texas. Not to validate the source of purchase funds mind you, but only to disclose that the transactions have closed. Curiously, no such regulations have yet been imposed on other states, and the $3,000,000 top figure for disclosure is woefully short of the size of most commercial property deals.

The situation poses a terrible dilemma for the commercial property broker. What broker wants to risk unnecessarily delaying or even killing a purchase transaction and a big commission by asking their offshore buyer to answer numerous personal questions? But what broker wants to be criminally charged with participating in a money laundering scheme?

Because the risk of inadvertent participation in a money laundering transaction is high, there are some fundamental practices that every broker should follow as the first line of defense. The following situations should raise a red flag:

  1. An offshore buyer who intends to make an all-cash purchase. Money launderers don’t want to deal with lenders who will ask all kinds of questions, so the transactions are almost always all-cash.
  2. The purchase is in an amount over $5 million. The Treasury regulations in the few states mentioned above set the area of scrutiny on transactions with a top price of $3 million, so larger purchases are not disclosed to the U.S. Treasury Department.
  3. The purchase funds are going to be wired directly from an offshore source to a U.S. escrow account and not through a U.S. bank account maintained by the buyers.
  4. The buyers don’t have a U.S. bank account. This is the biggest red flag of all. If a bank has conducted their own KYC process and opened an account for the buyer, this indicates they passed the bank KYC investigation and there is a presumption that the buyer is a legitimate player.

In Europe, the major brokerage firms have joined to form the Legal and Compliance Initiative Real Estate Group to set responsibilities and standards for scrutiny of suspicious transactions. These firms include JLL, CBRE, Savills, BNP Paribas Real Estate and Cushman & Wakefield.

Migration of similar self-imposed industry practices to the U.S. will undoubtedly come in time. In the meantime, Colliers International brokers need to be vigilant.