The U.S. government has new laws and rules intended to stop financial transaction involving known terrorists and their organizations. Mortgate bankers and brokers need to know how these rules apply to them and the stiff penalties for breaking them.
MANY OF YOU MIGHT BE SURPRISED TO HEAR THAT several provisions of the anti-terrorism laws apply to mortgage bankers. Over the past few years, lawmakers have cast the legal net broadly to prohibit the financing of certain terrorists, terrorist organizations and countries that support them.
In the wake of Sept. 11, Congress and President Bush put renewed emphasis on enforcement tools to thwart the ability of terrorists to finance attacks on U.S. citizens and interests. We expect that new regulations will follow in the coming months.
The anti-terrorism laws apply to all U.S. persons and entities here and abroad. ("U.S. persons" refers to any U.S. citizen, permanent resident alien, entity organized under the laws of the United States--including foreign branches--or any person or entity in the United States.) As a result, industries not typically thought of as terrorist havens--including mortgage banking--are included under this broad umbrella and must be wary when engaging in any kind of financial transaction. As recent events have demonstrated, people, companies and industries without their guard up and protections in place may be exactly where terrorists seek to hide their assets.
This article addresses the applicability on the mortgage banking industry of a new executive order and statute arising out of the Sept. 11 attacks on New York and Washington. It also examines, to a lesser extent, other expansive regulations that prohibit transactions with terrorists, terrorist organizations and countries that support terrorism.
The article also discusses compliance issues that are important to the industry. We anticipate that the government will now enforce these laws more vigorously, particularly if the violation relates to an investigation or prosecution of a listed terrorist or terrorist organization. For this reason, it is important for the mortgage banking industry to understand fully its compliance obligations and the significant, and potentially crippling, penalties for noncompliance. The stakes are high.
State of the law
The U.S. government has numerous methods for combating terrorism that affect the everyday business practices of American companies. All businesses should be aware of the statutes and regulations that apply to them.
Although numerous government agencies monitor and enforce statutes and regulations relating to the prevention of terrorism, foremost among them is the Department of the Treasury's Office of Foreign Assets Control.
OFAC develops, promulgates, administers and enforces economic and trade sanctions (including the freezing and blocking of assets) against targeted foreign countries, terrorism-sponsoring organizations and international narcotics traffickers under a number of statutes. Over the last four decades, and most recently in response to the Sept. 11 attacks, OFAC has had several expansive laws and regulations at its disposal to block and freeze assets of known individuals and organizations associated with international terrorism. These include the following:
* Executive Order 13224--Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism;
* Uniting and Strengthening America by Providing the Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (The Patriot Act);
* 31 Code of Federal Regulations (C.F.R.) Part 595 (Terrorism Sanctions Regulations);
* 31 C.F.R. Part 596 (Terrorism List Governments Sanctions Regulations); and
* 31 C.F.R. Part 597 (Foreign Terrorist Organizations Sanctions Regulations).
The executive order, statute and regulations identify certain designated individuals, organizations and countries and essentially bar U.S. persons and entities from doing business with them. In addition to the list of names and organizations in the order and regulations themselves, OFAC publishes updated lists of "blocked" individuals, entities and countries by category (e.g., specially designated terrorists and drug traffickers) on its Web site (www.treas.gov/ofac). The OFAC Web site also includes a complete list of all blocked individuals and entities, the "specially designated nationals and blocked persons" list (www.treas.gov/ofac/t11sdn.pdf).
Executive Order 13224
Executive Order 13224, issued on Sept. 24, 2001, aims to deny financing, financial services or anything of value to terrorists, terrorist organizations and anyone who otherwise supports or assists terrorists or terrorist organizations. To achieve this goal, the order blocks "all property and interests in property" of specially designated terrorists, resulting in an immediate, across-the-board prohibition against transfers or transactions of any kind with respect to such property or interests in property in the United States, property that comes within the United States or comes within the possession of United States persons.
"Blocking" or "freezing" is simply a manner of taking control over assets without requiring transfer of title. The order prohibits not only the transactions themselves, but any transaction, either by a U.S. person or any person within the United States who evades or avoids, has the purpose of evading or avoiding, or attempts or conspires to violate any provision of the order.
Key terms of the order are defined and will be interpreted broadly. For example, although the term "property" is not described in the order itself, it is commonly defined throughout the anti-terrorism regulations to include anything of value.
The Patriot Act
The Uniting and Strengthening America by Providing the Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (The Patriot Act) was passed on Oct. 26, 2001. The law enhances the money-laundering statutes and generally provides additional tools to law enforcement authorities to prevent and obstruct terrorism.
Although it is not yet clear to whom all of the statutory provisions apply, certain provisions, including those described here, will apply to mortgage bankers and brokers.
The Anti-Money Laundering Programs section provides that financial institutions, which by definition include loan or finance companies, must establish an anti-money-laundering program including, at a minimum, internal policies and controls, a compliance officer, ongoing employee training and an independent audit function to test programs. The Treasury Department may exempt loan companies through regulation, but until then, such companies must comply.
