BitcoinIn its recently-published 2017 National Drug Threat Assessment (NDTA), the Drug Enforcement Administration reports that drug trafficking organizations are turning to Bitcoin and other virtual currencies to enable easy transfer of illicit funds internationally. The NDTA is a comprehensive strategic assessment of the threat posed to the United States by domestic and international drug trafficking and the abuse of illicit drugs. The report combines a wide variety of law enforcement reporting and other data to determine which substances and criminal organizations represent the greatest threat to the United States.

The NDTA notes that in order to avoid law enforcement detection and banking regulations, transnational criminal organizations (TCOs) employ various strategies to move and launder drug proceeds into, within, and out of the United States. Preferred methods to move and launder illicit proceeds – such as bulk cash smuggling, money value transfer systems, trade-based money laundering, and through the formal banking sector – remain the same as in past years. Emerging as a new money laundering threat, however, are Bitcoin and other virtual currencies because of their “anonymizing nature and ease of use.” Bitcoin is the most common form of payment for drug sales on dark net marketplaces and is emerging as a desirable method to transfer illicit drug proceeds internationally. Bitcoin is the most widely used virtual currency due to its longevity and growing acceptance at legitimate businesses and institutions worldwide.

The NDTA notes that Bitcoin’s widespread popularity in China has now spread to trade-based money launderers operating in that country. Many trade-based money laundering schemes are China-based, and have historically consisted of the purchase by TCOs of large shipments of “made-in-China” goods via wire transfer or bulk cash carrying from the United States to China. The “made-in-China” goods are then shipped to business owners in Mexico and South America, who in turn reimburse the drug trafficking organizations in local currency. Now, many China-based firms manufacturing goods used in such schemes prefer to accept Bitcoin for payment.

The use of Bitcoin in this type of trade-based money laundering scheme no doubt facilitates the money laundering process for TCOs, which currently face scrutiny from U.S. banks whenever they wire money to Chinese manufacturers. In contrast, the NTDA notes that a TCO purchasing Bitcoin through a licensed money service business without raising red flags will face no further scrutiny when transferring the Bitcoin to China. Many TCOs can also buy Bitcoin from individuals selling Bitcoin on the Internet without any MSB license. Many TCOs will thus be able to convert their cash drug proceeds to Bitcoin and buy Chinese goods with no fear of oversight from a formal financial institution.

The NDTA also notes that Bitcoin is increasingly being used by Over-the-Counter (OTC) Bitcoin brokers who conduct high-risk Bitcoin trading consistent with Chinese capital flight and money laundering. These brokers likely use foreign Bitcoin wallet-hosting services and exchanges that do not properly conduct “know your customer” or anti-money laundering monitoring on Bitcoin purchases. OTC Bitcoin brokers primarily attract two types of clients: those who want to use Bitcoin to move their money out of China and those who want to convert large quantities of cash into Bitcoin. Chinese underground banking systems money brokers sell Bitcoin to drug traffickers for cash earned from drug sales in the United States, Australia, and Europe. This drug cash is then sold to Chinese nationals in exchange for Bitcoin the Chinese nationals use to transfer the value of their assets outside of China. The NTDA concludes that the increasing use of OTC Bitcoin brokers, who are capable of transferring millions of dollars in Bitcoin across international borders as part of a capital flight scheme, is expected to continue to intertwine criminal money laundering networks with capital flight.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has issued an advisory to alert financial institutions of widespread public corruption in Venezuela and the methods Venezuelan senior political figures and their associates may use to move and hide proceeds of their corruption through the U.S. financial system. The advisory also describes a number of financial red flags to assist financial institutions in identifying and reporting suspicious activity that may be indicative of corruption.

“In recent years, financial institutions have reported to FinCEN their suspicions regarding many transactions suspected of being linked to Venezuelan public corruption, including government contracts,” said Acting FinCEN Director Jamal El-Hindi in a press release. “Not all transactions involving Venezuela involve corruption, but, particularly now, during a period of turmoil in that country, financial institutions need to continue their vigilance to help identify and stop the flow of corrupt proceeds and guard against money laundering and other illicit financial activity.”

