On January 25, the Financial Crimes Enforcement Network (“FinCEN”) issued an “Alert on Potential U.S. Commercial Real Estate Investments by Sanctioned Russian Elites, Oligarchs, and Their Proxies” (the “Alert”). The Alert defines “commercial real estate,” which the Alert refers to as “CRE,” as “property that is used for investment or income-generating purposes rather than as a residence by the owner.” The Alert “specifically highlights sanctions evasion-related vulnerabilities in the CRE sector and is based on a review of Bank Secrecy Act (BSA) reporting indicating that sanctioned Russian elites and their proxies may exploit them to evade sanctions.”
The Alert seeks to assist financial institutions with identifying potential sanctions evasion activity in the CRE sector by providing potential red flags and typologies related to this activity. As we discuss, the Alert also may represent a step towards BSA regulations for the CRE sector.
Russia Sanctions Evasion: Risks and Typologies
The Alert states that it “complements ongoing U.S. efforts to isolate sanctioned Russian persons from the international financial system[,]” and that it is “part of broader effort by the Department of Treasury to effectively implement the U.S. Strategy on Countering Corruption by seeking to increase transparency in U.S. real estate transactions and prevent corrupt elites and other illicit actors from hiding their ill-gotten wealth in the U.S. real estate market.” Indeed, FinCEN has issued many alerts regarding alerts since 2022 regarding potentially illicit transactions involving Russian actors (as we have blogged repeatedly – see here, here, here, here, here and here).
The Alert highlights several risks posed by the CRE sector, which, according to FinCEN, make it relatively easy for bad actors to use to hide illegal funds. One stated risk is the routine use of “highly complex financing methods and opaque ownership structures.” This includes the involvement of private companies, institutional investors, trusts, shell companies, and pooled investment vehicles. Often times, a CRE deal involves multiple parties and parties located in offshore jurisdictions. Due to the relative financial stability of the CRE market, the opportunity for income streams, and the potential lack of transparency, FinCEN describes the CRE sector as a historically attractive market for bad actors looking to park their illicit funds. In support of its claims, the Alert cites the U.S. Department of the Treasury’s 2022 National Money Laundering Risk Assessment, which highlighted the compounding money laundering and terrorist financing risks in CRE transactions due to the additional types of purchasing options and financing arrangements available to acquire properties worth hundreds of millions of dollars.
The Alert identifies the following typologies associated with potential sanctions evasion and money laundering in the CRE sector:
- The use of pooled investment vehicles in CRE, which allows investors to own less than 25% of the fund and thereby fall below the ownership interest threshold for beneficial ownership screening of customers by banks under the Customer Due Diligence (“CDD”) Rule.
- The use of so-called shell companies and trusts to conceal ownership. Such use may include multiple layers and may spread across multiple jurisdictions.
- The involvement of third parties to invest in the CRE on behalf of the sanctioned person. This includes the use of a proxy, such as a relative or business associate, to set up the legal entity and invest in the CRE or create a trust to hold the asset. The Alert notes that when analyzing trusts where a sanction person was a grantor/settlor, trust protector, trustee, or beneficiary, financial institutions should ensure that the sanctioned person does not have a present, future, or contingent interest in the trust.
- Inconspicuous CRE investments that provide stable returns. The Alert notes that CRE investments will not always be in high-end, luxury CRE and can include multi-family housing, retail, office, and hotels. In addition, the CRE investments will not always take place in large U.S. urban areas and the risks posed in the largest markets are the same as small- to mid-size markets.
According to the Alert, financial institutions have helped shaped some of the above typologies with their reporting. For example, prior BSA reporting has indicated that sanctioned parties can decrease their ownership percentage in investments to purposely fall below a bank’s CDD Rule threshold. Because of their relationships with parties involved in CRE deals, such as developers and private investment vehicles, as well as their CDD Rule obligations, banks are positioned to identify and report suspicious activity. The Alert urges financial institutions to undertake a risk-based approach to the CRE sector and use the Section 314(b) reporting mechanism to share with each other information about potential sanctions evasion. The Alert also suggests that insurance companies, given their significant role in CRE financing, may be able to determine whether their CRE-related activities involve sanctioned Russian elites and their proxies, and file BSA reports.
