• USA Patriot Act Affects Real Estate Closings
  • September 4, 2003 | Author: Harris Ominsky
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • In 2001 the Federal government passed a law designated the "Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism," known as the USA Patriot Act. Title III of the Act, also known as the International Monetary Laundering Abatement and Financial Anti-Terrorism Act of 2001, made a number of amendments to the Anti-Money-Laundering provisions of the Bank Secrecy Act, which amendments are intended to make it easier to prevent, detect and prosecute international money laundering and financing terrorism.

    Comments Invited

    In Section 352 of the Patriot Act, 31 U.S.C. ยง 5318(h) was amended to require the creation of anti-money laundering compliance programs by financial institutions. Under that Act, the Financial Crimes Enforcement Network of the Treasury Department ("FinCEN") temporarily exempted certain financial institutions, including individuals involved in real estate closings and settlements, from the Act's anti-money laundering requirements. The stated purpose of that exemption was to enable the Treasury Department to study the affected industries and to consider the extent to which anti-money-laundering requirements should be applied to them.

    FinCEN has now issued an advanced notice of proposed rulemaking with respect to real estate closings and settlements. FinCEN posed a wide range of questions, including how to define "persons involved in real estate closings and settlements," the money-laundering risks posed by such persons, and whether they should be exempted from this requirement. Written comments were due by June 9, 2003.

    Based on the public comments received from affected groups, including lenders, title companies and lawyers, a cynic might conclude that this Anti-Terrorism Act has visited a form of terror on some of those parties.

    Let's look at the proposed requirements under the Act with which these parties are so concerned.

    The Act would require every "financial institution," including "persons involved in real estate settlements and closings" to establish an anti-money-laundering compliance program that includes at a minimum:

    (i) The development of internal policies, procedures and controls;
    (ii) The designation of a compliance officer;
    (iii) An ongoing employee training program; and
    (iv) An independent audit function to test programs.

    While the independent audit may prove to be the most intrusive and expensive requirement, the other requirements impose more fundamental concerns.

    Money-Laundering Risks

    Let's look at the money-laundering risks that Congress saw in real estate closings and settlements. The request for comments stated that money-launderers have used real estate transactions to attempt to disguise the illegal source of their proceeds. For example, narcotics traffickers have purchased property with monetary instruments that they purchased in structured amounts, that is, multiple purchases each below the Bank's Secrecy Act reporting thresholds ($10,000) that in aggregate exceeded the thresholds.

    Also, traffickers have tried to launder cash proceeds by exchanging them for checks from a real estate company. According to FinCEN, the funds from illegal activities or funds intended to support illegal activities could be introduced into the financial system through the payment for real estate with a large cash down payment. In addition, multiple pieces of real estate could be bought and resold, exchanged, swapped, or syndicated, making it more difficult to trace the true origin of the funds.

    Some examples provided by FinCEN of how the real estate industry is vulnerable to money laundering were apparently identified by the American Land Title Association. They include the following situations:

    • A prospective buyer pays for real estate with funds from a high risk country, or one that has been designated as a "primary money-laundering concern."
    • The seller requests that the proceeds of the sale of real estate be sent to a high-risk country.
    • A person seeking to purchase real estate in the name of a nominee has no apparently legitimate explanation for the use of a nominee.
    • A person acts as an agent for an undisclosed party and is reluctant to provide information about the party or the reason for the agency relationship.
    • A person does not appear to be sufficiently knowledgeable about the use or the purpose of the real estate being purchased.
    • A person appears to be buying or selling the same piece of real estate within a short period of time or is buying multiple pieces for no apparent, legitimate purpose.
    • A prospective purchaser or seller seeks to have documents reflect something other than the true nature of the transaction.
    • The person provides suspicious documentation to verify his or her identity.

    Obviously, this list of "red-flag situations" could include some in which brokers, lawyers, title companies or lenders routinely find themselves; and then the statutory duties imposed under the Act may be visited upon them.

    "Persons Involved in Real Estate Closings and Settlements"

    FinCEN points out that the Act, and the earlier Bank Secrecy Act, do not define a "person involved in a real estate closing or settlement as a financial institution." Also, according to FinCEN, the legislative history provides no insight into how Congress intended the term to be defined.

    Therefore, a reasonable interpretation of the section could cover even participants other than those who actually conduct the real estate settlement. Among those potential participants are real estate brokers, attorneys, banks, mortgage brokers, other financial entities, title insurance companies, and even appraisers and inspectors. The guiding principal, according to FinCEN, is to include those whose services can be abused by money launderers, including those who are positioned to identify the purpose and nature of the transaction.

    Of primary concern for diligent lawyers, is that FinCEN has mentioned that attorneys often play a key role in real estate closings and "thus merit consideration along with all the other professionals involved in the closing" process. The report specifically states that FinCEN does not believe that the application of the Act's requirements to attorneys poses any obligations inconsistent with the attorney-client privilege. It states:

    In fact, attorneys already must exercise due diligence when they receive funds from clients where there is an indication that the funds may be tainted, and cannot simply accept funds without the risk that their fees will be subject to forfeiture. When engaging in conduct subject to anti-money laundering regulations, attorneys, like other professionals, should take the basic steps contemplated by Section 352 to ensure that their services are not being abused by money launderers.

    The proposal should be considered in conjunction with the broader range of recommendations issued by the Financial Action Task Force ("FATF"), providing that attorneys should be "gatekeepers" not only subject to the due diligence FinCEN currently proposes but also to whistleblowing requirements, that is, the reporting of suspicious activities by clients. In fact, FATF has issued a revised version of its "The Forty Recommendations" in June which requires not only client investigation but the reporting of suspicious activities by attorneys who act in the buying and selling of real estate as well as the managing of client money, securities or assets, the organization or creation of companies, and the buying or selling of business entities. FATF, "The Forty Recommendations" (June 2003).

