Category: Anti-Money Laundering

Due Diligence for Politically Exposed Persons

Anti-money laundering 101 is to lookout for for terrorists, drug kingpins and oligarchs. You don’t want to do business with these people because they are on the government enforcement lists. AML 102 is to look out for “politically exposed persons.”

The international Financial Action Task Force defines a “politically exposed person as:

“an individual who is or has been entrusted with a prominent public function. Due to their position and influence, it is recognised that many PEPs are in positions that potentially can be abused for the purpose of committing money laundering offences and related predicate offences, including corruption and bribery, as well as conducting activity related to terrorist financing.”

You’re not barred from doing business with a politically exposed. You just need to be on higher alert to make sure the person is not using pilfered money or funneling money to bad people. The mayor of a small town should probably not be depositing millions of dollars in a personal account.

Last month FinCEN issued a new FAQ on client due diligence. That FAQ eschewed any bright-line testing or standards.

Two weeks ago, FinCEN joined up with the Federal Reserve, Federal Deposit Insurance Corporation, National Credit Union Administration and the Office of the Comptroller of the Currency to issue a joint statement on due diligence for politically exposed persons.

Like the earlier FAQ, this joint release adds very little to the compliance dialog.

“Banks must apply a risk-based approach to CDD in developing the risk profiles of their customers, including PEPs, and are required to establish and maintain written procedures reasonably designed to identify and verify beneficial owners of legal entity customers. More specifically, banks must adopt appropriate risk-based procedures for conducting CDD that, among other things, enable banks to: (i) understand the nature and purpose of customer relationships for the purpose of developing a customer risk profile, and (ii) conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.”

The joint statement does point out that there is no formal definition of a politically exposed person. Agreed.

The joint statement states that US public officials are not “politically exposed persons.” Disagree.

As I said above, the mayor of a small town should probably not be depositing millions of dollars in a personal account. Your financial institution should be keeping a close eye on the mayor to make sure illicit money does not come through you.

Unfortunately, this de-regulatory approach will put the burden on compliance having to push back against client relationship people. You will have to add on additional review to watch whether the politically exposed person breaks bad.

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New FinCEN FAQs on Client Due Diligence

The Financial Crimes Enforcement Network issued its latest collection of Frequently Asked Questions on the requirements for Customer Due Diligence requirements for Covered Financial Institutions. For anyone looking for decisive answers and bright-line tests, you’ll have to look elsewhere. The answers will leave you wondering why FinCEN even bothered to publish this answers.

Private fund managers and Registered Investment Advisers are not Covered Financial Institutions under the Customer Due Diligence Rule. I believe most adhere to the guidance to make sure they don’t run afoul of FinCEN.

The 2017 Customer Due Diligence Rule did create some bright-line tests on due diligence, particularly for potential investors in private funds that are not individuals. The uncertainty before the rule was how much diligence did you need to conduct on the entity. The 2017 Rule made it clear. You have to collect information on individuals who, directly or indirectly own 25% or more of the equity interests and one individual who has managerial control of the entity.

The new FAQ answers questions in three broad general areas about whether you must conduct additional diligence at opening, risk ratings for customers, and ongoing diligence requirements.

The answers all are squishy answers. It’s up the financial institution to develop policies based on risk. One example:

“There is no categorical requirement that financial institutions update customer information on a continuous or periodic schedule. The requirement to update customer information is risk based and occurs as a result of normal monitoring.”

I’m going to guess that the answers to the questions are not going make compliance officers feel any better. It might just confirm that what they are doing is okay, or at least, not wrong.

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OFAC Issues a Framework for Compliance Commitments

The Department of the Treasury’s Office of Foreign Assets Control (OFAC) is published A Framework for OFAC Compliance Commitments. OFAC wants to provide organizations its perspective on the essential components of a sanctions compliance program.

“As the United States continues to enhance our sanctions programs, ensuring that the private sector implements strong and effective compliance programs that protect the U.S. financial system from abuse is a key part of our strategy.”