The Reports Relating to Coins and Currency Received in Non-Financial Trade or Business section mandates that any person who is engaged in trade or business must report any receipt of more than $10,000 in coin or currency in a single transaction or two or more related transactions. This section broadens the scope of the currency transaction report (CTR) provisions and requirements of the Bank Secrecy Act.
The Treasury Department is expected to promulgate implementing regulations to clarify the scope and applicability of the Patriot Act provisions. In addition, the U.S. Sentencing Commission is expected to adopt proposed amendments to the United States Sentencing Guidelines (USSG) that will provide for significant upward adjustments for terrorism-related crimes, and may further elucidate Patriot Act anti-terrorism provisions. Therefore, as with Executive Order 13224, these provisions should be read broadly until the applicability and scope are clarified.
Code of Federal Regulations
The Code of Federal Regulations contains several anti-terrorism regulations that already apply to mortgage bankers and brokers. These regulations historically have not had much practical effect on commercial mortgage bankers and brokers within the United States. Recent events, however, have changed that for two reasons. First, OFAC has now identified individuals and entities located within the United States as specially designated foreign terrorists. Second, law enforcement and government agencies have substantially increased enforcement activities regarding all anti-terrorism--related laws and regulations since the Sept. 11 terrorist attacks.
Title 31 of the C.F.R. contains the applicable regulations relating to terrorism. The three sections that are particularly relevant and applicable to mortgage bankers and brokers are parts 595, 596 and 597 Together, these parts contain broad prohibitions against transactions by or through U.S. persons or entities, or on U.S. soil, with designated individuals, organizations and countries.
In addition, these parts mandate how blocked property must be maintained, if received, and impose specific reporting requirements on those who come into contact with the blocked property. Again, the regulations' terms are defined, and will be interpreted, broadly.
The executive order, statute and regulations provide for significant civil and criminal penalties. Although criminal violations require some type of "willful" violation, certain civil penalties may be imposed on a strict liability standard. Such penalties include a maximum possible fine of si 1,000 per violation.
Criminal penalties are more severe, including fines of up to $250,000 for individuals and $500,000 for organizations, fines based on the pecuniary gain from the violation, and/or significant periods of incarceration. In addition, businesses that contract with the government could also face suspension or debarment from government contracting.
The import of these provisions and the stiff penalties imposed on violators is that businesses and individuals must be vigilant in screening all parties with whom they do business. Although no screening process is infallible, demonstrated compliance with routine screening processes and reporting requirements may help businesses convince OFAC of good-faith compliance efforts in the event of an inadvertent or isolated violation.
Among the many compliance issues raised within the industry in the wake of new legislation and increased enforcement efforts, the most common questions relate to the screening process.
Mortgage bankers and brokers should screen all service providers and borrowers with whom they do business. In addition to new lending transactions, lenders should screen borrowers involved in refinancings and extensions of existing credit. Businesses should also be aware that the regulations apply in other contexts as well, including internal financial transactions such as employee payrolls.
Using tracking software is preferable when searching for blocked persons, because it corrects for human error (i.e., typographical errors), checks for multiple spellings of a name and automatically updates the list. Software is fast becoming the standard for due diligence in compliance programs. Notably, in the case of a blocked person whose name goes undetected, OFAC considers the use of software favorably as a mitigating factor in determining whether and to what extent a penalty is warranted. Most of this type of software is sophisticated and expensive. However, groups are working to develop a range of cost-effective software for smaller companies.
If a mortgage banker or broker encounters a match with a designated individual or entity on the government's list of blocked individuals, it should attempt to discretely obtain additional information to eliminate the possibility of a "false positive." A false positive occurs when a person's name matches a name on the list, but he or she is not the same person as the person listed; they merely share the same name. Information such as an address, Social Security number or tax returns will typically differentiate between a blocked person and someone with whom a mortgage banker or broker can do business.
If a mortgage banker or broker identifies a true match, it should halt all work on the transaction, freeze all funds or assets in its control and call OFAG, the FBI or the police to determine how to proceed and how to handle the blocked person or entity. The lender must file a report on all funds or assets frozen. If the lender has no funds or assets, there is no reporting requirement. However, it should still call OFAC, the FBI or the police to let them know what the blocked person or entity was attempting to do.
Eliminating the possibility of a false positive will typically require contacting OFAC to review any additional information the lender has obtained, and receiving assurances from OFAG that the person is not blocked. OFAC's assurance, however, does not constitute assurance that no enforcement action will be taken.
While the time constraints of individual transactions may not permit its use, there is another protective measure in place. The Specific License Application is 'a mechanism by which mortgage bankers or brokers may apply to OFAC for permission to conduct business with a person or entity whose name is on the list. Generally, these licenses are used for the limited exceptions of humanitarian or educational purposes. However, the licenses may be the only route enabling the mortgage banker or broker to do business with complete legal protection with a person whose identity comes up as a false positive, especially if a mistake is made and the person or entity later proves to be the listed blocked person or entity.