Background Regarding Venezuela

In its advisory, FinCEN notes that Venezuela faces severe economic and political circumstances due to the rupture of democratic and constitutional order by the government and policy choices. In recent years, financial institutions have reported to FinCEN their suspicions regarding many transactions suspected of being linked to Venezuelan public corruption, including government contracts. Based on this reporting and other information, all Venezuelan government agencies and bodies, including state-owned enterprises (SOEs), appear vulnerable to public corruption and money laundering. The Venezuelan government appears to use its control over large parts of the economy to generate significant wealth for government officials and SOE executives, their families, and associates. In this regard, there is a high risk of corruption involving Venezuelan government officials and employees at all levels, including those managing or working at Venezuelan SOEs.

FinCEN Recommends Risk-Based Approach

According to FinCEN, financial institutions should take risk-based steps to identify and limit any exposure they may have to funds and other assets associated with Venezuelan public corruption. Awareness of money laundering schemes used by corrupt Venezuelan officials may help financial institutions (1) differentiate between illicit and legitimate transactions, and (2) identify and report transactions involving suspected corruption proceeds being held or moved by their customers, including through their private and correspondent banking relationships. Consistent with a risk-based approach, however, financial institutions should be aware that normal business and other transactions involving Venezuelan nationals and businesses do not necessarily represent the same risk as transactions and relationships identified as being connected to the Venezuelan government, Venezuelan officials, and Venezuelan SOEs involved in public corruption that exhibit the red flags below or other similar indicia.

Recent OFAC Sanctions

On February 13, 2017, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) designated Venezuelan Vice President Tareck El Aissami for playing a significant role in international narcotics trafficking pursuant to the Foreign Narcotics Kingpin Designation Act. On the same day, OFAC also designated his front man, Samark Lopez Bello, for materially assisting El Aissami and acting on his behalf.  OFAC further designated or identified as blocked property 13 companies owned or controlled by Lopez Bello or other designated parties that comprise an international network spanning the British Virgin Islands, Panama, the United Kingdom, the United States, and Venezuela. Five U.S. companies owned or controlled by Lopez Bello were also blocked as well as significant real property and other assets in the Miami, Florida area tied to Lopez Bello. As a result of this action, U.S. persons are generally prohibited from engaging in transactions or otherwise dealing with these individuals and entities, and any assets the individuals and entities may have under U.S. jurisdiction are frozen. FinCEN believes that these OFAC designations increase the likelihood that other non-designated Venezuelan senior political figures may seek to protect their assets, including those that are likely to be associated with political corruption, to avoid potential future blocking actions.

Venezuela Government Corruption Red Flags

In its advisory, FinCEN states that transactions involving Venezuelan government agencies and SOEs, particularly those involving government contracts, can potentially be used as vehicles to move, launder, and conceal embezzled corruption proceeds. SOEs (as well as their officials) may also try to use the U.S. financial system to move or hide proceeds of public corruption. Among the SOEs referenced in OFAC’s recent designations related to Venezuela are the National Center for Foreign Commerce (CENCOEX), Suministros Venezolanos Industriales, CA (SUVINCA), the Foreign Trade Bank (BANCOEX), the National Telephone Company (CANTV), the National Electric Corporation (CORPELEC), Venezuelan Economic and Social Bank (BANDES), and similar state-controlled entities. As law enforcement and financial institutions increase scrutiny of transactions involving Venezuelan SOEs, corrupt officials may try to channel illicit proceeds through lesser-known or newly-created SOEs or affiliated enterprises.

