MLO Mentor is an ongoing series covering compliance best practices for mortgage loan originators (MLOs). This article outlines common money laundering practices and the programs that counter them. Enroll in firsttuesday’s 8-Hour NMLS CE to renew your California MLO license and learn more about anti-money laundering in your practice.

What is money laundering?

Money laundering is the process of making illegally gained profits appear legitimate. It facilitates access to funds for criminals engaged in crimes like drug trafficking or terrorism.

The three steps of money laundering are:

  • placement;
  • layering; and
  • integration.

Placement is the process of placing the profits into the legitimate financial system. Usually this is accomplished by depositing money into banks and/or smuggling currency into the country to deposit. For example, a drug trafficker would open several shell companies, and funnel money through them towards significant down payments on several high-end real estate properties.

Layering is the process of further concealing the money’s illegal source by completing multiple complex transactions. This makes following the money more difficult. For instance, laying might involve purchasing traveler’s checks, bank drafts, securities, bonds, etc. with other types of monetary instruments or transferring funds between accounts.

Finally, integration is the re-entry of the funds into the legitimate economy. For instance, the mortgage on the high-end property bought with drug money would be sold is paid down in large monthly payments, or completely, and the property sold. The profits are then legitimized as income from the sale of the property.

The Bank Secrecy Act

The Currency and Foreign Transactions Reporting Act of 1970, known as the Bank Secrecy Act (BSA), is one of the most effective tools against money laundering in real estate. It requires U.S. financial institutions to maintain records and file reports with government agencies to combat money laundering. [31 United States Code §5311 et seq.]

The Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Treasury Department, oversees regulations controlling anti-money laundering rules and suspicious activity report filings. [31 CFR §§1029 et seq.]

Some critical laws that assist the government in fighting money laundering include:

  • the Money Laundering Control Act of 1986, which established money laundering as a federal crime, prohibited structured transactions to evade required filings, introduced civil and criminal penalties for BSA violations and directed banks to establish procedures to monitor compliance with the BSA;
  • the Anti-Drug Abuse Act of 1988, which expanded the BSA large currency transaction reporting requirements to car dealers and real estate closing personnel and required the verification of identity for the purchase of monetary instruments over $3,000;
  • the Annunzio-Wylie Anti-Money Laundering Act of 1992, which strengthened sanctions for BSA violations, established the use of Suspicious Activity Reports (SARs), required verification and recordkeeping for wire transfers and established the BSA Advisory Group;
  • the Money Laundering Suppression Act of 1994, which required banks to review and enhance training and referrals to enforcement agencies, streamlined currency transaction reporting exemptions and required registration of money service businesses and associated authorized businesses;
  • the Money Laundering and Financial Crimes Strategy Act of 1998 required the Department of the Treasury to develop a National Money Laundering Strategy and created task forces to direct law enforcement efforts in areas where money laundering is prevalent;
  • the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act) which criminalized the financing of terrorism, prohibited doing business with foreign shell banks, required government-institution information sharing and voluntary information sharing among financial institutions, increased the penalties for money laundering and facilitated faster records access; and
  • the Intelligence Reform & Terrorism Prevention Act of 2004 which amended the BSA to require some financial institutions to report cross-border electronic transmittals of funds where reasonably necessary.

Curbing financial crime requires the effort of thousands of specially trained professionals in task forces and government agencies. It also depends on the diligence and care of mortgage professionals on the front lines, tasked with reporting suspicious activities and providing information crucial to the protection of the nation’s security.

Anti-money laundering

Mortgage loan originators are required to establish anti-money laundering programs to prevent or detect fraudulent and unlawful transactions. In residential mortgage transactions, money laundering most often involves the fraudulent use of money, obtained from criminal enterprises, to purchase residential real estate.

In 2002, FinCEN issued temporary regulations exempting residential mortgage lenders, brokers and mortgage loan originators from the anti-money laundering program requirement. However, after additional analysis and investigation, FinCEN determined the residential mortgage lending channel was indeed a significant target for fraudulent transactions.

Subsequently, in 2012, FinCEN established anti-money laundering rules for residential mortgage lenders, brokers and mortgage loan originators.

Editor’s note — Banks and other depository institutions were subject to FinCEN anti-money laundering rules when the rules were initially established, in 1970. [31 CFR §§1010 et seq.]

Who is to comply?

 Application of the anti-money laundering rules is broad. All residential mortgage companies (including sole proprietorships) that perform residential mortgage activities are required to establish a program to detect and report suspected money laundering schemes. [31 CFR §1010.100(lll)]

Individual MLOs are required to comply with the anti-money laundering rules established by their employing companies. FinCEN identified MLOs as an important first level of protection against fraud since they have the most contact with borrowers and borrower information. Thus, they have a greater exposure to information which may indicate fraud is present, or impending.

