This is the first of two articles unraveling the complicated risk exposure that unregulated industries present to the regulated institutions that bank them.
More anti-money laundering (AML) regulations could reduce regulatory burden for financial institutions if these new regulations are applied to industries that do not have AML requirements, such as title companies.
The U.S. does not have the most stringent regulatory environment when compared to peer countries. The Financial Action Task Force (FATF) requirements for designated nonfinancial businesses or professions (DNFBPs) include a variety of U.S. industries and professions, such as lawyers, real estate closing companies (title companies) and lenders. In FATF’s 2016 Mutual Evaluation Report, the U.S. was rated as not compliant for three FATF Recommendations concerning oversight of DNFBPs.1 This leads to increased risk exposure for the highly regulated financial institutions (FIs) that bank these unregulated industries. This article will focus on title companies and those involved in real estate closings, given the recent extension of the Financial Crimes Enforcement Network (FinCEN) Geographic Targeting Order (GTO). All title companies and individuals involved in the closing of real estate present risks to the institutions banking them, but for institutions and title companies in certain geographic regions, the risk is very high.
On November 8, 2019, the seventh GTO was issued by FinCEN. GTOs have morphed over the years from very specific locations (Manhattan and Miami-Dade County) to over 20 counties across the U.S. and went from a multimillion-dollar minimum ($3 million and $1 million) purchase price down to $300,000 applicable to all 22 named counties. Most FIs read these GTO news releases and see them as applying only to the title industry. In addition, most AML officers reasonably assume that if there are FinCEN-released directives, there is some way to ensure title companies are complying with this order. After all, banks and credit unions are highly regulated and they undergo independent as well as federal/state exams throughout a 12-month period. However, there is little to no oversight on title companies to ensure they are complying. State exam requirements for title companies vary from state to state, with California and Texas incorporating exams for compliance every two years and most other states performing no examinations of their title companies (with regard to GTO compliance).
Title companies, regardless of GTO applicability, are not subject to AML requirements. Period. They are included in the statutory definition of FIs (31 USC 5312[a]), yet there are FinCEN exemptions starting in 2003 and then again in 2013 clarifying that only nonbank mortgage lenders are subject to AML requirements.
This leads one to question: Since title companies have little to no accountability and they only make money when a closing is executed, what is the driving force behind their interest in complying? The American Land Title Association, the largest association of title companies and real estate attorneys in the U.S., has a link to the FinCEN GTO announcements on their association website for informational purposes. From a basic communication standpoint, how would one title insurance company in a little town in Miami-Dade County even receive the news release that they should be reporting any purchase of real estate over $300,000 performed by an entity that involves a monetary instrument, cash or personal check?
The GTOs only define the businesses subject to these reporting requirements as title insurance agencies. Therefore, GTOs only narrowly apply to title insurers and not lawyers, private lenders or the plethora of other ways to buy real estate, which leaves a large gap. So, how does this apply to the attorneys involved in real estate closings? They have no requirement to report GTO information to FinCEN. Moreover, lawyers (like title companies) are DNFBPs, which is another industry without AML requirements as noted in FATF’s 2016 Mutual Evaluation.
The Federal Financial Institutions Examination Council Bank Secrecy Act/Anti-Money Laundering Examination Manual does not explicitly list a title insurance company as a nonbank financial institution (NBFI), but it is implied in the manual’s definition, as it states the regulations “are not limited to” the explicitly listed industries. While FinCEN provides some relief in terms of institutions not being the de facto regulator of certain industries, it does not relieve them of reputational risk and possible criticism for not performing appropriate due diligence on their NBFIs. Essentially, institutions are expected to manage risk associated with NBFIs but are not held responsible for the NBFIs’ compliance with the Bank Secrecy Act or other regulations. What is left is transferred risk exposure—someone has to own it because the risk exists. Unfortunately, regulated institutions hold that net risk exposure more than title companies themselves. Unless an institution is staffed with the best in-house attorneys, most institutions will have a hard time walking back a customer due diligence (CDD) effectiveness exam finding by quoting that they are not the de facto regulator—especially if there is an underlying effectiveness issue.
Unfortunately, it does not stop there. If an institution banks title companies, it is easy to spot them as they are usually the high-flyers for wires—millions of dollars of wires coming in and going out with little to no visibility of the institution to see on whose behalf the wires are sent or received. These unregulated industries, specifically title companies, also chip away at the efficiency of the monitoring program because they are always showing up. However, there is not much an institution can do other than attempt to look up open-source information on the properties bought/sold in the case that information was passed through on the wire detail.
