passportThe Internal Revenue Service is moving forward with implementation of a new law requiring the State Department to deny, or revoke, the U.S. passports of individuals who owe the IRS more than $50,000. The passport revocation measure became law in December 2015, when President Obama signed a five-year, $305 billion highway funding bill that included several controversial tax measures designed to help fund the legislation, including authorizing the revocation of passports in the case of unpaid taxes and the use of private debt collectors to collect taxes.

A new provision of the Internal Revenue Code now authorizes the Treasury Secretary to certify, to the Secretary of State, that a taxpayer has a “seriously delinquent tax debt.” According to the IRS website, certifications to the State Department will begin in early 2017. Upon receipt of certification from the IRS, the Secretary of State is authorized to revoke the taxpayer’s passport or impose restrictions on the use of such passport, such as limiting its use to return travel to the U.S. only. The Secretary of State is also prohibiting from issuing a new passport to any individual who has a “seriously delinquent tax debt,” with limited exceptions provided for emergency circumstances or humanitarian reasons. Taxpayers who are serving in combat zones are granted relief from the law’s provisions.

Passport Revocation as a Tax Collection Tool

The threat of passport revocation provides the IRS with a powerful tool to force tax compliance, particularly for non-residents or dual citizens who regularly travel to or from the United States. Until Congress enacted this new law in December 2015, the State Department had no authority to restrict the issuance of passports to individuals because they owed back taxes. In contrast, other federal laws authorize the State Department to deny or revoke the issuance of passports in certain circumstances, such as in the case of individuals with delinquent child support obligations.

Several years ago, the Government Accountability Office studied the potential for using passport issuance/revocation to increase collection of unpaid federal taxes. As part of that study, the GAO found that during fiscal year 2008, the State Department issued passports to more than 224,000 individuals who collectively owed the IRS in excess of $5.8 billion in back taxes. The GAO concluded that even this amount was likely substantially understated, as it did not include amounts owed by taxpayers who did not file a tax return or by businesses associated with such taxpayers.

“Seriously Delinquent Tax Debt”

Under the new law, individuals with “seriously delinquent tax debt” may have their passports revoked or applications for passports denied. “Seriously delinquent tax debt” is defined as a federal tax liability that been assessed and is greater than $50,000 (including interest and penalties), and for which the IRS has either filed a lien or levy. The dollar threshold will be adjusted for inflation every year.

Taxpayers who have entered into installment agreements or offers-in-compromise, or have requested collection due process hearings or innocent spouse relief, are not considered to have “seriously delinquent tax debt” even if they owe the IRS more than $50,000.

New Taxpayer Notifications

The law includes certain safeguards to protect taxpayer rights. Taxpayers who are certified to the Secretary of State as having a “seriously delinquent tax debt,” or whose certifications are subsequently revoked, are entitled to prompt written notice. The IRS will mail “Notice CP 508C” to the taxpayer’s last known address notifying the taxpayer of his or her certification to the State Department for having “seriously delinquent tax debt.”

In addition, the new law amends existing Internal Revenue Code provisions to ensure that taxpayers are warned in advance that they could be subject to U.S. passport denial, revocation or limitation. For example, notices of federal tax lien and notices of intent to levy must now include language advising the taxpayer that they may be certified to the Secretary of State as having a “seriously delinquent tax debt” with attendant passport consequences. The specific language that now appears on IRS levy notices is as follows:

Denial or Revocation of United States Passport
On December 4, 2015, as part of the Fixing America’s Surface Transportation (FAST) Act, Congress enacted section 7345 of the Internal Revenue Code, which requires the Internal Revenue Service to notify the State Department of taxpayers certified as owing a seriously delinquent tax debt. The FAST Act generally prohibits the State Department from issuing or renewing a passport to a taxpayer with seriously delinquent tax debt. Seriously delinquent tax debt means an unpaid, legally enforceable federal tax debt of an individual totaling more than $50,000 for which a Notice of Federal Tax Lien has been filed and all administrative remedies under IRC § 6320 have lapsed or been exhausted, or a levy has been issued. If you are individually liable for tax debt (including penalties and interest) totaling more than $50,000 and you do not pay the amount you owe or make alternate arrangements to pay, we may notify the State Department that your tax debt is seriously delinquent. The State Department generally will not issue or renew a passport to you after we make this notification. If you currently have a valid passport, the State Department may revoke your passport or limit your ability to travel outside of the United States. Additional information on passport certification is available at

Before denying a passport application as a result of a certified tax debt, the State Department will hold such application for a period of 90 days to allow the applicant to either pay the tax liability in full or enter into a payment arrangement with the IRS. Note, however, that the State Department will not grant a similar grace period before revoking a passport as a result of a tax debt.

Taxpayer Options If Certified to the State Department

Once a taxpayer has been certified to the State Department as having “seriously delinquent tax debt,” such certification will only be reversed if (1) the tax debt is fully satisfied or becomes legally unenforceable (such as when the 10-year statute of limitations for collection expires); (2) the tax debt is no longer considered “seriously delinquent”; or (3) the original certification was erroneous. The IRS will provide notice as soon as practicable if the certification is erroneous by mailing “Notice CP 508R” to the taxpayer’s last known address. The IRS will provide notice within 30 days of the date the debt is fully satisfied, becomes legally unenforceable or ceases to be seriously delinquent.

