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Due Diligence: Beneficial ownership in real estate transactions

In March 2019, Transparency International Canada released a comprehensive report examining the ways in which Canada’s “lack of beneficial ownership transparency” contributes to money laundering (or “snow-washing”, as it’s known up North) within the Toronto real estate market.

The report points to serious weaknesses in anti-money laundering policies (AML) in the real estate sector, through which Canada’s property registers allow real estate purchases to be made through straw men, including shell companies and nominee buyers. Additionally, large-scale real estate purchases are often made through cash transactions, thereby circumventing scrutiny from lenders. The report found that 35 percent of the properties acquired by corporate entities in the Greater Toronto Area between 2008 and 2018 were paid for through cash transactions; and the overall percentage has been rising: in 2018 nearly half of these purchases were made in cash.

As the report points out, the lack of AML policy in the Canadian real estate market makes cities such as Vancouver and Toronto attractive destinations for dirty money. Furthermore, the situation creates “perverse incentives” for launderers to overstate the value of properties, causing negative effects in already tight real estate markets, and posing serious risks to unknowing partners.

The report gives the example of CLJ Everest Ltd, a shell company controlled by “disgraced fund manager and alleged fraudster Clayton Smith”. Reportedly, CLJ Everest acquired a “sprawling” CAD 2.7 million ($2 million) dollar estate in a Toronto suburb with misappropriated investor funds in January 2015. Reportedly, the property was later sold by court appointed receivers in 2018 for a substantial loss.

Second Act. On March 29, 2019, The National Law Review blog posted part two of an analysis on a trio of bills proposed by the House Financial Services Committee to reform and modernize the Bank Secrecy Act (BSA), Anti-Money-Laundering law, and Combating the Financing of Terrorism law. The post focused on the proposed bill for the Corporate Transparency Act of 2019. The Act, which was previously introduced in 2017 with bipartisan support, would reportedly “amend the BSA to compel the Secretary of Treasury to set minimum standards for state incorporation practices” such that all US states would be required to collect beneficial ownership information from LLCs and corporations and report this information to the Financial Crimes Enforcement Network (FinCEN).

Reportedly, the goal of the proposed Act is to “bolster the beneficial ownership identification requirements to prevent the use of shell companies for various illicit reasons, including facilitating tax and money laundering schemes as seen in the Panama Papers scandal”.

On March 13, 2019, The Real Deal reported on Congresswoman Carolyn Maloney’s decision to reintroduce the Corporate Transparency Act, which she also championed in its 2017 form. Maloney stated that the Act is meant to empower law enforcement in the investigation of financial crimes:

Law enforcement tells me that whenever they’re following the money in an investigation, they always hit a dead end at an anonymous shell company.

The article noted that this bill follows other regulations designed to reduce anonymous activity in the real estate sector. For example, in November 2018, the Treasury Department expanded the Geographic Targeting Order, which requires that LLCs provide the identities of buyers who spend $300,000 or more in 12 major real estate markets, including the New York City, Miami, Los Angeles, Chicago, and San Francisco metro areas.

“Rotten Onion.” While the abovementioned study by TI Canada and the proposed Corporate Transparency Act address the use of shell companies in hiding the ownership of assets, a recent court filing out of Texas highlights one way in which shell companies can be used to obscure a lack of assets.

On March 28, 2019, The Houston Chronicle reported that a federal jury in Houston awarded $15 million to SED Holdings, who purchased a “pool of nonperforming residential mortgage loans five years ago from a shell company that didn’t actually own the loans.”

As described in the complaint, which was initially filed in a Durham, NC Superior Court, the Defendant, 3 Star Properties LLC, sold over 1,000 non-performing mortgage loans to the Plaintiff, SED Holdings LLC. During negotiations, 3 Star represented itself as the owner of the loans, which it characterized as “in good shape and consistent with appropriate industry standards”.

The deal required that SED Holdings use the Defendants TMPS LLC and Mark Hyland as the loan servicer and document custodian for processing the loans in question. As stated in the complaint, following the completion of the deal, SED came to discover that “the loan files were in horrible shape: many of them were missing critical paperwork, many of them were basically empty, and for many of them being offered, there were no loan files whatsoever or the notes had actually been released before the sale to SED.” Furthermore, many of the loans sold to SED by 3 Star were actually owned by TMPS and Hyland.

According to the Houston Chronicle, the jury found that 3 Star was “serving as a pass-through entity to flip the assets for cash, concealing the true owners.” In a press release following the verdict, SED’s trial attorney, Jared Levinthal, described the discovery of the scheme as “like peeling back layers of a rotten onion.”

* * * 

As seen in the above media reports, shell companies can pose a number of problems for prospective investors or partner companies, as opaque ownership structures obscure the true nature of the parties and assets in question. While policy changes may be on the horizon, for now, companies must protect themselves when interacting with unnamed owners.

Due diligence regarding beneficial ownership can assist in overcoming these issues in a number of ways. First, a robust compliance program will often include a questionnaire in which the prospective partner company is asked to supply the names of its beneficial owners. A comprehensive due diligence review can fill in the details regarding these reported beneficial owners, their other business affiliations, possible government or political affiliations, and any unseemly derogatory information in their pasts, providing valuable context for a business engagement.

Even when due diligence is unable to determine a beneficial owner, the investigation may reveal some noteworthy features of the company in question.

A comprehensive compliance review of an entity whose ownership is unknown should seek to address the following questions: Does the company appear to function as a part of a larger group of companies? If so, does this group of companies appear to rely on a scaffolding of various shell organizations for the majority of its deals? Is there any media information regarding the group’s other business relationships or investments? What is the overall reputation of the group? Who is the purported management of the shell company? Do these managers have any other noteworthy business affiliations? Does a legal, regulatory, and media review of the managers suggest any compliance issues or other risk factors?

The answers to these questions can go a long way in assessing the risks in dealing with “black-box” shell entities.


Lauren Caryer, pictured above, is an investigator for the Kreller Group. She conducts domestic and international due diligence with an emphasis on high-risk industries and received a PhD in Philosophy from Emory University in 2016. She can be contacted here

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  1. Great article, Lauren. Coincidentally, FinCEN has indicated that out of identified all-cash transactions from the recent GTO, 30% or thereabouts were associated with subjects of previous SARs! Interestingly enough, you can find a few articles discussing the softening of the luxury real estate markets in major cities (New York in particular I recall) – perhaps the GTOs are chasing away buyers looking for easy ways to stash their loot and this is causing prices to drop?! Thanks again for this informative article!

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