Sigal P. Mandelker, Under Secretary for Terrorism and Financial Intelligence.

The United States has increasingly used its financial system to penalize countries it dislikes as well as drug kingpins and terrorists. The dollar has been the standard for international business. That may change if the US continues to weaponize the dollar against countries it disfavors.

OFAC has decided to coin the initialism “SCP” for Sanctions Compliance Program. An SCP has five essential components:

1. Management Commitment

  • Senior management has reviewed and approved the SCOP
  • Senior management delegate sufficient authority and provided direct reporting lines
  • Senior management has given adequate resources to the SCP
  • Senior management promotes a culture of compliance
  • Senior management recognizes the seriousness of deficiencies and violations

2. Risk Assessment

  • Organization has conducted an OFAC risk assessment
  • Organization has a methodology to identify and address the risks it identifies

3. Internal Controls

  • Written policies and procedures
  • Internal controls based on risk assessment
  • Enforces policies and procedures
  • Adequate record-keeping
  • Corrects discovered weaknesses
  • Communicates policies and procedures to relevant staff
  • Personnel appointed to integrate policies and procedures into corporate operations.

4. Testing and Auditing

  • Testing and auditing is accountable to senior management
  • Testing and auditing are appropriately sophisticated
  • Takes corrective actions after a negative result.

5. Training

  • OFAC Training provides adequate information
  • Training scope is appropriate
  • Training frequency is appropriate based on risk profile
  • Updates training after a negative result
  • Training provides easily accessible resources.

The Framework includes a short appendix that offers some analysis of some of the causes of sanctions violations that OFAC identified during its investigative process.

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A Focus on Residential Real Estate and Money Laundering

The Financial Crimes Enforcement Network announced the issuance of revised Geographic Targeting Orders. The threshold for reporting has been reduced down to $300,000 for all-cash purchases of residential real estate. The geographic scope has been expanded to now include nine cities: Boston; Chicago; Dallas-Fort Worth; Honolulu; Las Vegas; Los Angeles; Miami; New York City; San Antonio; San Diego; San Francisco; and Seattle.

The GTO requires U.S. title insurance companies to identify the natural persons behind all-cash purchases of residential real estate over that dollar threshold in those markets.

“All cash” means “[s]uch purchase is made, at least in part, using currency or a cashier’s check, a certified check, a traveler’s check, a personal check, a business check, or a money order in any form, a funds transfer, or virtual currency.”

I have no problem with virtual currency purchases having to be reported when used by a company buying residential real estate.

I think that threshold is going to be too low for those jurisdictions and overwhelm the FinCEN reporting structure.

I’m speaking a bit from personal experience. The GTO now covers my town. The definition of “Boston” includes all of Middlesex and Suffolk County. Suffolk is Boston proper and its various neighborhoods. Middlesex County, I assume, is targeted to Cambridge. But Middlesex county includes over fifty towns, stretching from Hopkinton, to Newton, to Ashby to Lowell.

There are lots of old houses and lots of developers buying those old houses and fixing them up. Like any good business, they use entities to limit liability and to meet lender single-purpose entity requirements.

Almost any residential purchase ends up using a check to cover part of the final purchase price. I expect the GTO will sharply increase the reports flowing into FinCEN. More so than expected.

I just think the GTO is too broad geographically and the dollar amount is too low. That can be fixed.

The GTO is effective. A study found a 95 percent drop in how much cash shell companies and other corporate entities spent on homes. The decline began immediately after the fist GTO rule took effect in March 2016. Before the rule, corporate entities bought an average of $111 million worth of homes with cash in Miami-Dade per week, or 29 percent of all residential transactions, according to the study. But almost immediately after the reporting requirement began, that number plummeted to $5 million per week, or 2 percent of all transactions.

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Selective Selection to Sanctions List to Sow Suspicion

According to a story by Franco Ordonez, the United States has been selectively using its sanctions regime in Venezuela in an effort to destabilize the government.