A previously certified debt is no longer considered to be “seriously delinquent” when any of the following occur:

  • the taxpayer enters into an installment agreement with the IRS allowing payment of the debt over time;
  • the IRS accepts an offer-in-compromise to satisfy the debt;
  • the Justice Department enters into a settlement agreement to satisfy the debt as a result of litigation;
  • collection is suspended because the taxpayer requests innocent spouse relief; or
  • the taxpayer submits a timely request for a collection due process hearing in connection with a levy to collect the debt.

The IRS will not reverse certification where a taxpayer requests a collection due process hearing or innocent spouse relief on a tax debt that is not the basis of the certification. Also, the IRS will not reverse the certification simply because the taxpayer makes a payment that brings the debt below $50,000, but not to zero.

Judicial Review

A taxpayer whose debt has been certified to the State Department has the right to challenge such certification by filing suit in the U.S. Tax Court or a federal district court to challenge the certification. A taxpayer may also file suit to challenge an IRS refusal to reverse a certification. If the court determines that the certification was erroneous or should have been reversed, it can order reversal of the certification. The law does not require a taxpayer to exhaust any administrative remedies before filing suit.


The ability to cause passport revocation or denial provides the IRS with powerful leverage over individuals who are delinquent in their tax debts. Taxpayers who owe the IRS more than $50,000 and are concerned about the possibility of passport revocation must take immediate steps to address their outstanding tax liabilities, by either paying such debt in full or seeking to negotiate a collection alternative such as an installment agreement or offer-in-compromise. In addition, because the IRS will mail certification notices to the taxpayer’s last known address, it is critically important that taxpayers ensure that the IRS has an up-to-date address on file so notices are timely received and can be addressed promptly. Individuals who owe the IRS more than $50,000 and fail to heed these warnings will face dire consequences with respect to their ability to travel to and from the United States.

For questions or more information about this alert, please contact Matthew D. Lee at 215.299.2765 or any member of the firm’s Tax Controversy and Litigation practice.

irsOur colleagues Mark McCreary and Kevin Dermody have published an excellent article entitled “Don’t Get Caught in ‘Phishing Season’” on their Privacy Compliance & Data Security blog.  Their article warns of the very real dangers that tax season brings to companies, which are increasingly being targeted by “phishing” or “spear phishing” cyberattack scams.  The goal of such scams is to steal employees’ Form W-2 information during tax season.  This data (which includes employee names, addresses, and Social Security numbers) can then be used by criminals to commit identity theft.

Every year the Internal Revenue Service compiles its “Dirty Dozen” list of common scams that taxpayers may encounter during the annual tax filing season.  For 2017, “phishing” schemes topped the “Dirty Dozen” list.

Previously, we discussed Congress’s enactment of the FAST Act requiring the IRS to use private debt collection agencies to recover inactive tax receivables. In September, the IRS announced that it had contracted with four collection agencies to begin private collection, and last week, the IRS posted to its website a sample of the letter it will send to some taxpayers to notify them that their overdue account has been assigned to a private collection agency (Notice CP40). A copy of the letter can be found here.

The letter contains the name, address and phone number of the private collection agency and notes the following:

  • The private collection agency will explain payment options.
  • The private collection will provide the taxpayer with a payment plan if the taxpayer can’t pay the full amount.
  • Taxpayers should go to for information about how to pay an account that was transferred to a private collection agency.
  • The private collection agency is required to maintain the security and privacy of the taxpayer’s tax information. To do this, it will ask the taxpayer to provide their name and address of record before assisting the taxpayer in resolving his account. Also, it will perform two-party verification by asking the taxpayer for the first five numbers of their taxpayer authentication number at the top of the CP40. The private collection agency will then provide the subsequent five numbers.

The letter also suggests that the taxpayer refer to Publication 4518, What You Can Expect When the IRS Assigns Your Account to a Private Collection Agency. Publication 4518 can be found here and provides answers to questions taxpayers may have when their account has been assigned to a private collection agency including:

  • What will the private collection agency do?

The private collection agency assigned to your account is working on behalf of the IRS. They will send you a letter confirming assignment of your unpaid tax liability and then contact you to resolve your account. They will explain the various payment options and help you choose one that is best for you.

  • How can I be sure it is the private collection agency calling me?

The private collection agency will send you a letter confirming assignment of your tax account. The letter will include the same unique taxpayer authentication number that is on the letter sent to you from the IRS.

  • Who do I make my payments to?

Make all payments to the IRS. The private collection agency can provide information on ways to pay.

Helpful Tips

The private collection agencies must abide by the consumer protection provisions of the Fair Debt Collection Practices Act (the “FDCPA”) and have agreed to be courteous and respectful of taxpayer rights. Under the FDCPA, if a taxpayer sends the private collection agency a letter stating that it does not want to work with the private collection agency and requests that the case be handled by the IRS, the private collection agency must honor the request.

In addition, it is important for taxpayers to be on the lookout for scams, especially around this time of year. Taxpayers should only make payments to the IRS, not the private collection agency. There are electronic payment options for taxpayers on and payments by check should be payable to the U.S. Treasury and sent directly to the IRS, not the private collection agency.

I was recently interviewed by the Wall Street Journal about the IRS LB&I audit campaigns discussed here.  An interesting part of the conversation included a discussion of why the IRS would tell taxpayers what issues they are targeting.  The bottom line is to increase compliance.  The IRS has identified issues it believes a significant number of taxpayers are non-compliant and is focused on those for one reason: to generate revenue and collections.  There are a few things to keep in mind as you evaluate how to respond to the IRS audit campaigns:

  • The use of “soft letters” indicates the IRS is encouraging taxpayers to self-correct.  It is always better to self-correct than to deal with an issue in audit.  Especially when that issue is something the IRS has highlighted publicly as an issue they are targeting.
  • Failure to self-correct may give the IRS a stronger position for asserting penalties.
  • The 13 IRS audit campaigns identified is not a finite list.  It is an initial list which we expect will evolve over time.