In addition, wires are part of the industry issue that technology and some fintechs have stepped in to help resolve. Wires take too long and various areas of the closing process are fraught with fraud. However, that seems to cast more shadows onto the already nebulous areas of money laundering and terrorist financing risk. Therefore, there are now payment companies that are leveraging the automated clearing house system existing funds with different payment flows, which have less information than wires to help speed up closings. These new payment companies are also mainly unregulated due to more FinCEN exemptions regarding payment processing.
With all that said, what is the solution? Well, it is difficult to unwind and even more difficult to pinpoint the right fix for this expanding area of risk. It certainly will not be cured with one party taking the majority of the burden. The best possible plan of attack is to use the trusty risk-based approach. The greatest area of risk seems to be a mainly unregulated (AML-wise) real estate market, from agents to title companies.
One size does not fit all; however, there are several groups within the real estate market that should be subject to certain AML requirements. For example, title companies (and all businesses involved in real estate closings) should have basic suspicious activity report requirements, broad GTO-like reporting, along with state-level AML-focused exams. Real estate agents and brokers should be required to both conduct CDD and report suspicious activity. The FATF released clear guidance over a decade ago as to how a country should regulate their real estate sector2 along with examples of how real estate is used in terrorist financing and money laundering.3 The GTO requirements issued by the U.S. seem to be a nod to this FATF guidance. However, without “teeth” or some regulatory body to enforce it, these requirements will not move the ball further down the field. It simply continues to transfer risk exposure of varying types to the regulated party in the flow of funds, which are banks and credit unions.
More specifically, the onus is placed on the already heavily regulated and examined depository FIs that bank these title insurance companies and attorneys involved in real estate. Moreover, because these NBFIs have essentially zero oversight, it shifts the burden on the institutions to perform enhanced due diligence (EDD) and ongoing due diligence. Add in title companies subject to GTO reporting and it expands the risk exposure of the institution banking them. Most institutions try to manage the obvious higher-risk title companies by looking at those depositing cash but without the cash element, there is a brick wall between the institution and the title company, which leads the institution to assume the title company is doing what it is supposed to be doing.
What to Do
First, regulated institutions should work with their lobbying groups and emphasize that dropping the cash-reporting threshold is not the best way to bring efficiency and effectiveness to AML compliance. Rather, lobbying groups for institutions should be encouraged to lobby for the regulation of other industries, such as title companies, that bring undue risk exposure for their clients, regulated institutions. Will this happen? Probably not, but it is worth a try. At the same time, legislative moves can and should be made to staff federal law enforcement oversight functions appropriately to ensure that if legislation is passed, there is some level of plausible enforcement for the requirements.
Second, regulated institutions should be incorporating GTO risk and compliance as part of their CDD and EDD processes. Most regional and community institutions are not asking their title company clients if they are complying with the GTO requirements. Aim to handle this in the same vein as currency transaction report exemptions that ask the customer to attest to a statement of compliance. If banking title companies is an attractive customer base for management or the board, consider utilizing an educational pamphlet based on FinCEN guidance. In addition, if title companies are depositing cash (even non-reportable levels) and they are in a GTO or offer their services to GTO-areas, this could and should be an indication that the title company is aware of and complying with the GTO. If institutions are very invested in commercial lending and/or have a large portfolio of real estate agents or mortgage lenders, taking the spirit of the GTO requirements and applying that to the related industries to title companies would mitigate risk.
Third, take the time to assess the transferred risk exposure within the title company space. Even if institutions or title companies do not fall into the GTO-named geographic regions, there is still risk within these unregulated customers. If there is a group of title companies, consider extracting them from volume-centric transaction monitoring rules and making them subject to their own rules. Most times, institutions increase their dollar volume rules because of a few high-flyers like title companies. However, these high-flyers could be clouding the view of risky customers that are performing high, but not as high, wires.
Lastly, educate the board and senior management of the risks and work involved in banking title companies. Most bankers are unaware of the nuances, lack of oversight and ways in which title companies and real estate in general can be used to finance terrorism or launder money. The FATF guidance mentioned earlier provide clear examples that can be leveraged for education and awareness.
- “United States’ measures to combat money laundering and terrorist financing,” Financial Action Task Force, December 2016, https://www.fatf-gafi.org/publications/mutualevaluations/documents/mer-united-states-2016.html
- “RBA Guidance for Real Estate Agents,” Financial Action Task Force, June 17, 2008, https://www.fatf-gafi.org/media/fatf/documents/reports/RBA Guidance for Real Estate Agents.pdf
- “Money Laundering & Terrorist Financing Through the Real Estate Sector,” Financial Action Task Force, June 29, 2007, https://www.fatf-gafi.org/media/fatf/documents/reports/ML and TF through the Real Estate Sector.pdf