On February 16, the Financial Crimes Enforcement Center (“FinCEN”) published a Notice of Proposed Rulemaking (“NPRM”) regarding residential real estate. The final version of the NPRM published in the Federal Register is 47 pages long. We have created a separate document which more clearly sets forth the proposed regulations themselves, at 31 C.F.R. § 1031.320, here.
FinCEN also has published a Fact Sheet regarding the NPRM, here. The Fact Sheet, slightly over four pages long, is helpful and walks through the basics of many of the proposed requirements.
The NPRM proposes to impose a nation-wide reporting requirement for the details of residential real estate transactions, subject to some exceptions, in which the buyer is a covered entity or trust. Title agencies, escrow companies, settlement agents, and lawyers need to pay particular attention to the NPRM because, based on FinCEN’s “cascade” approach to who should be responsible for complying with the reporting requirements, these parties are the most likely to be responsible.
Although the NPRM pertains only to residential transactions, FinCEN has indicated that it intends to publish a separate proposed rulemaking in 2024 regarding commercial real estate transactions.
Prelude
The NPRM has been long anticipated. FinCEN issued a lengthy Advanced Notice of Proposed Rule Making (“ANPRM”) in December 2021. Further, and for years, FinCEN has issued and expanded Geographic Targeting Orders (“GTOs”), which have accumulated Beneficial Owner (“BO”) information through reports regarding the purchases of certain real estate by entities in designated U.S. jurisdictions, if they exceeded certain monetary thresholds. The GTOs were a precursor to, and instruments to obtain data to support, the newly-published NPRM. Moreover, the Department of Treasury’s 2024 National Money Laundering Risk Assessment contains, again, a section specific to real estate, which posits that the U.S. real estate market is vulnerable to money laundering because “its historic reputation as a reliable store of long-term value” has attracted “those looking to find a reliable mechanism to launder money[,]” and because of “the ease through which illicit actors can anonymize their identity or the source of their funds through legal entities, legal arrangements, and pooled accounts like IOLTAs.”
In the 2021 ANPRM, FinCEN had raised the possibility that regulations could apply to both the residential and the commercial real estate sectors, and that they could require not just a relatively simple reporting form regarding real estate transactions, but also for covered businesses to implement and maintain more robust anti-money laundering (“AML”) compliance programs like many other institutions covered by the Bank Secrecy Act (“BSA”). As we will discuss, the new NPRM is limited to the residential sector and a proposed transaction-based reporting requirement. However, and as noted, FinCEN has stated that it also will propose regulations regarding the commercial real estate market later in 2024.
The Real Estate Report
The NPRM proposes a new BSA reporting form: the “Real Estate Report” (“Report”). The precise form of the Report will be the subject of a future Federal Register publication by FinCEN in 2024. Summarizing greatly, the Report would require the identification of the BOs of a covered transferee entity or transferee trust. The Report also would require certain information regarding the real property being transferred; the individuals representing the transferee; the seller; the person filing the Report; and payments made.
Importantly, and consistent with the above, the Report would not apply to transactions only between individuals, or to transactions in which the transferee is an individual. Rather, the Report would apply only to transactions involving a covered entity or trust as the transferee.
The NPRM refers to the Report as “a streamlined version of a Suspicious Activity Report (SAR)[.]” But the Report is nothing like a SAR, the filing of which requires, among other things, the exercise of judgment and discretion; a determination that a transaction is “suspicious;” and, typically, an entire BSA/AML program to continually monitor transactions and customers in order to identify suspicious activity. Indeed, the NPRM observes that “[b]ecause of the streamlined nature of these Real Estate Reports compared to traditional SARs, as well as the flexible ‘cascade’ framework, persons subject to this reporting requirement would not need to maintain the types of AML programs otherwise required of financial institutions under the BSA.” It appears that FinCEN characterizes the Report as a “streamlined” SAR because it is promulgating the Report pursuant to its statutory authority at 31 U.S.C. § 5318(g), which pertains to SARs.
Consistent with the above, the NPRM does not propose that a Report verify reported BO information or identify any Politically Exposed Persons, or PEPs, involved in a deal. Such duties “would require reporting persons to undertake independent research that would represent a dramatically increased burden, compared to collecting information from the transferee.”
The Report: Contents
Generalizing greatly, the proposed definition of a reportable BO for a transferee entity approximates the definition of a reportable BO for the purposes of the Corporate Transparency Act (“CTA”): a person who owns or controls at least 25 percent of the transferee’s ownership interests, or anyone who exercises “substantial control” over the transferee entity – a concept that is very broadly defined. For a transferee trust, a BO would be any individual who is a trustee or who has other, various and specifically-defined rights and powers regarding the trust or its assets.
