FinCEN recently broadened its anti-money laundering targeting orders amid skyrocketing luxury real estate prices in several U.S. markets. Stout’s Forensic Services practice is closely following the matter, analyzing the potential for illegal real estate funding via shell companies and the importance for businesses to protect themselves from potential criminal activity. The article below is a discussion on current analysis. Read a related article on this topic.
Over the past decade, we have seen dramatic increases in the average and median purchase prices of luxury residential real estate throughout the United States, specifically in the Borough of Manhattan, NY, and Miami-Dade County, FL. During this same period, the proportion of high-end residential properties purchased through shell companies also spiked significantly. Together, these factors sparked concerns amongst law enforcement officials that foreign criminals may be using the U.S. real estate market to launder so-called dirty money. U.S. regulators and law enforcement have taken steps to gain broader insight into the industry and ensure the U.S. is not a go-to safe haven for parking gains from corruption, drug trafficking, and other financial crimes.
As they have expanded their efforts, the authorities have signaled that they may begin to exert a greater focus on the gatekeepers, including real estate brokers, escrow agents, title insurers, and other real estate professionals. In August, the Financial Crimes Enforcement Network (FinCEN) issued a targeted advisory note to financial institutions and the real estate industry, highlighting the risks of money laundering associated with certain real estate transactions. This should be required reading for those in the real estate profession. With the potential for these money laundering crimes to go unnoticed, business leaders in this field need to take preventative measures to protect themselves from any corrupted employee or transaction.
The revelation of the 1Malaysia Development Berhad corruption scandal, the release of the Panama Papers, Paradise Papers, and other journalistic investigations have brought to the public’s awareness the issue of vulnerabilities to money laundering in the U.S. real estate market. Recent federal investigations by U.S. law enforcement “continue to show corrupt politicians, drug traffickers, and other criminals using shell companies to purchase luxury real estate with cash,” Jennifer Shasky Calvery, the former Director of FinCEN, said in a speech at an anti-money laundering conference in Hollywood, FL, in 2016.
The most recent figures published by Property Shark report 50% of all sales over $5 million in Manhattan were made to shell companies. A decade earlier in 2005, that figure stood at only 39%, according to data provided by Property Shark. That change represents a 4% year-over-year increase.
A shell company is a company, typically structured as a limited liability company, that may be created for perfectly legitimate reasons or may be created for more nefarious purposes, such as to evade laws and regulations or tax liabilities. These entities are often established in offshore locations, such as Cyprus or the British Virgin Islands. Typically, these companies have no real business purpose other than to carry out the transactions to which they are a party. These companies often have nonexistent operations and lack significant assets.
When this legal structure is misused to launder illicit funds, more often than not, multiple shell companies within a complex network of relationships may be established to carry out the scheme. Such complexity may make it more difficult to readily detangle the relationships and identify ultimate, true ownerships. In such circumstances, the shell companies may have no true purpose other than to shield the identities of the owners and the sources of their funds. Furthermore, the web of activity may make it more difficult to readily trace the flow of money.
After the network of shell companies is established, their owner(s) or associate(s) may establish bank accounts held in the names of the shell companies and move funds around the network in a complex web of transactions. Once the funds have been moved, they may be parked in high-value assets, including real estate, personal property (e.g., yachts, jets, or jewelry), and other items. Of particular concern are “all cash” purchases of high-value items made in the name of shell companies. Both elements decrease transparency. In Manhattan, condominiums may be a desirable choice because condominium boards may have limited authority to thoroughly research prospective buyers and there may be built-in incentives for the boards to approve new owners. For example, at the Time Warner Center (25 Columbus Circle) – and at many other high-end New York City condominiums – building rules require all current residents to chip in and purchase a unit in the event the board decides to reject a potential buyer. This creates a huge incentive for condominium boards to be less selective and lenient in their due diligence process. In contrast, co-operative (co-op) units tend to be subject to a more selective and often restrictive co-op acquisition process.
At the beginning of 2016, FinCEN announced plans to identify and track undisclosed buyers of properties in Manhattan. The new initiative requires purchasers of property at a price of $3 million or more to be reported. FinCEN issued Geographic Targeting Orders (GTO) to temporarily require U.S. title insurance companies to identify the actual identities behind any shell companies paying all cash for high-end properties in Manhattan. Shortly after the announcement, FinCEN acting Director Jamal El-Hindi announced that the GTO initiative is “producing valuable data that is assisting law enforcement and is serving to inform our future efforts to address money laundering in the real estate sector.”
Money laundering has been and will continue to be a pervasive systemic issue across the U.S. and around the world, including in world capitals like London, in New York, and in other geographically attractive cities such as Miami. Money laundering schemes have created so-called ghost buildings that are practically uninhabited, have overinflated prices of real estate in many major cities, and have encouraged criminal enterprise. The new level of awareness surrounding this growing issue and new initiatives from law enforcement will continue efforts to combat any illegal activity.