American Bar Association's Section of Real Property Law releases recommendations.

The Section of Real Property, Probate and Trust Law of the American Bar Association released the following comments to the Treasury Department's financial crimes enforcement network (FinCEN) in response to the request for public comment on the notice of proposed rulemaking regarding the definition of "persons involved in real estate closings and settlements." These views are being presented only on behalf of the Section. They have not been approved by the House of Delegates, nor the board of governors of the ABA and should not be construed as representing the position of the ABA.

This letter will address the questions posed by FinCEN in the ANPRM in the order presented.

What are the money laundering risks in real estate closings and settlements?

The first topic on which FinCEN seeks comment deals with the money laundering risks in real estate closings and settlements. The Section does not believe a material money laundering risk exists in the commercial real estate industry. This is not to say that money laundering does not occur in the commercial real estate industry. The Section, however, is not aware that it presents the degree of concern that justifies the imposition of a federally-mandated AML regime that has the potential to impede the efficient settlement of billions of dollars of real estate transactions that close every year.

In support of the statement that the real estate industry "could" be vulnerable by virtue of dealing with high value products, the ANPRM points to a 1996 report by the National Institute of Justice and three appellate court decisions. The 1996 report states that "real estate transactions offer excellent money laundering opportunities" and opportunities to "legitimate and repatriate illegal funds." The report, however, does not point to any empirical data, research, or studies to support this statement.

Based on the strength of the 1996 report and decisional law, FinCEN seeks to impose a regulatory regime on a multi-trillion dollar industry that is vital to the domestic economy.

Indeed, the institutional real estate market (principally pension funds) alone has a value of more than $4.2 trillion. Before imposing any regulatory regime on such an important sector of the national economy, the Section. believes that it is prudent for FinCEN to demonstrate through empirical data and research that the commercial real estate industry is, in fact, a source of money laundering activity in need of federal regulation.

The Section believes that FinCEN should provide more substantial and substantive evidence, through empirical data, research, or studies, that the industry is, in fact, a significant source of money laundering that would justify the imposition of AML program requirements. This is important because the scheme as now suggested could bring significant uncertainty, inefficiencies, delays, and increased costs.

Role of Participants in real estate closings and settlements.

FinCEN correctly states in the ANPRM that a typical commercial real estate transaction involves a number of participants, including real estate brokers, lawyers (sometimes several firms) representing each of the parties, the financing entity, the title insurer, and the escrow agent Other parties include surveyors, title officers, inspectors, accountants, contractors, architects, appraisers, and engineers, most of whom seldom, if ever, are involved in the flow of funds at a closing.

The involvement of each participants is not static: it will change and fluctuate from transaction to transaction and; often, even within an individual transaction. The degree of familiarity of the participants with their principals will also vary from deal to deal. Although a prudent lawyer will undertake some due diligence on the client, he or she may be dealing with certain representatives of the client and not have complete information on all aspects of the client's business.

Financial Intermediaries Standard.

To the extent FinCEN seeks to impose the Section 352 requirements on lawyers, the Section strongly believes that these requirements should be carefully tailored so that they apply, at most, only to those lawyers who act as financial intermediaries and actually handle the receipt and transmission of cash proceeds through accounts that they actually control in the act of closing a commercial real estate transaction.

Regardless of the scope of services performed or degree of familiarity of the participants, it is important that FinCEN focus on those participants in a transaction who actually handle the receipt and transmission of financial proceeds. These participants are in the best position to inquire into the source or origin of the closing funds and the disposition of the funds. An escrow agent, or other participant (often the bank or financial institution with an existing relationship with the seller or buyer) acting as the disbursing agent, or "financial intermediary," is better-positioned to make these inquiries and to detect and prevent money laundering. The ANPRM indicates that it is important to identify the level of involvement with the actual flow of funds used to purchase the property, and the Section believes the focus of inquiry should be on those participants who actually handle the receipt and transmission of cash proceeds.

A participant who acts as a financial intermediary may not know, in all cases, the origin of the funds other than the identity of the transmitting financial institution. In those circumstances, FinCEN should allow the financial intermediary to rely on a certificate or other appropriate form of confirmation from other participants in the real estate closing regarding the bona fides of the closing funds or the fact that another participant has undertaken the requisite AML due diligence for the closing.

For clarity and certainty to those involved in real estate closings and settlements, FinCEN should carefully prescribe when a participant, acting as a financial intermediary, is considered to be actually handling the receipt and transmission of cash proceeds through accounts that the participant actually controls in the act of closing and settling a commercial real estate transaction. Participants in a commercial real estate closing and settlement need clearly defined guidelines so that they will know whether and when they have to comply with the Section 352 requirements.

Should any persons involved in real estate closings or settlements be exempted from coverage under Section 352?

The ANPRM states that FinCEN "wishes to make it clear that it does not intend to cover purchasers and sellers of their own real estate.... The question of exemption is specifically directed to real estate professionals, and those who trade in real estate on a commercial basis." The Section questions the rationale for such a broad exemption. Rather than impose AML requirements on the sellers or buyers of commercial real estate, such as pension funds, FinCEN seeks to impose the requirements on the other participants in a commercial real estate transaction, not including the principals whose money is actually involved in the transaction.

The Section believes the exclusion should apply to purchasers and sellers of their own personal residences and to other real estate professionals involved in a commercial real estate transaction who have only a tangential relationship with the closing or settlement process. Examples of those having a tangential relationship include a property surveyor, an appraiser, local counsel who performs local due diligence or renders opinions relating to local law issues (e.g., enforceability opinions in commercial real estate financing transactions), and an environmental consultant. A lawyer who serves as local counsel will often not know the actual client. Because local counsel typically receive their assignments on a referral basis from the primary lawyer involved in the transaction, local counsel would not be in a position to make any level of substantive inquiry into the client or its business affairs.

How should the anti-money laundering program requirement for persons involved in real estate closings and settlements be structured?

As noted above, the Section urges FinCEN to be sensitive to the costs of imposing Section 352 AML requirements on the commercial real estate industry Section 352 of the USA Patriot Act requires the establishment of an AML program, including, at a minimum, the following:

The development of internal policies, procedures, and controls. These should be appropriate for the level of risk of money laundering identified.

The designation of a compliance officer.

An on-going employee training program.

An independent audit function to test the programs.

Section 352 of the USA Patriot Act directs the Treasury Secretary to "consider the extent to which the requirements imposed under [Section 352 of the USA Patriot Act] are commensurate with the size, location, and activities of the financial institutions to which such regulations apply."

The participants in a real estate transaction vary widely in their level of involvement, financial resources, staffing and "back office" support, and their acumen in preventing money laundering. For example, sole practitioners and small firms handling may incur significant costs in adopting AML requirements. These costs could cause them not to offer these services. In many areas, however, these lawyers are the only source of real estate closing services. The benefit in detecting and preventing money laundering may be negligible or non-existent. But the cost will be significant and, in some cases, prohibitive.

Any AML regime needs to be predicated on clear and definitive rules. It may be constructive for FinCEN, along with the other measures outlined in this letter, to formulate guidelines to assist participants in this compliance effort. Although not necessarily embracing all of the "red flags" developed by the American Land Title Association and noted in the ANPRM, the Section feels these types of guidelines would be helpful in providing meaningful guidance to the industry. These red flags need to be developed to ensure they are compatible with common sense.