The NPRM and FinCEN’s Fact Sheet discuss the CTA, apparently to address the critique that the CTA and the reporting requirements the NPRM proposes are overlapping and too costly for industry. According to FinCEN, the CTA and the NPRM “serve different purposes” because “[i]nformation proposed to be collected pursuant to th[e] NPRM would enable law enforcement to directly tie individuals, entities, and trusts of interest to specific non-financed sales and transfers of U.S. residential real estate.” That claim, on its own terms, is accurate. Nonetheless, many entities conducting real estate transactions will need to file BO reports under the CTA, and also will have their transactions reported under the NPRM.
The Report: Application
The NPRM proposes that the Report should apply to all residential deals, as defined, with no monetary threshold. Pure gifts involving zero consideration are subject to reporting. As noted, the deals must involve a defined entity or trust as at least one of the transferees, including foreign entities and trusts. Reportable deals would involve transfers pertaining to single-family houses, townhouses, condominiums, cooperatives, and buildings designed for occupancy by one to four families. The final prong of this definition (buildings designed for occupancy by one to four families) tracks language in the existing definition of real estate transactions involving residential mortgage lenders and originators, to which the BSA and implementing FinCEN regulations already apply. Reportable deals also would include vacant or unimproved land which is zoned or permitted for occupancy by one to four families, and shares in a cooperative housing corporation.
Importantly, the Report only would apply to “non-financed” transactions. That means that a covered transaction would not involve an extension of credit that is secured by the transferred property, and extended by a financial institution subject to AML and SAR filing requirements. Stated otherwise, if the transaction involves financing by an entity the BSA already covers, then the NPRM does not apply. Explaining in part FinCEN’s justification for this definition, the NPRM states that “approximately 42 percent of non-financed real estate transfers captured by [the GTOs] are conducted by individuals or legal entities on which a SAR has been filed.” In regards to how this definition will impact filings, the 2024 National Money Laundering Risk Assessment, referenced earlier, states that “an estimated 20 to 30 percent of residential real estate purchases in the United States are non-financed and not fully subject to comprehensive AML/CFT requirements.” For context, it has been reported that there were about 4.0 million residential real estate transactions in January 2024. These statistics suggest that approximately 800,000 to 1,200,000 residential, non-financed transactions occurred in 2023.
Although transferee entities and trusts are defined broadly, there are proposed exceptions for highly regulated types of entities that, in FinCEN’s view, illicit actors are less likely to use to launder funds. These exceptions include but are not limited to entities the BSA already covers (such as banks, credit unions, money services business, and broker-dealers in securities) and securities reporting issuers – i.e., U.S. public companies. Thus, although there is no “large entity” exception per se, the exception for securities reporting issuers serves de facto as such an exception, as the NPRM itself implicitly acknowledges.
Transferee trusts are defined broadly. Unlike the CTA, trusts are covered by the NPRM if they are not created through a filing with a state or tribal entity. Rather, a transferee trusts is defined to mean “any legal arrangement created when a person (generally known as a settlor or grantor) places assets under the control of a trustee for the benefit of one or more persons (each generally known as a beneficiary) or for a specified purpose, as well as any legal arrangement similar in structure or function to the above, whether formed under the laws of the United States or a foreign jurisdiction.” The proposed exceptions for transferee trusts are limited: trusts which are securities reporting issuers, trusts in which the trustee is a securities reporting issuer, or statutory trusts. Subsidiaries of exempt entities and trusts are also exempt.
The NPRM makes very clear that the proposed definition of transferee entity includes non-profit organizations – although “the reportable beneficial owners would be limited only to the individuals who exercise substantial control[,]” because the owners or directors of such organizations do not have direct ownership. In regards to pooled investment vehicles (PIVs), the NPRM emphasizes that PIVs that are not registered with the SEC, such as private real estate investment trusts, certain real estate funds, special purpose financing vehicles, and private funds, may be transferee entities.
The Report: Who Files
Only one entity or person must file a Report for a particular covered transaction. FinCEN states it “expects that the obligation to file Real Estate Reports would generally apply to settlement agents, title insurance agents, escrow agents, and attorneys.” More specifically, the NPRM proposes a “cascading” reporting regime by listing seven different functions which could occur in a real estate deal – the business that performs the function that appears highest on the list has the reporting requirement.
Here is FinCEN’s proposed “cascading” list of responsible filers:
- The person listed as the closing or settlement agent on the closing or settlement statement for the transfer;
- The person that prepares the closing or settlement statement for the transfer;
- The person that files with the recordation office the deed or other instrument that transfers ownership of the residential real property;
- The person that underwrites an owner’s title insurance policy for the transferee with respect to the transferred residential real property, such as a title insurance company;
- The person that disburses in any form, including from an escrow account, trust account, or lawyers’ trust account, the greatest amount of funds in connection with the residential real property transfer;
- The person that provides an evaluation of the statute of the title; or
- The person who prepares the deed or, if no deed is involved, any other legal instrument that transfers ownership of the residential real property.
