The U.S. levies stiff penalties for breaking U.S. sanctions, and “I didn’t know” isn’t a strong defense. FinCEN notes red flags Realtors should look for.
WASHINGTON – The Financial Crimes Enforcement Network (FinCEN) issued an alert to financial institutions on Jan. 25 to be on the lookout for sanctioned Russian elites, oligarchs and their family members who might be trying to circumvent sanctions by investing in U.S. commercial real estate.
That creates new a challenge for banking and commercial real estate professionals – how to spot and avoid potential sanctions violators?
FinCEN pointed out potential red flags involving attempted sanctions evasion in the commercial real estate sector and reminded financial institutions of their obligation to report such incidents. FinCEN released a statement to Wealth Management that commercial real estate professionals should be just as vigilant.
After all, in addition to reputational harm, civil penalties for sanctions violations can reach up to $356,579 or twice the amount of the transaction involved, whichever is greater, says Michael Lowell, chair of global regulatory practice with law firm Reed Smith LLP. Willful violations can also result in criminal fines of up to $1 million and imprisonment for up to 20 years, he adds.
A knowing violation of sanctions, and even an unknowing one, can not only lead to civil monetary penalties and possible criminal ones, but people and companies can lose licenses if they were deemed complicit in illegal transactions, even if they weren’t the entity that executed those transactions, says Bonnie Hochman Rothell, a partner and chair of the litigation practice at Morris, Manning & Martin LLP in Washington, D.C.
For example, it could cost the entity a license to do business with Fannie Mae, Freddie Mac or HUD, or be put on an exclusionary list and be banned from participation in certain programs, she says.
Attempts to evade sanctions
Sanctioned Russian elites and their proxies are likely attempting to evade sanctions by exploiting vulnerabilities in the U.S. commercial real estate market, according to FinCEN.
“Although targeted specifically at financial institutions obligated by the Bank Secrecy Act (BSA) to file suspicious activity reports with FinCEN, the typologies and red flags highlighted in the alert could be helpful to all commercial real estate professionals in ensuring that they do not violate or facilitate the violation of U.S sanctions,” the FinCEN statement to Wealth Management reads. “The typologies and red flags in the alert are based on a review of BSA reporting from financial institutions, open-source reporting and information from law enforcement partners. As stated in the alert, they should not be considered an exhaustive list. Moreover, financial institutions should be aware that other bad actors engaged in various types of illicit financial activity, such as money laundering, may use these or other methods to invest in commercial real estate.”
Commercial real estate transactions routinely involve highly complex financing methods and opaque ownership structures that diminish transparency in a way that can allow bad actors to hide illicit funds in commercial real estate investments, according to FinCEN.
Additionally, the stability of the U.S. commercial real estate market and the high value of commercial real estate properties also gives the bad actors a way to generate a steady income and store large amounts of wealth, FinCen notes.
“You need to be careful who you get in bed with,” says Jonathan Kurry, a Miami-based real estate finance partner with Reed Smith. “It’s pretty obvious. Don’t take money from unknown sources and don’t think you are going to get away with not disclosing who your financial sources are just because they’re offshore investors.”
To stay on the right side of the law, commercial real estate professionals should be practicing the same type of know-your-client approach that banks are required to do, according to Kurry. He notes that’s the kind of due diligence he advises to his own clients – they should trace the money back to an individual and make sure they are not on a designated person’s list for sanctions.
According to one study of 2021 U.S. commercial real estate transactions, 8.4% of those surveyed reported that they closed a sale with a foreign client residing abroad, and this figure was above 10% for several years prior to the pandemic, FinCEN reports.
Through the third quarter of 2022, the four-quarter rolling cross-border investment into U.S. commercial real estate properties reached $63.4 billion, according to real estate data firm MSCI Real Assets.