The red flags noted below, which are derived from information available to FinCEN (including suspicious activity reporting), published information associated with OFAC designations, and other public reporting, may help financial institutions identify suspected schemes by corrupt officials, their family members, and associates to channel corruption proceeds, often involving government contracts or resources, through transactions involving Venezuelan SOEs and subsidiaries:

FinCEN believes that corrupt officials may use contracts with the Venezuelan government as vehicles to embezzle funds and receive bribes. In this regard, some financial red flags can include:

  • Transactions involving Venezuelan government contracts that are directed to personal accounts.
  • Transactions involving Venezuelan government contracts that are directed to companies that operate in an unrelated line of business (e.g., payments for construction projects directed to textile merchants).
  • Transactions involving Venezuelan government contracts that originate with, or are directed to, entities that are shell corporations, general “trading companies,” or companies that lack a general business purpose.
  • Documentation corroborating transactions involving Venezuelan government contracts (e.g., invoices) that include charges at substantially higher prices than market rates or that include overly simple documentation or lack traditional details (e.g., valuations for goods and services). Venezuelan officials who receive preferential access to U.S. dollars at the more favorable, official exchange rate may exploit this multi-tier exchange rate system for profit.
  • Payments involving Venezuelan government contracts that originate from non-official Venezuelan accounts, particularly accounts located in jurisdictions outside of Venezuela (e.g., Panama or the Caribbean).
  • Payments involving Venezuelan government contracts that originate from third parties that are not official Venezuelan government entities (e.g., shell companies). Public reports indicate that the use of third parties, or brokers, to deal with government entities is common in Venezuela and is a significant source of risk. Brokers, particularly when colluding with corrupt government officials, can facilitate overseas transactions in a way that circumvents currency controls and masks payments from SOEs.
  • Cash deposits instead of wire transfers in the accounts of companies with Venezuelan government contracts.

In addition, FinCEN identifies these other financial red flags observed in transactions suspected of involving Venezuelan government corruption include:

  • Transactions for the purchase of real estate – primarily in the South Florida and Houston, Texas regions – involving current or former Venezuelan government officials, family members or associates that is not commensurate with their official salaries.
  • Corrupt Venezuelan government officials seeking to abuse a U.S. or foreign bank’s wealth management units by using complex financial transactions to move and hide corruption proceeds.

Overlap with Geographic Targeting Orders

It is noteworthy that two of the “red flags” identified by FinCEN its advisory directly relate to recent Geographic Targeting Orders (GTOs) issued by FinCEN. A GTO is an administrative anti-money laundering device, authorized by the Bank Secrecy Act and the USA Patriot Act, which is 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.

One of the red flags identified by FinCEN are “[p]ayments involving Venezuelan government contracts that originate from non-official Venezuelan accounts, particular accounts located in jurisdictions outside of Venezuela (e.g., Panama or the Caribbean).” In its advisory, FinCEN noted that “[e]xport businesses in South Florida that specialize in sending goods to Venezuela are particularly vulnerable to trade-based money laundering (TBML) schemes. These include businesses that send heavy equipment, auto parts, and electronics (cell phones and other appliances) from Florida to Venezuela.” In April 2015, FinCEN issued a GTO focused on trade-based money laundering schemes used by drug cartels to launder illicit proceeds through electronics exporters in South Florida. At that time, FinCEN disclosed that an ongoing criminal investigation conducted jointly by the U.S. Immigration and Customs Enforcement’s Homeland Security Investigations and the Miami Dade State Attorney’s Office South Florida Money Laundering Strike Force revealed that many electronics exporters are exploited as part of sophisticated trade-based money laundering schemes in which drug proceeds in the United States are converted into goods that are shipped to South America and sold for local currency, which is ultimately transferred to drug cartels.

Another “red flag” involves “[t]ransactions for the purchase of real estate – primarily in the South Floria and Houston, Texas regions – involving current or former Venezuelan government officials, family members or associates that is not commensurate with their official salaries.” The purchase of high-end real estate in the United States – particularly in an all-cash transaction – is a common money laundering vehicle, and FinCEN has taken aim at this practice by issuing a series of GTOs focused on cash purchases of luxury residential real estate in seven major metropolitan markets, including South Florida. In an advisory to the real estate industry issued a few weeks ago, FinCEN warned that “real estate transactions involving luxury property purchased through shell companies – particularly when conducted with cash and no financing – can be an attractive avenue for criminals to launder illegal proceeds while masking their identities.” In that same advisory, FinCEN specifically identified Venezuelan Vice President Tareck El Aissami and his frontman Samark Lopez Bello as a prime example of this practice:

An example of abuse of the luxury real estate sector involves current Venezuelan Vice President Tareck El Aissami and his frontman Samark Lopez Bello. The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) designated El Aissami under the Foreign Narcotics Kingpin Designation Act for playing a significant role in international narcotics trafficking. Lopez Bello was designated for providing material assistance, financial support, or goods or services in support of the international narcotics trafficking activities of, and acting for or on behalf of, El Aissami. In addition, OFAC designated shell companies tied to Lopez Bello that were used to hold real estate. Lopez Bello is tied to significant property and other assets, which were also blocked as a result of OFAC’s action.

While FinCEN’s advisory mentions real estate transactions taking place in South Florida and Houston, Texas, FinCEN does not presently have a GTO covering the real estate market in Houston.  This may suggest that an additional GTO may be issued by FinCEN to cover that particular geographic market.


FinCEN stated that it is providing this advisory to assist U.S. financial institutions in meeting their due diligence obligations that may apply to activity involving certain Venezuelan persons. To best meet these obligations, financial institutions should generally be aware of public reports of high-level corruption associated with senior Venezuelan foreign political figures, their family members, associates, or associated legal entities or arrangements. Financial institutions should assess the risk for laundering of the proceeds of public corruption associated with specific particular customers and transactions. Financial institutions also should be aware that OFAC has designated (and provided related guidance on) several Venezuelan persons and entities located in or related to Venezuela.

This article is Part I of a series in which we address the U.S. government’s attempts to combat money laundering in real estate transactions.

This week the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced that it was both extending and broadening its anti-money laundering efforts in the luxury real estate area to capture a broader array of suspicious transactions. In January 2016, FinCEN issued Geographic Targeting Orders (GTOs) that required U.S. title insurance companies to report beneficial ownership information on legal entities, including shell companies, used to purchase certain luxury residential real estate in Manhattan and Miami—specifically, luxury residential property purchased by a shell company without a bank loan and made at least in part using a cashier’s check or similar instrument. In July 2016 and February 2017, FinCEN reissued the original GTOs and extended coverage to all boroughs of New York City, two additional counties in the Miami metropolitan area, five counties in California (including Los Angeles, San Francisco, and San Diego), and the Texas county that includes San Antonio. Confirming that its prior GTOs generated meaningful intelligence for law enforcement, FinCEN has now extended the measures for a third time and also expanded them to include another geographic market – Honolulu, Hawaii – as well as transactions involving wire transfers, a critical payment method not covered by the prior GTOs, which focused instead on all-cash purchases.

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 within a designated 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 (with renewals permitted). 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, however, 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 the fashion district of Los Angeles, exporters of electronics in South Florida, check cashing businesses in South Florida, and most recently, all-cash purchases of luxury residential real estate in high profile U.S. real estate markets. 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. These GTOs demonstrate an increased attention to trade-based money laundering schemes by FinCEN and confirm that criminals are aggressively using legitimate U.S. businesses to launder the proceeds of their illegal activity.

Enactment of Countering America’s Adversaries Through Sanctions Act

FinCEN’s extension and expansion of the real estate GTOs was prompted, at least in part, by the recent passage of a wide-ranging sanctions law called the “Countering America’s Adversaries Through Sanctions Act” that was signed by the President on August 2, 2017. While primarily focused on sanctions directed at Iran, Russia, and North Korea, the law made a critical modification to the statute authorizing FinCEN to issue GTOs. Previously, that statute authorized the issuance of a GTO to obtain information regarding transactions in which a financial institution or nonfinancial trade or business is involved “for the payment, receipt, or transfer of United States coins or currency (or such other monetary instruments as the Secretary [of the Treasury] may describe in such order).” As amended, the statute now authorizes the issuance of a GTO to obtain information regarding transactions in which a financial institution or nonfinancial trade or business is involved “for the payment, receipt, or transfer of funds (as the Secretary may describe in such order).”