Due to budget constraints, it makes sense that the IRS is targeting significant issues and encouraging self-correction which allows the IRS to increase revenues without significant manpower.

You can read the Wall Street Journal article here.

The Internal Revenue Service continues to make frequent use of a relatively unknown information-gathering tool in its nearly decade-old crusade against offshore tax evasion: the “John Doe” summons. A John Doe summons may be used to obtain information and records about a class of unidentified taxpayers if the IRS has a reasonable belief that such taxpayers are engaged in conduct violating the U.S. laws.

Because the identities of the targeted taxpayers are unknown, the summons is denoted with a “John Doe” moniker. Expressly authorized by Internal Revenue Code, a John Doe summons must first be approved by a federal judge before it can be served.

To date, federal judges have authorized the IRS to issue sweeping John Doe summonses for information and records around the globe, in countries including Switzerland, India, the Bahamas, Barbados, Belize, the Cayman Islands, Guernsey, Hong Kong, Malta, the United Kingdom and others.

In its most recent John Doe summons, the IRS obtained authority to summons documents and records relating to the use by U.S. taxpayers of debit cards linked to secret offshore bank accounts, a common technique used to repatriate funds held in foreign accounts.

IRS Authority to Seek John Doe Summonses

The Internal Revenue Code authorizes the IRS to issue a summons to gather information and/or testimony about a specific taxpayer whose identity is known, and the IRS frequently uses traditional summonses in the normal course of conducting audits and investigations.

A John Doe summons, by contrast, allows the IRS to gather information about a group of unidentified taxpayers believed to be violating the tax laws, such as investors in a tax shelter or account holders at a financial institution.

In United States v. Bisceglia, 520 U.S. 141 (1975), the United States Supreme Court expressly recognized the authority of the IRS to issue a John Doe summons in order to uncover the identities of individuals who may have failed to disclose all of their income.

Congress subsequently enacted section 7609(f) of the Internal Revenue Code, which authorizes service of a John Doe summons if the IRS convinces a federal judge that (1) the summons relates to the investigation of an ascertainable group or class of persons; (2) there exists a reasonable basis for believing that such group or class or persons may have failed to comply with U.S. tax laws; and (3) the information sought by the summons is not readily available from any other source.

To ensure that the John Doe summonses are not used as pure “fishing expeditions,” internal IRS policy mandates that such summonses may only be used in investigations that are at an advanced stage, rather than at the outset of an investigation. In addition, only certain high-ranking IRS officials are authorized to approve issuance of a John Doe summons; special agents, revenue agents and revenue officers are not authorized to issue such summonses.

A federal court’s determination of whether the IRS has satisfied the requirements for a John Doe summons is required to be conducted ex parte and must be based solely on the basis of a petition and supporting affidavits. Once a court determines that the IRS has met its burden, the agency is then authorized to serve the John Doe summons on the party to whom it is directed.

IRS Use of John Doe Summonses In Its Offshore Crackdown

Since 2009, the IRS (working hand-in-hand with the U.S. Department of Justice) has worked aggressively to combat tax evasion by U.S. taxpayers making use of secret offshore bank accounts, and John Doe summonses have played a prominent role in that enforcement effort.

In 2009, the IRS served a John Doe summons seeking the identities of U.S. taxpayers maintaining bank accounts at UBS in Switzerland. Two years later, the IRS received court approval to serve a John Doe summons seeking the identities of U.S. taxpayers maintaining undisclosed bank accounts at HSBC in India.

In January 2013, a federal judge authorized the IRS to serve a John Doe summons seeking the names of account holders at Swiss bank Wegelin & Co. In September 2015, a federal court in Miami authorized the issuance of a John Doe summons seeking information about U.S. taxpayers who held offshore accounts at Belize Bank International Limited or Belize Bank Limited.

The Latest John Doe Summons Target: Users of Offshore Debit Cards

Most recently, on Jan. 25, 2017, a federal judge in Montana authorized the IRS to serve a John Doe summons seeking information about U.S. taxpayers who had been issued a debit card that could be used to access the funds in offshore accounts in such a manner as to evade their tax obligations.[1]

The summons specifically seeks records regarding U.S. taxpayers who possessed a “Sovereign Gold Card” during the years 2005 to 2016 which could be used to access funds held in accounts established by Sovereign Management & Legal LTD, a Panamanian company (Sovereign).

Sovereign is an offshore services provider alleged to have offered clients, among other things, the formation and administration of anonymous corporations and foundations. The IRS believes that Sovereign’s related services included the maintenance and operation of offshore structures, mail forwarding, availability of virtual offices, re-invoicing and the provision of professional managers who appoint themselves directors of the client’s entity while the client maintains ultimate control over the assets.

The IRS has long been concerned with the use of debit cards by U.S. taxpayers as a way to repatriate funds held in offshore accounts. In 2000, the IRS began investigating the use of offshore credit cards and served numerous John Doe summonses on major credit card companies.