Residential mortgage activities which trigger compliance with the anti-money laundering rules include:

  • the acceptance of an application for a residential mortgage; or
  • the offering or negotiating of the terms of a residential mortgage for itself, or on behalf of a lender or borrower. [31 CFR §1010.100(lll)(1)(ii)]

A residential mortgage under the anti-money laundering rules is a mortgage secured by a one-to-four unit residential property, condo, co-op, mobilehome or trailer. This includes purchases, refinances and loan modifications, if they involve a residential mortgage application or offering or negotiating the terms of a residential mortgage. [31 CFR §1010.100(lll)(1)(iii); 77 FR 8152]

Unlike the definition of a residential mortgage lender under the Secure and Fair Enforcement Act (SAFE Act), the anti-money laundering rules are triggered even if the lender or mortgage loan originator does not expect or receive compensation for the residential mortgage activity. [77 FR 8152; 31 CFR §1010.100(lll)(1)]

Anti-money laundering requirements

Anti-money laundering rules require non-bank residential mortgage companies to:

  • establish a written internal policy to prevent the company from being used to launder money or facilitate other unlawful financial activity;
  • designate a compliance officer responsible for implementing and policing compliance with the policy;
  • establish anti-money laundering education programs for the company’s employees, whether completed in-house or through a third-party educator; and
  • arrange an independent audit of the effectiveness of the established anti-money laundering policy and program. [31 CFR §1029.210]

Programs are to be commensurate with the size, location and activities undertaken by the non-bank residential mortgage lender. The requirements of the anti-money laundering program can be integrated into existing risk management, anti-fraud, consumer protection and compliance guides used by the company to detect business risks.

Suspicious activity reports

A residential mortgage company must file a suspicious activity report (SAR) with FinCEN if it knows or suspects a transaction involving funds or assets in aggregate of at least $5,000:

  • involves funds derived from unlawful activities;
  • is intended to hide or disguise funds or assets derived from unlawful activities;
  • is otherwise designed to evade the BSA;
  • has no apparent business or lawful purpose, and for which no reasonable explanation exists; or
  • involves the use of the mortgage funds to facilitate criminal activity. [31 CFR §1029.320(a)(2)]

Editor’s note — Although the anti-money laundering rules compel the identification and reporting of suspected money laundering schemes, a mortgage company may voluntarily use a SAR to file a report about a suspected violation of any law or regulation. [31 CFR §1029.320(a)]

Often in mortgage and real estate fraud schemes, the perpetrator’s goal is to gain access to the equity or mortgage funds and abscond. With money laundering schemes, the goal is to obscure and legitimize illicit funds. Thus, these transactions often involve seemingly legitimate transactions: the mortgages involved are performing, and/or paid off quickly.

Suspicious activity can be easy to miss without real-world context. Take a look at the following examples of suspicious activities which have triggered past SARs:

  1. A company reported that one of its loan officers supplied false references for borrowers in connection with dozens of mortgages. The company found that all the borrowers were using the same real estate agent and real estate appraiser, and suspected the property values had been inflated. Further, it suspected the loan officer was the actual owner of the properties. Despite the company’s fears that it was facing multiple loan defaults based on overinflated values and unqualified straw buyers, all the mortgages were current. While not alleged by the company, money launderers commonly use straw buyers to obtain multiple mortgages. They then funnel illicit funds towards mortgage payments, thereby “legitimizing” the money in the form of equity.
  2. A company reported it funded several residential mortgage refinances through a mortgage company totaling upwards of six million dollars. In each of the suspicious transactions, each borrower requested a rescission of the mortgage after funding, and, when denied, immediately paid off the mortgage. While not alleged by the company, FinCEN noted that the activity may have been part of a money laundering scheme.
  3. A bank reported that, in a short span of time, a customer made a very large cash deposit in $50 bills, and requested a bank check for the same amount payable to a mortgage company. While not alleged in the SAR, FinCEN identifies this pattern as a potential means of converting cash income to evade income taxes. [FinCEN Report: Money Laundering in the Residential Real Estate Industry]

If more than one mortgage company observes the suspicious activity, companies may choose to jointly file one SAR. All mortgage companies party to an SAR have a duty to keep records of the filing, and any supporting documentation. [31 CFR §1029.320(a)(3)]

SAR filing

Within 30 days of becoming aware of a suspicious transaction, mortgage companies are required to complete and file a SAR with FinCEN. The SAR is filed electronically on FinCEN’s website. [31 CFR§1029.320(b)]

For violations which involve ongoing money laundering or suspected ties to the financing of terrorism, mortgages companies must also immediately notify law enforcement officials. [31 CFR§1029.320(b)(4)]

The SAR consists of:

  • an identification of the person or company under suspicion;
  • details regarding the suspicious activity, including the type of fraud or illicit activity suspected;
  • identification of the company where the suspicious activity took place;
  • contact information of the SAR filer; and
  • a narrative account of the activities under suspicion.

Recordkeeping requirements

SAR filings and supporting documentation are to be kept on file for five years from the date of the filing. [31 CFR §1029.320(c)]

The existence of a SAR filing and its contents are to be kept confidential. A company filing a SAR is only able to release information about the SAR to law enforcement officials to comply with the BSA. It may also release SAR information with a co-filer if filing a joint SAR. However, the company is not required to disclose the existence of a SAR or its contents in response to a subpoena. [31 CFR §1029.320(d)]

Money launderers continue to expand into new territories and technologies, like cryptocurrency. As fraudsters’ designs grow in their sophistication, the common sense and compliance of experienced MLOs becomes more valuable than ever.