Since the beginning of Russia’s invasion of Ukraine, the U.S and other G7 countries have been focused on sharing information about effectively responding to potential sanctions evasion, notes Lowell. While the FinCEN alert highlights the sanctions evasion risk in the commercial real estate market, financial institutions and other businesses must remain vigilant for evasion schemes by sanctioned Russians, he notes.
When a sanctioned person owns a 50% or greater interest in any entity, that entity also falls within the sanctions’ prohibitions, Lowell says. Once commercial real estate professionals know who their customers and counterparties are, they can screen those names against the government’s Consolidated Screening List to help ensure they are not violating U.S. sanctions, he adds.
“I have been interested in the topic and have my antenna up,” notes Rothell. “Right now, with the interest rates and real estate market being more volatile and a lot of belt-tightening around the country, I think it’s even more important for my lender clients to scrutinize and do an impeccable job of underwriting.
“For the real estate developers looking for investors, not only do you need to be careful who you borrow your money from, you want to make sure that the investors in your properties aren’t violating the sanction rules.”
What to look for
The easiest way to try and circumvent the sanctions would be to structure the commercial real estate transaction to evade detection by industry-standard customer due diligence practices, according to Lowell. This could include reducing the sanctioned party’s ownership interest to be below the 25% threshold commonly used to screen beneficial owners; establishing off-shore shell companies in countries that do not track or report beneficial ownership information; or using a family member or business associate to invest in a project in place of the sanctioned party, he notes.
Foreign investment in the U.S. real estate industry reaches into tens of billions of dollars every year, says Rothell, and she suspects that investment from Russian sources is a small fraction of that, with the greatest interest being in individual homes and condos. But commercial real estate investment by Russian oligarchs occurs as well.
For example, in April of last year, Bloomberg reported that Viktor Vekselberg, a Russian oligarch and billionaire with close ties to Russian President Vladimir Putin invested in an apartment complex just off the Louisiana State University campus. The 2016 investment was made before sanctions were put in place.
Wealthy Russian citizens “owning office buildings and multifamily, to the extent it exists, is well-hidden,” Rothell says. “I don’t think it’s a huge problem, but it certainly exists out there and with the U.S. imposing the sanctions, lenders are going to need to be a lot more aware and really work on their underwriting and make sure they don’t fall victim in being complicit and face potential penalties for violating sanctions.”
Because the structures in commercial real estate can be complex even with the best underwriting, it’s often difficult to “nail down” who the ultimate ownership of the structure is, she notes. As a result, it’s a potentially easier outlet for Russian investors to hide their money.
Banks have to dig down until they get to individual investors because with real estate structures such as LLCs, there’s often a significant amount of foreign investment, Rothell says. But if there’s a consortium of 100 or 200 individuals with an interest in an LLC, many times you won’t know who the individual investor is if they own less than 25%, she adds.
“You can have one individual in the U.S. investing and the rest that are foreign, and you will never know who those investors are because there’s no disclosure requirement,” Rothell says. “I’ve heard a lot of underwriters are lowering that threshold, but even if you get it lower to 15%, 10% or even 5%, it’s easy enough for someone looking to evade detection to lower their interest. They might put a percentage in their wife’s or brother’s name, so it becomes difficult to get down to those individuals.”
Rothell is telling her clients to fine-tune their underwriting and drill down another level to get to individuals because it’s so easy to have shell companies that evade detection. It’s important to get full names and Social Security numbers and citizenship information to ensure there’s no hidden sanctioned Russian investment in those pools, she notes.
“The problem is our current structure allowing for real estate investment pools makes it hard,” she notes. “If there’s a 1% interest in 20 different pools it would be very easy for it to go unnoticed. By drilling down, the lenders can make sure they have done all they can.”
And if the worst happens and someone discovers they may have violated existing U.S. sanctions, the Office of Foreign Assets Control has a voluntary self-disclosure program that can help mitigate potential penalties. Working with an experienced international trade attorney to prepare a self-disclosure can be a particularly effective strategy for addressing a potential violation, Lowell says.
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