Based upon information gathered through that project, the IRS confirmed that the use of payment cards (including credit and debit cards) linked to offshore bank accounts is a common means of obtaining access to such funds. A United Nations report focused on money laundering similarly concluded that “[c]redit and debit cards are the way people who have laundered money draw ready cash without leaving a financial trail. As one advertisement for a bank put it, it is the best way to stay in touch with your offshore account.”[2]

In its petition seeking court approval for the John Doe summons, the government alleged that Sovereign advertised various “packages” that afforded individuals the ability hide assets offshore. These packages include corporations owned by other entities (including phony charitable foundations) which are held in the name of nominee officers provided by Sovereign.

Sovereign would then open bank accounts for these entities and provide debit cards in the name of the nominee to the U.S. taxpayer. By using such debit cards, taxpayers could access their offshore funds without revealing their identities.

Upon consideration of the government’s petition, the court determined that the IRS had a reasonable basis for believing that U.S. taxpayers may be using Sovereign Gold Cards to evade their U.S. tax obligations.

The IRS investigation of Sovereign has been ongoing for several years, and was initiated as a result of information derived from a federal narcotics investigation. As part of an investigation of online marketplaces for drug trafficking, the Drug Enforcement Administration learned that traffickers frequently moved money through Panamanian bank accounts controlled by Sovereign using debit cards.

Using information generated through that drug investigation, the IRS sought, and obtained, court approval for several John Doe summonses in late 2014 requiring various courier delivery services and U.S. financial institutions to produce information about U.S. taxpayers who might be evading or have evaded federal taxes by using Sovereign’s services.[3]

The IRS alleged that Sovereign used certain couriers to correspond with U.S. clients, and certain money transmission services to transmit funds to and from clients in the United States. In addition, the IRS alleged that wire services operated by various financial institutions, and U.S. correspondent bank accounts held for Sovereign’s banks in Panama and Hong Kong, were believed to have records of financial transactions between Sovereign and its clients in the United States.

The IRS also relied upon information generated through its ongoing Offshore Voluntary Disclosure Program to support its latest application for the John Doe summons seeking debit card information. In a revenue agent’s affidavit submitted to the court, the IRS disclosed that its “voluntary disclosure program databases” revealed at least one taxpayer who acknowledged using Sovereign’s services to establish numerous offshore structures and 21 undeclared accounts, 11 of which were opened in Panama.

During an IRS interview, that taxpayer stated that he discovered Sovereign through an Internet search and subsequently utilized Sovereign’s services to set up structures, establish offshore accounts and open a Sovereign Gold Card to access funds in those accounts.

Warning to Non-Compliant Taxpayers

The most recent John Doe summons stands as yet another stern warning to non-compliant taxpayers that the era of bank secrecy and secret offshore accounts in tax haven jurisdictions is over.

Indeed, in a Justice Department press release announcing court approval of the latest John Doe summons, Tax Division Acting Assistant Attorney General David A. Hubbert stated that “[t]his John Doe summons is yet another example of how we are using all available tools to identify, investigate and hold accountable those who cheat our nation’s tax system by hiding money offshore, as well as those individuals and entities facilitating U.S. taxpayers engaged in this conduct.”[4]

Hubbert further warned that “[t]he time to come forward and come into compliance is running short, and those who continue to violate U.S. tax and reporting laws will pay a heavy price.”

The IRS continues to offer voluntary disclosure initiatives, including the Offshore Voluntary Disclosure Program, that provide a pathway for taxpayers with undisclosed foreign assets to come back into compliance and avoid criminal prosecution, but those options are generally available only if the taxpayer comes forward before the IRS or Justice Department learn of their non-compliance.


As its latest John Doe summons demonstrates, the IRS now has more access to information about the offshore activities of U.S. taxpayers than at any previous time in the tax agency’s history. With a wealth of information gathering tools at its disposal, including John Doe summonses, the IRS has the ability to command production of a vast array of documents relating to offshore tax evasion schemes and to uncover the identities of those involved.

And the IRS can be expected to make full use of that information in undertaking enforcement activity against non-compliant taxpayers. Taxpayers with undisclosed offshore financial assets would be well-advised to take advantage of IRS voluntary disclosure options promptly, as time is of the essence as the IRS continues to aggressively crack down on offshore tax evaders.

[1] See In the Matter of the Tax Liabilities Of: John Does, Case No. CR 17-02-BU-BMM (D. Mont.).

[2] United Nations, Global Programme Against Money-Laundering, Office for Drug Control and Crime Prevention, “Financial Havens, Banking Secrecy and Money Laundering” (1998).

[3] See In the Matter of the Tax Liabilities Of: John Does, Case 1:14-mc-00417 (S.D.N.Y.).

[4] U.S. Department of Justice Press Release, “Court Authorizes Service of John Doe Summons Seeking the Identities of U.S. Taxpayers Who Have Used Debit Cards in Furtherance of Tax Evasion” (Jan. 25, 2017).