With the replacement of the limited phrase “United States coins or currency” with the significantly broader term “funds,” FinCEN can now issue significantly more expansive GTOs that are not limited to transactions involving cash and other monetary instruments (like checks and money orders). Indeed, in the press release announcing the GTO expansion, FinCEN Acting Director Jamal El-Hindi acknowledged that this change in the law enabled his agency to capture a broader range of transactions: “FinCEN also thanks Congress for its modification of the Geographic Targeting Order authority, the first use of which will enable FinCEN to collect further information to combat the potential misuse of shell companies to purchase luxury real estate.”

The new sanctions law also directed Treasury to expand the number of real estate geographic targeting orders or other regulatory actions in order to counter money laundering and other illicit financial activity relating to Russia.  We therefore expect to see FinCEN impose significantly more anti-money laundering measures like GTOs in the coming months.

Extension of Previous GTOs

FinCEN’s announcement means that the prior GTOs covering six major metropolitan areas, which are set to expire on September 21, 2017, will be extended for an additional six months. In its press release announcing the extension, FinCEN stated that the GTOs were producing meaningful information that was advancing criminal investigations. (See prior blog coverage here.)  Specifically, FinCEN announced that nearly one-third of the transactions reported pursuant to the GTOs involved a beneficial owner or purchaser representative that was also the subject of a previous suspicious activity report (SAR). An article written by Kevin G. Hall of the Miami Herald contains the following GTO data obtained from FinCEN through a Freedom of Information Act request for the period February 29, 2016, through March 9, 2017.

 County or Borough


Transactions with
Related Suspicious
Percent of
Manhattan 137 30 22
Miami-Dade 32 16 50
Brooklyn 35 13 37
Los Angeles 15 5 33
Bexar (San Antonio) 4 3 75
Queens 8 3 38
Palm Beach 4 2 50
Santa Clara 5 1 20
Bronx 0 0 0
San Diego 1 0 0
San Francisco 1 0 0
San Mateo 1 0 0
Staten Island 1 0 0

Of particular note are the reported transactions in Manhattan, Miami-Dade, and Brooklyn, where both the actual number of transactions and the percentages of reported transactions are significant.

Expansion of GTO Coverage to Hawaii

The revised GTOs, which effective September 22, 2017, now cover seven major geographic markets in the United States, with the addition of Honolulu, Hawaii. The markets now covered by GTOs, and the minimum purchase price thresholds in each market, are as follows:

  • Bexar County, Texas – $500,000
  • Miami-Dade, Broward, and Palm Beach Counties, Florida – $1,000,000
  • Boroughs of Brooklyn, Queens, Bronx, and Staten Island, New York – $1,500,000
  • Borough of Manhattan, New York – $3,000,000
  • San Diego and Los Angeles Counties, California – $2,000,000
  • San Francisco, San Mateo, and Santa Clara Counties, California – $2,000,000
  • Honolulu County, Hawaii – $3,000,000

FinCEN’s announcement is silent as to why the GTOs were extended to cover the Honolulu real estate market. The expansion of coverage to Hawaii is presumably based upon FinCEN’s conclusion that criminals are attempting to launder money through purchases of real estate in that market just as in the six markets already covered by GTOs.

Closing the “Wire Transfer” Loophole

In addition to expanding the geographic scope of the GTOs, the revisions announced yesterday also address a significant perceived weakness in the prior GTOs: they only covered all-cash transactions, and omitted from their scope any real estate transaction where the purchase price was paid by wire transfer. Critics of the prior GTOs contended that criminals could easily exploit this loophole by simply using wire transfers, rather than cash or checks, to pay for real estate purchases. The revised GTOs, which take effective in September, will apply to real estate transactions where the purchase price is paid, at least in part, using cash, check, money order, or funds transfer.

As noted above, before enactment of the Countering America’s Adversaries Through Sanctions Act, FinCEN’s authority to issue GTOs was limited to transactions involving cash or monetary instruments. With the newly expanded authority granted to it by Congress, FinCEN has the authority to issue GTOs covering transactions involving the payment, receipt, or transfer of “funds.”