The Alert implicitly acknowledges that the typologies above also describe perfectly legal activity that is commonly undertaken in the CRE sector by good-faith actors, such as the use of pooled investment vehicles and LLCs. The Alert also acknowledges that the standard use of legal entities in CRE deals makes it more difficult for financial institutions to identify and report illicit conduct. One thing that the Alert does not acknowledge is the huge breadth of the CRE market – estimated to have been over $800 billion in 2021 alone. This breadth, coupled with the fact that both good and bad actors likely will use the exact same methods to conduct a CRE deal, present special challenge for financial institutions attempting to identify illicit conduct.
Focus on Commercial Real Estate
The Alert is unusual because it focuses on commercial real estate. Although FinCEN has addressed the nexus between potential money laundering and residential real estate through the constant issuance of Geographic Targeting Orders (“GTOs”) since 2016, the last publications by FinCEN specifically addressing commercial real estate were in March 2011 and December 2006 – and these aging publications were rudimentary by today’s standards in their level of detail.
Possibly, the Alert is an effort by FinCEN to build support for regulating the commercial real estate market under the BSA. FinCEN issued on December 6, 2021 an Advanced Notice of Proposed Rulemaking (“AMPRM”) to solicit public comment on potential requirements under the BSA for certain persons involved in real estate transactions to collect, report, and retain information. As we blogged, the ANPRM envisions imposing nationwide recordkeeping and reporting requirements on specified participants in transactions involving non-financed real estate purchases, with no minimum dollar threshold. One substantial question presented by the ANPRM is: will any reporting requirements apply to “just” the residential real estate market, or both residential and commercial? Commenting upon the commercial real estate industry, the ANPRM stated that, “[b]roadly speaking, FinCEN has serious concerns with the money laundering risks associated with the commercial real estate sector.” The ANPRM further observed that “[t]he commercial real estate market is both more diverse and complicated than the residential real estate market and presents unique challenges to applying the same reporting requirements or methods as residential transactions.” Through the GTOs, FinCEN has amassed years of data regarding the residential market which it could use to justify regulations. But, FinCEN has no such similar mass of data to date regarding the commercial market. Thus, the Alert may be a step, in the view of FinCEN, towards creating a public record supporting the regulation of commercial deals.
As with most alerts, FinCEN provides a list of red flags regarding potentially illicit behavior for the purposes of financial institutions attempting to detect suspicious activity. They are:
- The use of a private investment vehicle that is based offshore to purchase CRE and that includes Politically Exposed Persons (“PEPs”) or other foreign nationals (particularly family members or close associates of sanctioned Russian elites and their proxies) as investors.
- When asked questions about the ultimate beneficial owners or controllers of a legal entity or arrangement, customers decline to provide information.
- Multiple limited liability companies, corporations, partnerships, or trusts are involved in a transaction with ties to sanctioned Russian elites and their proxies, and the entities have slight name variations.
- The use of legal entities or arrangements, such as trusts, to purchase CRE that involves friends, associates, family members, or others with a close connection to sanctioned Russian elites and their proxies.
- Ownership of CRE through legal entities in multiple jurisdictions (often involving a trust based outside the United States) without a clear business purpose.
- Transfers of assets from a PEP or Russian elite to a family member, business associate, or associated trust in close temporal proximity to a legal event such as an arrest or an OFAC designation.
- Implementation of legal instruments (e.g., deeds of exclusion) that are intended to transfer an interest in CRE from a PEP or Russian elite to a family member, business associate, or associated trust following a legal event such as an arrest or an OFAC designation of that person.
- Private investment funds or other companies that submit revised ownership disclosures to financial institutions showing sanctioned individuals or PEPs that previously owned more than 50 percent of a fund changing their ownership to less than 50 percent.
- There is limited discernable business value in the CRE investment or the investment is outside of the client’s normal business operations.
If you would like to remain updated on these issues, please click here to subscribe to Money Laundering Watch. Please click here to find out about Ballard Spahr’s Anti-Money Laundering Team. Please also check out our detailed chapter on these issues, The Intersection of Money Laundering and Real Estate.