Reprinted with permission from Law360. (c) 2017 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

In a strongly worded opinion that is very favorable for taxpayers who engage in sophisticated tax planning, the Sixth Circuit overturned a Tax Court opinion denying the benefits of a domestic international sales corporation (“DISC”) under the theory that the transaction violated the substance over form doctrine.  In short, a DISC was used to channel large amounts to a Roth IRA, permitting accumulation of substantial funds which will be available tax free to the owners of the Roth IRA after they reach a certain age.  The details are not as fun as the opinion, which, assuming it stands, will surely be cited many times over.  The Court’s words are strong:

  • “If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is.”
  • Because the taxpayer “used the DISC and Roth IRAs for their congressionally sanctioned purpose – tax avoidance – the Commissioner has no basis for recharacterizing the transaction and no basis for recharacterizing the law’s application to them.”
  • “It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction-to honor the fiscal realities of what taxpayers have done over the form in which they have done it.  But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes-to ignore their form, their words, in favor of his perception of their substance.”
  • “The line between disregarding a too-clever-by-half accounting trick and nullifying a Code-supported tax-minimizing transaction can be elusive.”
  • “Decisions from our sister courts also straddle the line between holding that the transactions were a sham and suggesting that the Commissioner has a broad power to recharacterize transactions that minimize taxes, though none of them holds that a tax-avoidance motive alone may nullify an otherwise Code-compliant and substantive set of transactions.”
  • “The substance-over-form doctrine does not authorize the Commissioner to undo a transaction just because taxpayers undertook it to reduce their tax bills.”

The case is Summa Holdings, Inc. v. Comm’r.

T2000px-US-FinancialCrimesEnforcementNetwork-Seal_svghe Financial Crimes Enforcement Network (FinCEN) and Office of the Comptroller of the Currency (OCC) yesterday announced the assessment of a $7 million civil money penalty against Merchants Bank of California of Carson, California, for willful violations of several provisions of the Bank Secrecy Act (BSA). (The FinCEN press release is here and assessment is here; the OCC press release is here and consent order is here.) FinCEN and the OCC found that the bank failed to (a) establish and implement an adequate anti-money laundering (AML) program, (b) conduct required due diligence on its foreign correspondent accounts, and (c) detect and report suspicious activity. FinCEN found that “Merchants’ failures allowed billions of dollars to flow through the U.S. financial system without effective monitoring to adequately detect and report suspicious activity. Many of these transactions were conducted on behalf of money services businesses (MSBs) that were owned or managed by Bank insiders who encouraged staff to process these transactions without question or face potential dismissal or retaliation.” In addition, FinCEN determined that bank insiders directly interfered with the BSA staff’s attempts to investigate suspicious activity related to these insider-owned accounts.

Seal_of_the_Office_of_the_Comptroller_of_the_Currency_svgThe OCC (Merchants’ federal functional regulator) previously identified deficiencies in Merchants’ BSA/AML compliance program which resulted in the issuance of consent orders in June 2010 and June 2014. Those consent orders required the bank to correct deficiencies in all four pillars of its BSA program (the system of internal controls, independent testing, a designated individual or individuals responsible for coordinating and monitoring BSA/AML compliance, and training for appropriate personnel). OCC concluded that Merchants violated numerous provisions of those consent orders, which no doubt contributed to the decision by FinCEN and the OCC to impose such a significant civil money penalty against the bank.

Merchants specialized in providing banking services for check-cashers and money transmitters (commonly referred to as “money services businesses” or MSBs). However, FinCEN found that it provided those services without adequately assessing the money laundering risks and without designing an effective AML program. Merchants also provided its high-risk customers with remote deposit capture services without adequate procedures for monitoring their use.

FinCEN’s assessment disclosed that one of Merchants’ MSB customers was the subject of a federal criminal investigation into its anti-money laundering compliance program. That customer, a Los Angeles-based check cashing store, its head manager, and its designated anti-money laundering compliance officer eventually pleaded guilty to criminal charges including conspiracy to fail to file currency transactions reports (CTRs) and failing to maintain an effective anti-money laundering program in connection with over $8 million in transactions. The head manager was sentenced to 5 years in prison, and the AML compliance officer was sentenced to 8 months in prison. FinCEN concluded that even after learning that this customer was under criminal investigation in February 2012, Merchants failed to report the customer and its activity on a Suspicious Activity Report (SAR).

According to FinCEN, Merchants also failed to provide the necessary level of authority, independence, and responsibility to its BSA officer to ensure compliance with the BSA as required, and compliance staff was not empowered with sufficient authority to implement the Bank’s AML program. Merchants’ leadership impeded BSA analysts and other employees from investigating activity on transactions associated with accounts that were affiliated with Bank executives, and the activity in these accounts went unreported for many years. FinCEN found that Merchants’ interest in revenue compromised efforts to effectively manage and mitigate its deficiencies and risks.

In addition, Merchants banked customers located in several jurisdictions considered to be high-risk but did not identify these customers as foreign correspondent customers and therefore did not implement the required customer due diligence program. In a three-month period, Merchants processed a combined $192 million in high-risk wire transfers through some of these accounts.

Merchants consented to imposition of the $7 million civil money penalty and accepted the findings of FinCEN that the bank had willfully violated the BSA’s program, recordkeeping, and reporting requirements. Merchants also consented to imposition of another OCC consent order. Notably, FinCEN’s settlement with Merchants does not preclude consideration of separate enforcement actions that may be warranted with respect to any financial institution or any partner, director, officer, or employee of a financial institution, suggesting the possibility that future criminal or civil enforcement actions may be forthcoming.

The specific findings made by FinCEN and accepted by the bank are outlined in more detail below.

  1. Failure to Establish and Implement an Adequate AML Program

The OCC requires each bank under its supervision to develop and provide for the continued administration of a program reasonably designed to assure and monitor compliance with the BSA’s recordkeeping and reporting requirements. At a minimum, a bank’s AML compliance program must: (a) provide for a system of internal controls to assure ongoing compliance; (b) provide for independent testing for compliance to be conducted by bank personnel or by an outside party; (c) designate an individual or individuals responsible for coordinating and monitoring day-to-day compliance; and (d) provide training for appropriate personnel. FinCEN found that Merchants failed to establish and maintain adequate internal controls to assure ongoing compliance. In particular, Merchants did not conduct a sufficient independent audit commensurate with the institution’s complexity and risk profile; it failed to provide the necessary level of authority, independence, and responsibility to its BSA Officer to ensure day-to-day compliance; and it did not provide adequate training for appropriate personnel.