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Over at the In The Weeds blog (which explores developments in cannabis law and business), Melissa T. Sanders writes about the recent publication by the Treasury Department’s Financial Crimes Enforcement Network of its “Marijuana Banking Update.”  In this publication, FinCEN summarizes the number of depository institutions providing banking services to marijuana-related businesses in the United States as reported by the filing of “suspicious activity reports” (SARs).  Marijuana-related businesses present myriad anti-money laundering compliance challenges, as well as complex federal tax issues as our colleague Jennifer E. Benda has addressed here, here, and here.

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.

The IRS released an advanced version of Revenue Procedure 2016-56 that requires three more countries – Israel, the Republic of Korea and Saint Lucia – to participate in the automatic exchange of information on bank interest paid to nonresident alien individuals for interest paid on or after January 1, 2017. There are now 40 countries participating in the automatic exchange program.

Generally, nonresident individuals are exempt from U.S. taxation on the receipt of interest on bank deposits (unless the interest is effectively connected with a U.S. trade or business). This exemption is designed to encourage capital investment in the U.S. and the reporting requirements do not affect the taxation of interest income from bank deposits. The reporting requirements were adopted in 2012 to increase information exchange necessary to combat offshore tax evasion that exists because of the exemption.

The Treasury Department believes that reciprocal information exchange will allow the IRS to gather more information and combat U.S. tax evasion by U.S. taxpayers to falsely claim to be nonresidents when establishing bank accounts in foreign countries and thereby attempt to avoid U.S. taxation on interest income.

The IRS may only share information with a foreign government who has entered into a mutual information exchange agreement. The U.S. only enters into information exchange agreements after the U.S. Treasury and IRS are satisfied that the foreign government has strict confidentiality protocols and protections. The IRS is statutorily barred from sharing information with another country without such an agreement in place. All U.S. information exchange agreements require that the information exchanged under the agreement be treated and protected as secret by the foreign government.

As has been the case for the last decade, U.S. is ramping up enforcement through use of information reporting requirements, which is one of the most effective tools it has to combat tax evasion.


On Oct. 18, 2016, a federal judge sentenced a well-known Chicago restaurant owner to prison for carrying out an extensive scheme to avoid paying state sales tax collected from customers of his establishments. Two important lessons may be drawn from this criminal case. First, criminal prosecutions of business owners for avoiding payment of state sales tax, which historically have been pursued by state authorities under state law tax statutes, may now be brought by federal prosecutors using the federal fraud and money laundering statutes. Second, the sentence imposed reflects the growing tendency of judges to impose sentences in tax cases that are below the applicable range as calculated under the United States Sentencing Guidelines.

Factual Background

The defendant in the case, Hu Xiaojun (also known as Tony Hu), owns and operates nine restaurants in the Chicago area. He was charged with federal wire fraud and money laundering offenses arising from his failure to pay sales tax to the state of Illinois on nearly $10 million in cash transactions occurring at his restaurants over a four-year period. Earlier this year, Tony Hu pleaded guilty to one count of wire fraud and one count of money laundering.[1]

According to the guilty plea agreement, between January 2010 and September 2014, the defendant failed to pay sales tax on transactions in which customers paid cash. To conceal cash sales, he instructed restaurant managers and employees to provide him with daily summaries of restaurant sales, which he would in turn alter to conceal cash sales. Hu and others would destroy the daily summary reports and cash transactions receipts, replacing them with incorrect reports that omitted the bulk of each restaurant’s cash sales. To hide cash sales from the state tax authorities, the defendant instructed employees to withhold cash generated from the restaurants from the corporate bank accounts to avoid creating financial records for those cash sales. Specifically, the restaurants in question discarded cash receipts until the reported amount was approximately 15 to 20 percent of credit card sales. The “discarded” cash was used to pay restaurant employees and suppliers without recording those expenses in the corporate books and records. The defendant also deposited a portion of the cash into his personal bank account, which he then used to pay personal expenses.