“For over a year, Diosdado Cabello, the former military commander and vice president of Venezuela’s governing United Socialist Party, escaped sanctions that hit more than 50 other Venezuelan officials, including [President] Maduro, on corruption and other charges.”

The plan was to plant seeds in Venezuela that Cabello was taking to the United States or, worse, acting as agent of the US. The plan was eventually abandoned after Senator Rubio pressed the administration to subject Cabello to sanctions.

I find this story interesting from a diplomatic perspective, but troubling from an ALM/KYC perspective.

That period of time where a foreign person should have been on the sanctions list, but was not placed due to some Washington trickery, means that companies may have been doing business with him. When he is suddenly added to the list, those companies are then in trouble.

Of course, he likely would have been identified as Politically Exposed Person. But that just means caution, not a ban on a business relationship.

What may have been a fun exercise for Foggy Bottom spies, creates a minefield for ALM/KYC practitioners.

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Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions

On April 3, the Financial Crimes Enforcement Network published Frequently Asked Questions Regarding the Customer Due Diligence Requirements for Financial Institutions. The questions are about Customer Due Diligence Requirements for Financial Institutions, published on May 11, 2016, as amended on September 29, 2017. FinCEN is labeling it the CDD the Rule.

The CDD Rule requires financial institutions to identify and verify a legal entity’s “beneficial owners” when an accounts is opened. The CCD Rule’s mandatory compliance date is May 11, 2018.

I don’t think the CDD Rule applies specifically to the investors in private equity funds or to investment advisers in general. But the SEC has been threatening to impose a know-your-customer, anti-money-laundering, Customer Due Diligence requirement on investment advisers. I think it’s worth looking at the rule to see how the broader industry is addressing this.

The big change is for legal ownership of entities. The CDD requires the identification of anyone who directly or indirectly owns more than 25% of the equity interest in the entity and at individuals who have managerial control of the entity. The new FAQ makes it clear that a financial institution can dig deeper than 25%.

For banks, the CDD process has to be run each time a new account is opened. Each time a loan is renewed or a certificate of deposit is rolled over, the bank is establishing another banking relationship and a new account is established. Covered financial institutions are required to obtain beneficial ownership information of a legal entity that opens a new account or renews a product, even if the legal entity is an existing customer. For financial services or products established before May 11, 2018, Covered financial institutions must obtain certified beneficial ownership information of the legal entity customers of the new or renewed products.

The FAQ goes deep. It’s worth reading to think about how your firm should amend its AML procedures.

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Paper as a Sanctions Violation

The United States has a long arm in imposing financial restrictions. U.S. companies cannot assist their foreign subsidiaries or affiliates with sales to sanctioned countries or persons on the blocked persons list. A US company got caught doing this.

White Birch was accused of facilitating the sale and shipment of Canadian paper from White Birch’s Canadian subsidiary to Sudan. Sudan was subject to a U.S. embargo under the Sudanese Sanctions Regulations, 31 C.F.R. part 538. The Office of Foreign Asset Control determined that White Birch personnel from both its U.S. headquarters and Canadian subsidiary “were actively involved in discussing, arranging, and executing the export transactions to Sudan.” Assistance is prohibited under OFAC’s regulations that bar U.S. persons from “facilitating” transactions between non-U.S. companies (such as foreign subsidiaries) and sanctioned countries.

I’m not sure “discussing” by itself is enough to trigger a sanctions violation. Many companies discuss how to deal with potential transactions that implicate sanctions. The discussion will generally end in “no.” It was taking the steps to help with arranging and executing that are the problem.

This was not a little paper. It was over 500 metric tons of paper worth over $300,000 when the sale and shipment happened in 2013.

As with the recent diamond case, FinCEN was short on details. The enforcement information did note that White Birch tried to conceal the ultimate destination of the paper shipment from its bank. The bank was involved as the confirming bank on the letter of credit for the export. I would assume that the bank would have filed a suspicious activity report that caught FinCEN’s attention.