Merchants provided banking services for as many as 165 check-cashing customers and 44 money transmitters, many of which were located hundreds of miles away from the bank. According to the assessment, Merchants did so without adequately assessing the money laundering risk of these customers and designing an effective AML program to address those risks. Specifically, it did not implement adequate due diligence programs and provided its high-risk customers with remote deposit capture services (RDC) without adequate procedures for monitoring their use. In addition, in several instances, bank insiders directly interfered with the BSA staff’s attempts to investigate suspicious activity related to insider-owned accounts. Insiders owned or managed MSBs, which had accounts at Merchants, and from 2007 to September 2016 certain of these accounts demonstrated highly suspicious transaction patterns including possible layering schemes, transactions not commensurate with the business’s purpose, and commingling of funds between two independent check cashing entities. Merchants’s leadership impeded BSA analysts and other employees investigating activity on transactions associated with accounts that were affiliated with Bank executives, and the activity in these accounts went unreported for many years. Employees who attempted to report suspicious activity in these accounts were threatened with possible dismissal or retaliation. Merchants’s executives weakened the Bank’s AML program by creating a culture that did not sufficiently detect or report on suspicious activity involving the accounts of insiders.

Until 2015, Merchants failed to conduct an independent audit that was commensurate with the Bank’s customer complexity and risk profile. Merchants is required to conduct independent compliance testing commensurate with the BSA/AML risk profile of the Bank to monitor and maintain an adequate program. By not conducting the required independent review, Merchants was unable to identify vulnerabilities in its compliance program and properly monitor the account activity of its customers to detect suspicious activity going through the Bank.

Merchants failed to have proper requirements within the Bank’s AML program to ensure that the audit firm conducted a comprehensive independent audit of its program. Specifically, Merchants failed to adequately review the engagement proposal of the audit firm to confirm it was sufficient in scope to identify weaknesses in the Bank’s program.

Merchants’ independent audit was not commensurate to the risk and complexity of the types of customers Merchants served, including its high-risk MSB customers. Therefore the 2012 independent audit failed to identify internal control deficiencies in Merchants’s AML program. The audit’s scope, procedures, and transaction review of Merchants’s independent testing were inadequate, given the bank’s high-risk customer base. In 2014, a new independent consultant conducted an audit but failed to identify significant gaps in Merchants’s overall BSA compliance program. In 2015, Merchants hired a different independent consultant only to conduct a required SAR look-back review of the bank’s MSB account activity. During this review, the consultant identified a number of AML compliance issues that Merchants’s former auditors failed to identify. The consultant identified issues that were consistent with Merchants’s internal controls violations related to providing banking services to high-risk MSBs without implementing the appropriate risk-based controls required by the BSA or creating an appropriate due diligence program.

2.  Due Diligence Program for Correspondent Accounts

From 2008 to 2014, Merchants failed to maintain a due diligence program for foreign correspondent accounts, which FinCEN refers to as “gateways to the U.S. financial system.” In particular, FinCEN concluded that the bank did not have policies and procedures to elevate foreign correspondent bank customers for enhanced due diligence, as required by the USA PATRIOT Act. For example, Merchants had four banking customers located in several jurisdictions considered to be high-risk including Honduras, Mexico, Colombia, and Romania but did not identify these customers as foreign correspondent customers, and therefore did not implement the required customer due diligence program. These four customers sent and received a combined $192 million in high-risk wire transfers during the period of August 2014 through October 2014. Merchants failed to establish adequate alert parameters for these accounts, resulting in the exclusion of this wire activity from monthly transactional monitoring because the bank failed to establish appropriate alert parameters on the accounts. Merchants also failed to identify suspicious wires and report that activity to FinCEN during this time.

3.  Failure to Report Suspicious Transactions

The BSA and its implementing regulations impose an obligation on banks to report transactions that involve or aggregate to at least $5,000, are conducted by, at, or through the bank, and that the bank “knows, suspects, or has reason to suspect” are suspicious. A transaction is “suspicious” if the transaction: (a) involves funds derived from illegal activities, or is conducted to disguise funds derived from illegal activities; (b) is designed to evade the reporting or recordkeeping requirements of the BSA or regulations under the Act; or (c) has no business or apparent lawful purpose or is not the sort in which the customer normally would be expected to engage, and the bank knows of no reasonable explanation for the transaction after examining the available facts, including background and possible purpose of the transaction. From 2012 to 2016, Merchants failed to adequately monitor billions of dollars of transactions for suspicious activity. Because of this failure, Merchants failed to file or file timely on hundreds of millions of dollars of suspicious activity including millions of dollars of transactions of 57 of its customers later identified as part of an independent look-back review.

