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FinCEN Proposes to Require Mortgage Lenders and Originators to Report Suspicious Transactions and to Develop Anti-Money Laundering Policies
By Patty Covington and Meghan Musselman

On December 9, 2010, the Financial Crimes Enforcement Network (FinCEN) issued a proposed rule that would subject residential mortgage lenders and originators to certain provisions of the Bank Secrecy Act (BSA); specifically, requiring them to file Suspicious Activity Reports (SARs) and establish anti-money laundering (AML) programs. The financial services community is not a stranger to the BSA. For years, other types of entities, including banks, money services businesses, mutual funds and insurance companies have been required to keep records, file reports and maintain an AML program. FinCEN now seems poised to expand these BSA requirements to other types of financial institutions, starting with a subset of loan and finance companies – residential mortgage lenders and originators.

The statutory authority for FinCEN to apply the BSA to other financial institutions has existed for years. In fact, as to AML programs, § 5318(h) of Title 31 of the U.S. Code requires “financial institutions,” a defined term that includes loan and finance companies, to implement and maintain an AML program. FinCEN issued a temporary exemption from this definition for financial institutions on two separate occasions, April 29, 2002, and again on November 6, 2002. Since then, FinCEN has twice surveyed the possibility of imposing BSA requirements on participants in the mortgage industry. On April 10, 2003, FinCEN issued an advance notice of proposed rulemaking regarding AML requirements for “persons involved in real estate closings and settlements.” Then on July 21, 2009, FinCEN issued an advance notice of proposed rulemaking (ANPRM) querying specifically about AML program and SAR filing requirements on non-bank residential mortgage lenders and originators.

Analysis of the data collected by FinCEN supports the application of the SAR filing and AML program requirements to mortgage lenders and originators. Since 2006, FinCEN has been visibly monitoring fraud in the mortgage arena, and even maintains a webpage on the subject (see http://www.fincen.gov/mortgagefraud.html). In addition, FinCEN seems to want to join the federal movement to reduce abuse and fraud with respect to mortgages. FinCEN believes that doing so will complement its own mission of conducting intelligence and counterintelligence to protect against criminal activities and terrorism. In its December 6, 2010 release, available at http://www.fincen.gov/news_room/nr/html/20101206.html, FinCEN states that the “new regulations requiring non-bank residential mortgage lenders and originators to adopt AML programs and report suspicious transactions would be consistent with those business’s due diligence and information collection processes to assess creditworthiness in lending, and could augment FinCEN’s initiatives in this area.” FinCEN also cites the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act) rules, particularly, the nationwide licensing system and registry for certain mortgage professionals, as enhancing the proposed SAR filing and AML program requirements.

As proposed, the rule will impose only two BSA requirements, the filing of SARs and the implementing and maintaining an AML program. FinCEN has heeded comments on its July 21, 2009 ANPRM, which urged FinCEN to limit the BSA requirements to only these two items. FinCEN agrees that an incremental approach to applying the BSA to loan and finance companies is appropriate. FinCEN did reserve the right to later impose other BSA regulations, including Currency Transaction Report (CTR) requirements. FinCEN would like comments on whether it should consider other BSA regulations in addition to AML program and SAR filing requirements.

The proposed rule would apply to a “loan or finance company,” which is defined narrowly to include residential mortgage lenders and residential mortgage originators. Residential mortgage lender is defined as “the person to whom the debt arising from a residential mortgage loan is initially payable on the face of the evidence of indebtedness or, if there is no such evidence of indebtedness, by agreement, or to whom the obligation is initially assigned at or immediately after settlement.” Residential mortgage originator is defined as a person who “takes a residential mortgage loan application and offers or negotiates terms of a residential mortgage loan for compensation or gain.”

“Residential mortgage loan” is defined as any loan secured by a mortgage, deed of trust, or other equivalent security interest on a 1 to 4 family residential structure or real estate on which a residential structure will be built. The definition is intended to capture any loan secured by residential real property (including condominiums, coops and mobile homes), regardless of the purpose of the transaction. Therefore, in addition to mortgages on primary residences, the rule would govern mortgages on vacation or investment properties, as well as refinancing transactions and time shares.

The rule would not apply to individuals employed by a loan or finance company or other financial institution. FinCEN does not intend to regulate individuals, but rather businesses, including sole proprietorships. Also exempt are real estate agents and other persons involved in real estate closings, and seller-financed transactions.

The rule would require mortgage lenders and originators to do two things under the BSA: (1) file SARs in connection with suspicious transactions; and (2) establish an AML program.

A SAR is required in connection with a transaction that is conducted by, at or through a mortgage lender or originator, involving at least $5,000 in funds or other assets, and the mortgage lender or originator knows, suspects, or has reason to suspect that the transaction:

1. Involves funds derived from illegal activity or is intended or conducted to hide or disguise funds or assets derived from illegal activity;

2. Is designed, whether through structuring or other means, to evade the requirements of the BSA;

3. Has no business or apparent lawful purpose, and the loan or finance company knows of no reasonable explanation for the transaction after examining the available facts; or

4. Involves the use of the loan or finance company to facilitate criminal activity.

If the loan or finance company detects a suspicious transaction, it must file a SAR with FinCEN within 30 days. If the situation requires immediate attention, such as suspected terrorist financing or an ongoing money laundering scheme, the mortgage lender or originator must immediately notify the appropriate law enforcement agency in addition to filing a SAR. The loan or finance company must collect and maintain supporting documentation relating to each SAR and make that information available to any federal, state or local regulator that conducts an examination for BSA compliance. Loan or finance companies must maintain a copy of the SAR and any supporting documentation for five years.

The proposal would also require loan or finance companies to develop an AML program that is reasonably designed to prevent the loan or finance company from being used to facilitate money laundering or the financing of terrorist activities. The proposal would establish the following minimum requirements for an AML policy:

1. Incorporate policies, procedures and internal controls based on the mortgage lender or originator’s assessment of the money laundering and terrorist financing risks associated with its policies.

2. Designate a compliance officer who will be responsible for ensuring that the AML program is implemented effectively and updated as needed, and that appropriate persons are educated and trained.

3. Provide for ongoing training of appropriate persons with respect to their responsibilities under the AML program.

4. Provide for independent testing to monitor and maintain an adequate program, including testing of the company’s agents and brokers.

As discussed above, FinCEN has hinted that the proposed rule is the first in likely a series of incremental expansions of BSA regulation. Additional BSA requirements may be imposed on mortgage lenders and originators, and others in the financial services industry, in particular those in consumer credit, may face SAR filing and AML program obligations.

FinCEN is accepting comments on the proposed rule until February 7, 2011.

Patty Covington is a partner in the Maryland office of Hudson Cook, LLP. Patty can be reached at 410-865-5409 or by email at pcovington@hudco.com.

Meghan Musselman is a partner in the Maryland office of Hudson Cook, LLP. Meghan can be reached at 410-865-5403 or by email at mmusselman@hudco.com.

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