Reports must be filed (preferably faxed) with OFAG within 10 days of blocking. The report must identify the following: the owner or account party; the property; the property's location; any existing or new account number or similar reference necessary to identify the property; actual or estimated value; the date it was blocked and a photocopy of the payment or transfer instructions. All such reports must be maintained by the mortgage banker or broker for five years. OFAG also requires the filing of comprehensive annual reports by Sept. 30 on blocked property held as of June 30.
Fannie and Freddie requirements
Although no regulatory guidance regarding Executive Order 13224 or the Patriot Act is available to date, two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, have issued compliance requirements for companies that sell mortgages to them.
Fannie Mae's Announcement 01-09 (Nov. 9, 2001) and DUS (Delegated Underwriting and Servicing) Lender Letter Special Alert 2001-30 (Nov. 9, 2001) and Freddie Mac's Developments (December 2001) require multifamily lenders doing business with the GSEs as mortgage originators to comply with all relevant laws, including Executive Order 13224. Fannie Mae's Announcement 01-09 (Nov. 9, 2001) also applies to single-family lenders.
Both GSEs require lenders to check all relevant parties against the list of specially designated nationals. Although the Fannie Mae announcement specifically references the list of specially designated terrorists, Fannie Mae intends for its lenders to check all names against the complete list of blocked entities (i.e., the comprehensive list of specially designated nationals available on OFAC's Web site).
In addition to general compliance with applicable law, multifamily lenders selling to Freddie Mac must certify to Freddie Mac, prior to rate lock, that the lender has checked the relevant parties against the list of specially designated nationals on the day the lender makes the certification. Because Freddie Mac participates in the credit decision for multifamily loans it purchases, it has assumed an obligation to independently check the names against the list of specially designated nationals before it issues a commitment or countersigns the rate. With regard to single-family loans, however, no such obligation exists because Freddie Mac purchases its loans in large pools and has no contact with the borrower.
Both GSEs have suggested as a rule of thumb that, at minimum, originators should cross-check the names of all persons underwritten against the specially designated nationals list. According to Freddie Mac, originators should check all borrowers, co-borrowers, guarantors and principals (any general partner, any 25 percent equity owner and any 25 percent trust beneficiary).
Although both GSEs have published guidance regarding the new anti-terrorism provisions, in their publications each reserves the right to change its stated position as events or circumstances warrant. Further, each makes it clear that lenders should seek their own counsel for advice regarding how to comply with new and existing laws.
Equal Credit Opportunity Act refresher
Despite the broad requirements on mortgage bankers and brokers, we remind all businesses that a creditor cannot refuse or discourage applications from borrowers of a particular race, national origin or religion. The Equal Credit Opportunity Act (ECOA), applicable to any creditor or person who participates in the credit decision, prohibits creditors from discriminating on any prohibited basis, including, but not limited to, race, religion and national origin.
The bottom line
The latest regulations and emphasis on anti-terrorism enforcement are a wake-up call to all businesses, including those in the mortgage banking industry. Although there has been little practical guidance on how to implement these laws in the mortgage banking business, we expect this will come in time. In informal discussions, OFAG representatives have stated that OFAG does not seek to handcuff businesses. However, OFAC expects ordinary due diligence with respect to all applicable transactions. Indifference to, ignorance or affirmative rejection of the regulations will likely be treated harshly.
The best defense for businesses is to educate management and other key employees to address changes in the law as they arise and to develop proactive compliance strategies before becoming the subject of a government investigation or enforcement action.
Should a government official contact one of your employees to inquire about a potential violation, your company should immediately contact in-house or outside counsel to review the matter and assist in preparing appropriate responses. Sloppy, incomplete or uninformed responses can create as much havoc as the violation itself. It might also cause the government to suspect malice is afoot.
Taking these precautions early will help protect the organization and individuals from potentially crippling penalties and ensure their legal rights are respected.
Gary S. Smuckler, Mark N. Bravin, Lisa E. O'Donald and Amy J. Conway are attorneys at Morgan, Lewis & Bockius LLP, Washington, D.C. Smuckler, a partner in the real estate section, represents lenders and servicers under the multifamily programs of Fannie Mae, Freddie Mac and private mortgage conduits, as well as mortgage bankers and financial institutions. Bravin, a partner in the litigation practice section, specializes in transnational litigation and manages the firm's customs and international regulations practice. ODonald, an associate in the real estate section, focuses on regulatory and compliance issues within the banking and real estate areas. Conway, an associate in the litigation sections corporate investigations and criminal defense practice group, specializes in compliance issues, internal investigations and white-collar criminal defense The content of this article is for informational purposes only and does not constitute legal advice.…