FinCEN determined that many of Merchants’ failures to file or file timely SARs were related to its higher-risk MSB customers’ activities, which were inconsistent with the anticipated behavior, stated business purpose, or customer profile information of these MSBs. FinCEN’s assessment set forth the following examples:

  • One of the MSB customers was a money transmitter located in the basement of the owner’s private residence in New York. Despite several red flags resulting from Merchants’s account review, including the fact that this MSB was the subject of multiple information requests from law enforcement, had significant increases in its account activity, and its wire transfers were, in two instances, rejected by another bank, Merchants determined that its activities were not suspicious and failed to timely file a SAR.
  • Merchants failed to file a SAR on another MSB customer engaging in suspicious activity. In a six-month period between 2011 and 2012, the MSB conducted approximately $500,000 and $700,000 in deposits and withdrawals, respectively, and received over $1.3 million in wire transfers. Within two to three days of receiving the funds, the MSB wrote large checks, cashing them out at other financial institutions. In January 2012, Merchants conducted a due diligence analysis on the same MSB’s activity and did not consider it suspicious. In February 2012, after learning of a criminal investigation involving the MSB, Merchants again conducted a due diligence analysis and again failed to report the customer and its activity in a SAR. As noted above, on September 19, 2012, the MSB, its manager, and its compliance officer pleaded guilty to eight counts of failing to file currency transaction reports and one count of failing to maintain an effective AML program.
  • Merchants failed to file a SAR on another licensed money transmitter and seller of money orders with physical locations in Nevada and California. This MSB’s customer base was located in Russia, Armenia, the United Kingdom, and Germany, and the MSB sent most of its money transmissions to these regions. Merchants rated this account as high-risk and conducted an account review, which indicated that for several months, the volume of account activity had significantly exceeded the anticipated activity established by the MSB during the account application process. Although the review indicated that Merchants asked the MSB for an explanation of its unexpected account behavior, the customer never provided the requested information and the Bank failed to investigate further. Merchants also failed to identify evidence of structuring flowing through the account.

In 2015, an independent consultant completed a look-back review of a sample of 100 of Merchants’s high-risk MSB accounts for the period of July 1, 2012 through June 30, 2014. The look-back review identified 57 customer accounts with activity that was deemed potentially suspicious and required escalation to management level along with an additional 11 customer accounts requiring further review due to a lack of documentation or a lack of transparency in the customer transactions. As a result of the look-back review, Merchants filed SARs on the activity and transactions identified through the review. The late SAR filings included reports covering structured transactions that were conducted through Merchants for two consecutive years totaling over $400 million. The subjects of one of the SARs engaged in a suspicious pattern of cashing multiple structured checks made to the order of the same individuals in Mexico without providing information concerning source of funds. Also, these subjects engaged in several suspicious wire transfers to the Office of Foreign Assets Control sanctioned countries. These same subjects were under a U.S. federal law enforcement investigation for fraudulent tax returns. This activity started in 2014 and was reported on a SAR two years later only after Merchants was required to conduct a look-back review. Another late SAR covered transactions worth over $395 million related to customers conducting large wire transfers between multiple foreign financial institutions without validating the source of funds or identifying the ultimate beneficiary. This activity resulted in large payouts to unknown entities in Colombia.


The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced today that its aggressive efforts to combat money laundering in the luxury real estate market have been extended for an additional six months. Confirming his agency’s concerns about illicit funds flowing through the U.S. real estate industry, FinCEN Acting Director Jamal El-Hindi said today that this initiative is “producing valuable data that is assisting law enforcement and is serving to inform our future efforts to address money laundering in the real estate sector.” Today’s announcement means that temporary measures requiring U.S. title insurance companies to identify the natural persons behind shell companies used to pay all-cash to high-end residential real estate in six major metropolitan areas – known as “Geographic Targeting Orders” (GTOs) –remain in place for six more months.

Background Regarding Geographic Targeting Orders

A GTO is an administrative order issued by the director of FinCEN requiring all domestic financial institutions or nonfinancial trades or businesses that exist within a geographic area to report on transactions any greater than a specified value. Authorized by the Bank Secrecy Act, GTOs were originally only permitted by law to last for 60 days, but that limitation was extended by the USA Patriot Act to 180 days. Historically, FinCEN’s issuance of a GTO was not publicized, and generally only those businesses served with a copy of a particular GTO were aware of its existence.

Over the course of the last three years, FinCEN — the primary agency of the U.S. government focused on anti-money laundering compliance and enforcement — has aggressively exercised its GTO authority frequently throughout the United States in areas of money laundering concern. Recent, publicly announced GTOs have focused on shipments of cash across the border in California and Texas, the fashion district of Los Angeles, exporters of electronics in South Florida, and check cashing businesses in South Florida. In each of these examples, FinCEN publicly announced the issuance of the GTO and its terms, and expressed concern that the industries or regions in question were vulnerable to money laundering.

Prior Efforts to Prevent Money Laundering in Real Estate Transactions

For several years, FinCEN has sought to ensure financial transparency and combat illegality in the real estate market. In February 2015, The New York Times published a series of articles focused on the use of shell companies to purchase high-value real estate in New York City. In a November 2015 speech, FinCEN’s then-director disclosed that through analysis of Bank Secrecy Act reporting and other information, FinCEN has observed the frequent use of shell companies by international corrupt politicians, drug traffickers and other criminals to purchase luxury residential real estate in cash. In particular, FinCEN uncovered fund transfers in the form of wire transfers originating from banks in offshore havens at which accounts have been established in the name of the shell companies. The perpetrator will typically direct an individual involved in the settlement and the closing in the U.S. to place the deed to the property in the name of the shell company, thereby obscuring the identity of the owner of the property.

