On January 25, 2023, the US Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) issued an alert to financial institutions regarding potential investments in the US commercial real estate (“CRE”) sector by sanctioned Russian individuals, their family members, and entities through which they act (“Alert”).
The Alert complements an earlier alert that FinCEN issued in March 2022, shortly after Russia invaded Ukraine. Our coverage of the March 2022 alert can be found here.
In addition to reminding US financial institutions of their reporting obligations under the Bank Secrecy Act (“BSA”), the Alert identifies sanctions-evasion vulnerabilities specific to the CRE market, including four potential evasion methods, and lists nine red flags that financial institutions should consider when assessing the risks associated with a given customer or transaction.
Methods of Sanctions Evasion in the CRE Market
Due to the financial costs and tax and legal risks involved, investors in CRE transactions tend to use legal entities such as trusts, shell companies, and pooled investment vehicles to make their investments. These entities often have multi-layered and opaque ownership structures that can make it difficult for financial institutions to identify the beneficial owners. Although FinCEN acknowledges the legality and utility of complex investment structures that are based on legitimate business needs, it cautions that the lack of transparency, along with the stability of returns, in the CRE market may have attracted a significant number illicit actors, including sanctioned Russians and their proxies.
The Alert outlines some of the most common methods for sanctions evasion in the CRE market, including:
- Pooled investment vehicles or funds – By keeping their ownership interest in a pooled investment vehicle or fund below a certain threshold (usually 25% or 10%), sanctioned parties can avoid detection by financial institutions’ customer due diligence (“CDD”) and beneficial ownership screenings.
- Shell companies and trusts – Similarly, sanctioned parties might hide their ownership interest in a commercial property behind multiple layers of legal entities and trusts, often spread across multiple jurisdictions, making it difficult for financial institutions to identify the ultimate beneficial owners.
- Third-party involvement – Sanctioned parties might also enlist relatives, friends, or business associates to act on their behalf in creating legal entities or trusts through which to invest in CRE projects.
- Inconspicuous CRE investments – FinCEN warns that the sanctions-evasion vulnerabilities of the CRE market are not restricted to luxury or high-end properties or properties located in major markets, noting that inconspicuous commercial properties located in small- and mid-sized markets could be targeted as vehicles for sanctions evasion. The Alert also notes that the CRE market encompasses any property used for investment or income-generating purposes, which covers a broad range of property types, including multifamily housing, offices, retail stores, hotels, and industrial properties.
Adding to financial institutions’ difficulties, a single CRE transaction could involve a combination of any and all of the methods described above.
Red Flags Identified
The Alert lists the following red flags that financial institutions should watch for:
Involvement of persons associated with sanctioned party
- The use of an offshore private investment vehicle that includes politically exposed persons (“PEPs”) or other foreign nationals (e.g., family members or close associates of sanctioned persons and their proxies) as investors.
- The use of legal entities or arrangements, such as trusts, that involve friends, associates, family members, or others with a close connection to sanctioned Russian parties and their proxies.
Prior transfer of assets or interest from sanctioned party
- Transfers of assets from a PEP or Russian sanctions target to a family member, business associate, or associated trust around the same time as an arrest or a sanctions designation.
- Submissions of revised ownership disclosures to financial institutions showing that sanctioned individuals or PEPs who previously owned more than 50 percent of a fund changed their ownership to less than 50 percent.
- The use of legal instruments, such as deeds of exclusion, that are designed to transfer an interest in CRE from a PEP or Russian sanctions target to a family member, business associate, or associated trust when triggered by a legal event such as an arrest or a sanctions designation of that person.
Evasiveness regarding beneficial ownership
- Customers who decline to provide information when asked about the ultimate beneficial owners or controllers of a legal entity or arrangement.
Complex structure with little discernible business benefit
- Multiple limited liability companies, corporations, partnerships, or trusts—often with slight name variations—involved in a transaction with ties to sanctioned Russian parties.
- No clear business purpose for ownership of CRE through legal entities in multiple jurisdictions (often involving a trust based outside the United States).
Investment does not fit typical business activity
- Lack of a discernible business value in the CRE investment or the investment is outside of the client’s normal business operations.
FinCEN Recommendations and BSA Reporting Requirements
FinCEN advises BSA-regulated financial institutions to apply a risk-based approach to identifying potential sanctions evasion. It notes that banks are best positioned to identify and report suspicious activities in the CRE sector given their frequent work with developers, investors, and other types of companies involved in the sector. FinCEN also encourages financial institutions to share information with one another pursuant to Section 314(b) of the USA PATRIOT Act, which allows them to do so under a safe harbor that offers protections from liability. The Alert also reminds financial institutions of their BSA reporting obligations, particularly with respect to Suspicious Activity Reports (“SAR”) if they know, suspect, or have reason to suspect an actual or attempted transaction involves funds derived from illegal activity or is designed to disguise the funds’ illegal source; is designed to evade BSA regulations; lacks a business or apparent lawful purpose; or involves the use of financial institutions to facilitate criminal activity, including the evasion of sanctions. When filing a SAR, the accompanying narrative should indicate a connection between the suspicious activity being reported and the activities highlighted in the Alert by including the term “FIN-2023-RUSSIACRE.” FinCEN further advises that financial institutions can expedite their reports of suspicious transactions related to the Alert can call FinCEN’s Financial Institutions Toll-Free Hotline at: 866-556-3974.
