9/22/2014: Money Laundering and Real Estate – This webcast talks about money laundering, more specifically the dangers of money laundering and inadvertent money laundering.
The practical inability of marijuana entrepreneurs to deposit funds into banks, combined with low interest rates (which reduces the opportunity cost for sellers to hold cash outside of financial institutions) creates pressure to use real estate transaction to launder money. Learn how to spot the red flags of money laundering and the risks associated with it.
Money Laundering Anecdote
Let me start with a little anecdote, this anecdote is probably from about 20 years ago but I had a client, this client was a listing brokerage company, they had a property listed, it had sat for a long time and along comes a buyer that wants to buy the property. The buyer wanted to put up earnest and I don’t remember the exact figure but for purposes of this discussion let’s just say that the buyer wanted to put up earnest money of $18,000 in cash. Now there is nothing unusual about that except that this buyer wanted to put up the $18,000 of earnest money in cash. And my client was smart enough to know that if the buyer handed my client, the real estate broker, $18,000 in cash and then the broker deposited $18,000 or tried to deposit that $18,000 cash into that brokerage firms trust account that it would trigger certain reporting obligations of the bank, something that we call a suspicious activities report, and that suspicious activities report had the potential to cause problems for the buyer. So, what my client in his infinite wisdom, remember I said my client was smart enough to recognize the trigger for the suspicious activities report but the way my client intended to avoid the suspicious activities report is to deposit the $18,000 in two chunks. At least the way I remember it, and I am probably embellishing this a little bit, but what he did is he took say $9,000 of that money, in his car, drove up to the drive up window and made a deposit through the drive up window of $9,000. His assistant then in the car right behind him made a deposit of another $9,000, into the same account. That obviously was not successful in avoiding the suspicious activities report. In fact, breaking up large sums of money to try and get under the $10,000 figure is called structuring and is also a violation of the money laundering laws. I can’t tell you that my client was criminally prosecuted but it came to my attention because it came to the attention of his regulatory body, the Division of Real Estate of the Estate of Colorado and my client was disciplined for that activity.
Real Estate Earnest Money Deposit to Launder Money
Now, just to be clear, what was probably happening in that scenario is something trendy, more toward 20 years ago, is that one of the ways of laundering money was that people with cash, who had earned this cash through elicit purposes would use it for earnest money deposits to buy real property. Those contracts would inevitably have contingencies that would excuse the buyer from performing under the contract, the buyer would exercise that contingency, terminate the contract and get a check back, in the example I just gave you for the $18,000 of earnest money. So that is how they converted $18,000 of dirty cash, got it into the banking system and then got a check back. Now it didn’t work, it didn’t work for sums over $18,000 but it did work, probably pretty well for sums under $10,000. I have not personally seen that as money laundering technique in a long time, and would suggest that for two reasons. One of the reasons I don’t think we have seen it for a long time is that over the last twenty years brokerage firms have shied away from holding earnest money trust deposits. At least in my state, the state of Colorado there is a tendency for medium and small brokerage firms to allow title companies to hold these funds and title companies are more sophisticated about these issues. It’s harder to pull the wool over of the eyes of the title companies, and so that is one reason think it has declined. The other reason is that $10,000 is so much less now then it was 20 years ago, I don’t see the use of real estate contracts and earnest money and then the later termination of earnest money of a way for money laundering funds so much anymore.
Money Laundering in Colorado
So, you ask, “Why the heck are we broadcasting this?” The reason I think money laundering is especially relevant topic now at least in the state of Colorado is because for some time now Colorado has had a legalized medical marijuana business and more recently Colorado adopted a form of legalized recreational marijuana use. Because the cultivation, consumption, growing and sale of marijuana is still illegal under federal law, the marijuana entrepreneurs are not allowed to deposit the proceeds of their operations into the federal banking system. It is a cash business and having all that cash flooding around creates tremendous amount of pressure to introduce that cash into the banking system and there is pressure to use real estate to do so.
So, here are just some structures that I think are being contemplated. So again title companies, there is not meaningful way for title companies or reputable lawyers to accept $100,000 and introduce it into the banking system. Because depositing those sums of money will trigger the obligation to report suspicious activities reports and the people that are trying to introduce the money into the banking system are intending to avoid exactly that. So what else can they do? Imagine you have $100,000 in cash, one of the things you can do is find a seller who is willing to accept cash proceeds, close that transaction and not use a title company, not run the money through the title company. The title company can issue a title commitment but just because the title company issues a title commitment and later on issues a policy does not mean that the title company handles the closing. The seller and the buyer essentially meet at a closing, there is a swap let’s say of a deed for $100,000 in cash, there are other details of course, and then the seller has $100,000. Then, the reason there is money laundering risk associated with that now all of a sudden the person has converted, the buyer has converted $100,000 of cash into $100,000 of real property which that owner can then, that buyer can in turn sell on the market place, run that transaction through a title company, the buyer will buy with whatever funds the buyer uses, their own funds, funds that they’ve borrowed, or some combination of the two. Those funds are already in the banking system and the person who had $100,000, who acquired the lot with cash, will walk away from their sale transaction with a check, not for $100,000 right, because they’ll have transactions costs of reselling the property, they may not be so motivated by price, but maybe for a premium of paying essentially $10,000 in transaction costs they will sell that lot for $100,000, walk away with $90,000 in cash and reintroduce the funds into the banking system.
So, who does not need to worry about this? I don’t think the listing broker who lists the property for the person who bought it with cash needs to worry about the resale transaction. Unless that listing broker is aware that their client bought it for cash, because if they are aware that their client bought it for cash then they are arguably part of a conspiracy to convert illicitly earned cash (yes, it still illicit under federal law) into a check, that is money laundering. But the money launderers will hopefully be smart enough to hire listing brokers who are clueless about the source of funds that the money launderers used to buy the dirt. I think the people who have more reason to be concerned about it are the people who are obviously trying to launder money, they are sophisticated players, they are lawyered up, and this broadcast is not designed for them, its more designed for the brokers who might help put that transaction together, that transaction for the cash acquisition of the $100,000 lot where the owner swaps a deed for the cash. Arguably that owner is engaging in criminal activity, arguably the brokers are engaging in criminal activity, part of a conspiracy to enable the person with the cash to launder the funds. If you are asked to be involved in one of those transactions you need to talk to a lawyer in your state, I am in the state of Colorado, if you are outside of the state of Colorado do not talk to me, talk to a lawyer in your state. If you are asked to participate in one of those transactions, and you are inclined to do so, you very much need legal advice to help you analyze, balance and manage that risk. Thank you for your attention. Hope you catch the next one. Be careful out there.