FinCEN brought the charges even though the Sudan ban has now been lifted. Effective January 17, 2017, all transactions prohibited under the Sudanese Sanctions Regulations are authorized pursuant to the general license (31 C.F.R. § 538.540). In the enforcement action, FinCEN made it clear that this general license does not affect past, present, or future OFAC enforcement investigations or actions related to any apparent violations of the Sudanese Sanctions Regulations relating to activities that occurred prior to the effective date of the general license.

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Diamonds Are A Sanctions Violation

On four separate occasions, an individual purchased jewelry from one of the Cartier boutiques located in California or Nevada for shipment to Shuen Wai Holding Limited in Hong
Kong. I’m sure the store routinely ships purchases around the world. The problem is that Shuen Wai Holding Limited is named as a Specially Designated Narcotics Trafficker pursuant to the Foreign Narcotics Kingpin Designation Act. Shuen Wai Holding Limited is associated with Wei Hsueh Kang and the United Wa State Army that produce opium out of Golden Triangle in Burma.

If a person is on the sanctions list, you can’t do business with them in the United States.

I had never thought about the sanctions list in the context of consumer transactions. It did bring to mind a story I heard while attending the FBI’s Corporate Compliance Officer Outreach Event several years ago. An agent told the story of a border guard who flagged through a car with a suitcase full of gift cards. The border guard was looking for cash and didn’t think twice about the gift cards. Of course the gift cards, have some limitations, but are just as good as cash in most instances.

The same could be true of Cartier. They many never have thought that their customers would be drug kinpin associates trying to launder money.

There is no background in the sanctions notice about the circumstances of the purchases, so I used my imagination to think of scenarios that I thought likely.

The first scenario that came to mind would be one of mistaken name. Cartier was audited and the shipping to Shuen Wai Holding Limited was a false positive. Cartier should have resolved it and did not. Assuming Cartier even checks shipments against the SDN list. That seems unlikely given that there was an enforcement action.

The second scenario was a foolish associate of Wei Hsueh Kang spending time in the US and looking for some fancy jewelry. The associate foolishly uses a real address instead of an anonymous one.

The third scenario is Wei Hsueh Kang actively used a weakness in Cartier’s shipping policies to launder money. The Cartier boutiques were located in California or Nevada. I assume that means Las Vegas, the home of gambling and lots of cash transactions. The casinos are going to check off-shore wires against the SDN list. With that path blocked, the associate chose instead to walk into the Cartier in the casino. There is one in the Wynn hotel. Or the associate could have walked down the street to the Las Vegas Forum or the The Shops at Crystals. The associate purchases a suitcase full of jewelry that can easily be resold. Or perhaps its unset diamonds or other precious items.

That looks like some a soft spot that money laundering syndicates could take advantage of. The Office of Foreign Assets Control points that out in the enforcement press release:

This enforcement action highlights the risks for companies with retail operations that engage in international transactions, specifically including businesses that ship their products directly to customers located outside of the United States. OFAC encourages companies to develop, implement, and maintain a risk-based approach to sanctions compliance, and to implement processes and procedures to identify and mitigate areas of risks. Some of the multitude of factors that a company could consider with respect to its compliance program is an assessment of its products and services, frequency and volume of international transactions and shipments, client base, and size and geographic location(s).

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More Targeting of Real Estate Transactions by FinCEN

The US Financial Crimes Enforcement Network has started to look closely at cash purchases of expensive real estate as a possible source of money laundering. In January, FinCEN issued two Geographic Targeting Orders, one for New York and one for Miami. Now more metropolitan areas are in FinCEN’s sights.

Alamo

According to the press release, FinCEN has been gathering some good data from the small step it took earlier this year. Apparently it thinks there are other jurisdictions that are likely places for money laundering.

The new order targets all of New York City, more of the greater metropolitan Miami area, and adds in metropolitan areas in California and the area around San Antonio.