The Bank Secrecy Act established anti-money laundering obligations for financial institutions, including institutions involved in real estate transactions. By including these businesses in the definition of “financial institution,” Congress recognized the potential money laundering and financial crime risks in the real estate industry. In the USA Patriot Act, Congress mandated that FinCEN issue regulations requiring financial institutions to adopt AML programs with minimum requirements, or establish exemptions, as appropriate. Since that time, FinCEN has implemented AML requirements for certain real estate businesses or established exemptions for others consistent with the Bank Secrecy Act.

The Original Manhattan and Miami-Dade Real Estate GTOs

Approximately one year ago, FinCEN issued what were believed to be the first-ever GTOs focused on real estate transactions. Effective March 1, 2016, these GTOs required certain title insurance companies to identify the natural persons behind companies used to pay all cash for luxury residential real properties located in the borough of Manhattan and Miami-Dade County. All-cash transactions exceeding $3 million in Manhattan, or exceeding $1 million in Miami-Dade County, were to be reported to FinCEN with an identification of the “beneficial owner” behind the transaction.

The enhanced reporting required by the GTOs applied to “covered transactions,” which were defined as transactions in which (1) a legal entity (2) purchases residential real estate either in the borough of Manhattan or Miami-Dade County (3) for a total purchase price of excess of $3 million (Manhattan) or $1 million (Miami-Dade) (4) without a bank loan or other similar form of external financing and (5) using, at least in part, currency or a cashier’s check, certified check, traveler’s check, or money order. “Legal entity” was defined as a corporation, limited liability company, partnership or other similar business entity, whether domestic or foreign.

If a title insurance company is engaged in a transaction that meets all of the requirements for a “covered transaction,” it was required to report said transaction to FinCEN within 30 days of the closing using a designated form entitled “FinCEN Form 8300.” On the Form 8300, the title insurance company must identify (1) the purchaser; (2) the purchaser’s representative, if any; and (3) the beneficial owner, which is defined as each natural person who, directly or indirectly, owns 25 percent or more of the equity interests of the purchaser. The title insurance company must obtain and copy the driver’s license, passport, or other similar identification for each beneficial owner.

Expansion of GTOs to Six Other Major Metropolitan Areas

On the eve of the expiration of the original Manhattan and Miami-Dade GTOs in August 2016, FinCEN announced a significant expansion of its efforts to combat money laundering in real estate transactions with the issuance of six more GTOs. Effective on August 28, 2016, those GTOs covered the following geographic areas: (1) all boroughs of New York City; (2) Miami-Dade County and the two counties immediately north (Broward and Palm Beach); (3) Los Angeles County, California; (4) three counties comprising part of the San Francisco area (San Francisco, San Mateo, and Santa Clara counties); (5) San Diego County, California; and (6) the county that includes San Antonio, Texas (Bexar County). The monetary thresholds for each geographic area varied.[1]

Beyond expanding their geographic reach, the six new GTOs contained two significant changes from the original Manhattan and Miami-Dade GTOs. First, the earlier GTOs defined “cash” transactions to include money orders, cashier’s checks, certified checks, and traveler’s checks. The newly-issued GTOs also applied to personal and business checks, thereby expanding the types of transactions that will be subject to enhanced reporting. Notably, however, none of the GTOs apply to real estate transactions conducted solely using wire transfers, an area that FinCEN currently lacks authority to regulate. Critics of the real estate GTOs pointed out that money launderers could exploit this gap in the regulatory scheme by using wire transfers from offshore banks to finance their luxury real estate purchases. Second, the new GTOs applied to all U.S. title insurance companies, instead of the few title companies originally selected.

Implications of FinCEN’s Renewal of the Six Real Estate GTOs

Today’s action by FinCEN to extend the six real estate GTOs for an additional six months is not surprising and confirms that FinCEN remains concerned about the risk of money laundering when individuals attempt to purchase high-end real estate in all-cash deals through limited liability companies or similar structures. In a press release issued today, FinCEN revealed that approximately 30 percent of the transactions covered by the GTOs involved a beneficial owner or purchaser representative that is also the subject of a previously-filed “suspicious activity report,” thereby corroborating FinCEN’s long-expressed concerns about the use of shell companies to buy luxury real estate in all-cash deals.

Title insurance companies handling transactions occurring in the six geographic regions covered by the latest GTOs, and their employees and agents, must be familiar with the obligations imposed by these latest GTOs. Title insurance companies should have training programs in place so that they are prepared to address these ongoing compliance obligations. Companies that fail to comply with the reporting and record-keeping requirements of these GTOs, and their employees, may face civil or criminal penalties.

It will be interesting to see whether FinCEN will make permanent the temporary measures imposed by these GTOs through regulations. With a new administration in place committed to rolling back regulations, it is entirely possible that the GTOs may eventually expire without further regulatory action. On the other hand, the GTOs appear to have produced valuable information for law enforcement, and that result may prompt FinCEN to implement these anti-money laundering measures on a permanent basis.

[1] The New York thresholds are as follows: the Borough of Manhattan – $3,000,000; the Borough of Brooklyn – $1,500,000; the Borough of Queens – $1,500,000; the Borough of Bronx – $1,500,000; and the Borough of Staten Island – $1,500,000. The Florida thresholds are as follows: Miami-Dade County – $1,000,000; Broward County – $1,000,000; Palm Beach County – $1,000,000. The California thresholds are as follows: San Diego County – $2,000,000; Los Angeles County – $2,000,000; San Francisco County – $2,000,000; San Mateo County – $2,000,000; Santa Clara County – $2,000,000. The Texas threshold is as follows: Bexar County – $500,000.