Importantly, the NPRM also proposes that parties may enter into written agreements with each other to designate exactly who must fulfill the reporting requirement. As noted already, the NPRM includes attorneys involved in real estate transactions, despite commentators who urged otherwise, explaining that “FinCEN would require reporting by attorneys only when they perform certain functions—functions that generally may be performed by non-attorneys.”
The NPRM does not discuss potential penalties for not filing Reports, or for filing inaccurate Reports. However, because FinCEN is invoking its authority under 31 U.S.C. § 5318(g), penalties for Report violations presumably will track the civil and criminal penalty regime for this section – i.e., they will be the same penalties as for SAR violations. Current civil penalties under Section 5318(g) (as adjusted for inflation and effective as of January 25, 2024) are $1,394 for each “negligent” violation and up to $278,937 for each “willful” violation; criminal penalties include up to five years of imprisonment and a criminal fine of up to $250,000.
The Report: When (and Required Records)
A required Report would need to be filed within 30 days of the property’s transfer. The reporting person would need to keep a copy of the Report for five years, along with a form signed by the transferee or its representative certifying the Report is correct. The reporting person also would be required to keep a copy of any designation agreement by the parties.
As to access, the NPRM explains that the Reports and reports filed under the CTA “would be housed in different databases with differing access privileges. The proposed Reports would be stored electronically in the same database as traditional SAR and other BSA reports, in keeping with the nature, purposes, and use of those reports.” The so-called “SAR confidentiality rule” imposed by Section 5318(g), which prohibits a reporting person from disclosing to a report any person involved in the transaction, would not apply to the Reports.
Pending Questions and Requests for Comment
The NPRM contains 61 requests for comment. They include:
- The benefits and drawbacks to the proposed cascading hierarchy of reporting persons.
- What due diligence is “normally” conducted on the parties to a transfer and source of funds? Should the NPRM require additional information regarding the source of funds?
- Generally, comments regarding the various proposed definitions.
- Whether the NPRM implicates attorney-client privilege concerns.
Costs
The NPRM’s Section VII provides a regulatory analysis of the proposed rule. Specifically, the regulatory impact analysis (“RIA”) attempts to assess the costs and benefits the proposed rule will have on those considered as “reporting persons.” Consistent with other, recent Federal Register publications by FinCEN, this section is very long and detailed.
The RIA attempts to articulate the social costs which justify the concrete compliance costs to industry. The RIA asserts that money laundering through real estate creates price distortion and makes it difficult to decipher the information necessary to making optimal decisions from observable market behaviors. The price the property is sold at reflects not only the buyer’s private valuation of the property but also their willingness to pay for money laundering services. Further, purchasing property to launder money can exert additional upward pressure on home prices by creating additional demand in markets where the quantity of demand already exceeds local supply.
The RIA acknowledges the NPRM has requirements that either mirror or are consistent with current reporting and procedural requirements, such as the CTA or the Customer Due Diligence rule. Further, the RIA states the proposed rule will have a bigger effect on transferee trusts than transferee entities because purchases by transferee trusts have not been covered under the GTOs and transferee trusts, as defined, are not subject to the CTA’s BO reporting requirements.
FinCEN estimates the aggregate first-year costs of the proposed rule will be between $267.3 million and $476.2 million, and each subsequent year will cost between $245 million and $453.9 million. One cost affected parties will face is training personnel, as well as drafting and/or revising policies and procedures regarding reporting, complying, and documenting compliance. In total, FinCEN estimates an aggregate cost of $44.3 million for initial training and between $20.2 million and $27.3 million in training costs for each subsequent year.
Another cost the RIA details is the cost associated with reporting non-financed property transactions. While such costs will vary based on the specific facts and circumstances of the transfer (e.g., which party in the cascade is the reporting person), FinCEN’s estimate allots two hours per reportable transaction time cost to collect and review transferee and transaction-specific reportable information and related documents, and thirty minutes for reporting. FinCEN estimates the reporting costs to be between $158.2 million and $314.2 million.
The RIA also details the costs stemming from the proposed rule’s recordkeeping requirements on reporting persons and, in some instances, on members of a given reportable transaction’s cascade that are not reporting persons. The RIA estimates an aggregate recordkeeping cost between $56.3 million and $75.6 million for one year’s reportable transactions. For a party that is the reporting person as a result of a designation agreement, the proposed rule would impose additional recordkeeping costs related to the electronic dissemination, signing, and storage of the agreement. FinCEN estimates this aggregate annual cost to be between $9.5 million and $28.6 million.
Industry commentators of course will react to these estimates. If history is any guide, the feedback will be that these cost estimates are very optimistic and unrealistically low.
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