The covered transactions must meet the following criteria:

  1. An entity is the purchaser .
  2. It’s purchasing residential real estate.
  3. It’s for a large purchase price (see below).
  4. There is no bank loan or similar external financing.
  5. The purchased in made in part with cash or check or or certified check or cashier’s check.

One problem is the inclusion of a certified check or cashier’s check in the included transactions. If you’ve ever bought a home, you usually come to the closing with a certified check or cashier’s check. The closing needs cash equivalents at the closing to make sure it can send the money back out to the seller. In Massachusetts, its mandated by law.

I would guess that the FinCEN targeting order is generating mostly reports of ordinary, legal transactions.

That’s not to say that the efforts should not be applauded. Legitimate parties in real estate transactions do not want to be engaged in money laundering.

I would guess that most people engaged in this type of residential real estate money laundering have stopped using title companies in the transaction. That moves it out of the reporting requirements of the order. Title companies provide a great service, but not a required part of the transaction. It seems easy to structure around.

The purchase price guidelines in the targeted areas:

New York:

  • The Borough of Manhattan $3,000,000
  • The Borough of Brooklyn $1,500,000
  • The Borough of Queens $1,500,000
  • The Borough of Bronx $1,500,000
  • The Borough of Staten Island $1,500,000

Florida:

  • Miami-Dade County $1,000,000
  • Broward County $1,000,000
  • Palm Beach County $1,000,000

California:

  • San Diego County $2,000,000
  • Los Angeles County $2,000,000
  • San Francisco County $2,000,000
  • San Mateo County $2,000,000
  • Santa Clara County $2,000,000

Texas:

  • Bexar County $500,000

FinCEN is using title insurance companies as the gatekeeper because title insurance is a common feature in real estate transactions. FinCEN is quick to note that the title insurance companies themselves are not being implicated in the money laundering. “To the contrary, FinCEN appreciates the continued assistance and cooperation of the title insurance companies and the American Land Title Association in protecting the real estate markets from abuse by illicit actors.”

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New Anti-Money Laundering Rules

The U.S. Treasury Department’s Financial Crimes Enforcement Network’s new customer due diligence rule requires covered financial institutions to collect information on the significant beneficial owners of customers that are legal entities.

laundering dollar bills money

For a private fund manager, the rule is not explicitly applicable. The term ‘‘covered financial institution’’ refers to: (i) Banks; (ii) brokers or dealers in securities; (iii) mutual funds; and (iv) futures commission merchants and introducing brokers in commodities.

But I don’t think private fund managers should ignore the rule. FinCEN really wants to force investment advisers into an anti-money laundering regime. And it’s still illegal to do business with those people and companies on the blocked lists.

I look at the rule as a new standard or best practice.

The Final Rule requires each covered financial institution to verify the identity of each beneficial owner of an account using risk-based procedures to the extent reasonable and practicable.

There are two prongs to the definition of “beneficial ownership”:

  1. Ownership: An individual who directly or indirectly owns 25% or more of the equity interests of a legal entity customer.
  2. Control: An individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager or any other individual who regularly performs similar functions.

The first thing I noticed was the 25% threshold for ownership to trigger beneficial ownership. The release discusses this choice, noting that many comments proposed a 10% threshold.  FinCEN notes that 25% is the FATF standard.

FinCEN continues to believe that a 25 percent threshold strikes the appropriate balance between the benefit of identifying key natural persons who have substantial ownership interests in the legal entity and the costs associated with implementing this information collection requirement.

The release makes it clear that you can set a lower threshold, but the 25% is the maximum baseline.

Investment advisers and private fund managers can continue to argue that the KYC rules should not apply to them. But FinCEN’s response will be that you are supporting terrorism and drug lords by not implementing a program.

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Laundering Dollar Bills by TaxRebate.org.uk CC BY
https://www.flickr.com/photos/59937401@N07/5857345827/