    Critical Comments

    As expected, the proposed rules have spurred those groups that deal with real estate closings to provide critical analyses on the proposed rules. For example, a spokesperson of the American Land Title Association has responded that property transactions are not a very good way to launder money because many cash-reporting requirements already exist. While this point is questionable, the underlying concerns are well taken.

    The American Bar Association House of Delegates passed a resolution this February opposing any anti-money-laundering law that would force lawyers to disclose confidential client information or compromise the lawyer-client relationship. That resolution noted that the ABA would continue to review its Model Rules to determine whether they should be modified in order to permit some disclosure if it is clear that clients intend to break money-laundering laws. The ABA Task Force on Gatekeeper Regulation and the Profession has stated that any requirement that attorneys must report to the federal (or any) government regarding the activities of their clients "would undermine the independence of the Bar from the government, erode the essential trust relationship between the attorney and the client which is a bedrock of the U.S. administration of justice and rule of law, and compromise the principle of confidentiality in communications between the lawyer and the client."

    Currently, the ABA Model Rules of Professional Conduct prohibit attorneys from revealing information related to their representation of clients without consent. This is a way of assuring the client that full and frank communication can occur without fear of disclosure. The single exception to the rule has been a recent modification to state bar rules in some states which requires attorneys to divulge information disclosed by clients when that disclosure may be necessary to prevent the commission of a crime, or death or bodily harm to others. However, even under this very limited exception, attorneys have no obligation to conduct investigations of clients.

    It should be noted, however, that the ABA recently, under pressure because of the Sarbanes-Oxley legislation, has proposed modification of the Model Rules to permit disclosure to prevent, mitigate or rectify substantial injury to the financial interests of another where the client used the attorney's services. While not specifically directed at money laundering, the proposed amendments would open the door to whistleblowing rules.

    The American College of Mortgage Attorneys ("ACMA") has submitted comments that argue that mortgage and real estate attorneys should not be subject to any requirements under the Act, i.e., they should be exempt from being considered as "financial institutions" or "involved in real estate closings and settlements."

    ACMA emphasized the effect that the proposed rule will have on sole practitioners and smaller firms, that will not be able, on a cost-effective basis, to carry out the functions required under the proposed rule:

    They will not have the time, financial means or ability to develop the requisite internal policies, higher compliance officers or provide training programs -- and certainly will not be able to establish and carry out independent audit functions involving the client's intentions and the source of its funds, which additionally would place attorneys in the awkward, and perhaps unethical, position of informing on their clients to federal authorities with their clients' knowledge or consent. To impose such requirements on attorneys would significantly increase the cost of legal services and may even cause some attorneys to abandon this area of the practice of law.

    ACMA has also pointed out that many closings are conducted without the physical presence of the parties who sign documents separately in advance, and many involve individuals or the use of ownership entities that are often created for the specific purpose of holding title to the real estate. It further stated:

    The institution of the proposed rule would likely require attorneys for both lenders and borrowers to be present at the closing, along with all of their clients in order to properly and completely investigate the individuals and/or entities receiving or providing funds at the closing. Such a requirement would often add a significant closing expense to clients . . . Further, it would seem impractical -- if not impossible -- for attorneys representing borrowers to effectively investigate the source of funding of loans from financial institutions making the loan in question or to check the background of the principals of the parties to the transaction. The attorney, who may be acting only as local counsel in the transaction or may not even have met the client before the closing (or who very often will never meet the client at any stage of the transaction), often will have no knowledge of the identity of all the shareholders or constituent members or partners of a corporate, limited liability company or partnership client that is purchasing property or obtaining a loan especially at "second-tier" or non-management levels. At the very least, an attorney involved in a real estate closing should be able to rely on a FIRPTA-type affidavit or certification from another participant at the closing as to the source and nature of the funds and/or the fact that such other participant has performed appropriate due-diligence regarding the parties to the transaction and their business purpose and constituent members for the purpose of complying with applicable anti-laundering and terrorism statutes and regulations.

    The American College of Real Estate Lawyers has also drafted a detailed response to the proposed lawmaking. ACREL has taken a similar position to ACMA on most issues. In addition, it has proposed what might be characterized as certain compromise positions for FinCEN to consider. One of those positions is that a protocol be set up that would require only one of the participants in a real estate closing to have primary responsibility for performing due diligence and confirming to the other participants the results of those investigations. Depending on the nature of the transaction, that Confirming Party may be the lender, the escrow agent, the title company, or the broker; and the other participants would be entitled to rely on the Confirming Party's certification (with certain limited exceptions). Also, ACREL suggested that certain real estate closings should be exempt from the Act's requirements.

    Those exemptions should include transactions below a significant amount (say $10 million) where the transaction is financed by an institutional lender. This amount is substantially higher than other whistleblowing rules which currently set a threshold of $5000. Also, certain transactions where the due diligence has been previously performed, and those where real estate is not the principal asset. ACREL is most concerned with any requirements that would obligate a lawyer to perform due diligence investigations on the lawyer's own client because those activities may violate the attorney-client privilege and the duty of client confidentiality. It also forces the lawyer to assume an adversarial relationship with the client. ACREL's full comments are well worth reading and are available at its website, www.acrel.org. and clicking on Public Documents.

    In light of all the critical and incisive comments, it appears that FinCEN will have its work cut out in trying to devise reasonable regulations to the Patriot Act that will accommodate both the needs of the government to combat terrorism and the needs of the real estate industry. All lawyers involved in real estate closings should follow the progress of the rules very carefully so that they and their clients do not find themselves targeted as lawbreakers in the new federal environment.