During the 2010 to 2014 time period, Hu instructed others to submit fraudulent sales figures to the Illinois Department of Revenue on monthly sales tax returns. Each month, the defendant directed his employees to provide false sales figures to his accountants, who in turn provided those figures to the state. In all, the defendant underreported his sales to the state by nearly $10 million, resulting in his underpayment of sales taxes by more than $1.1 million.

The wire fraud charge to which the defendant pleaded guilty is based upon his sending of an email containing false sales figures for the month of May 2014. The money-laundering charge to which the defendant pleaded guilty is based upon a series of financial transactions that he conducted using proceeds of his scheme to defraud the Illinois Department of Revenue. Specifically, the defendant deposited over $72,000 in cash into his personal bank account, which he knew consisted of funds derived from cash sales at his restaurants that were concealed from the state tax authorities. The defendant thereafter withdrew $60,000 from that account and purchased an official bank check, which he then deposited into a different business account. The defendant used the funds in that second bank account to purchase a restaurant and equipment, which he subsequently operated.

Sales Tax Fraud: No Longer Just a State Crime

At first glance, the facts of United States v. Xiaojun read like a typical criminal tax case and include the all-too-common attributes of tax fraud in the restaurant industry: the concealment of cash sales and the use of diverted cash to pay employees, purveyors and personal expenses of the restaurant’s owners. Indeed, the Justice Department’s website is replete with press releases announcing criminal tax charges against restaurant owners who engaged in conduct similar to that of this defendant, mostly commonly filing of false income tax returns in violation of 26 U.S.C. § 7206 or tax evasion in violation of 26 U.S.C. § 7201.

What makes United States v. Xiaojun notable is that the Justice Department did not assert a single federal tax charge against the defendant. The defendant’s payment of his employees in cash alone could have led to employment tax-related charges. Instead of charging Title 26 offenses, the government transformed what otherwise appears to be a garden-variety criminal tax case into a wire fraud and money laundering case by focusing on the defendant’s failure to pay state sales taxes.

The government’s case against Hu was premised upon a Justice Department policy titled Tax Directive No. 128, “Charging Mail Fraud, Wire Fraud or Bank Fraud Alone or as Predicate Offenses in Cases Involving Tax Administration.” This directive provides federal prosecutors with significantly expanded authority to use the mail and wire fraud statutes to charge additional crimes, and seek correspondingly increased penalties, in tax-related cases. Under a preceding policy, prosecutors were generally not permitted to use the fraud statutes where the use of the mails or wires was only incidental to a violation arising under the Internal Revenue laws.

Tax Directive No. 128 now authorizes prosecutors to use mail and wire fraud offenses and, more importantly, state tax violations where the mails or wire communication facilities are used, to transform cases that traditionally would be prosecuted under the tax laws into fraud and money laundering prosecutions. By charging mail and wire fraud in tax cases, the government can significantly change the charging and plea bargaining process. The mere threat of a mail fraud or money laundering charge may well cause targets of government investigations to plead guilty more willingly, and to agree to cooperate against other targets, than would have been likely under the prior policy where the charges were likely limited to federal tax offenses absent exceptional circumstances. In addition, the ability to include mail or wire fraud charges in a tax-related case provides prosecutors with an additional tool not previously available in traditional tax cases — the ability to seek forfeiture of the proceeds of the fraudulent scheme.

By relying upon the authority conferred by Tax Directive No. 128, the government can significantly ratchet up the pressure on targets of criminal tax investigations. By bringing charges under Title 18 rather than Title 26, the government can seek a longer prison sentence: the statutory maximum sentences available for mail fraud and money laundering, 20 years each, are significantly higher than the statutory maximum sentences available for tax fraud or tax evasion, which are three years and five years, respectively. In addition, the U.S. Sentencing Guidelines for mail fraud and money laundering crimes typically call for longer sentences than those applicable to tax offenses.

Charging mail fraud and money laundering also enables the government to seek restitution to be paid to the state agency that was defrauded. Had the government only charged federal tax crimes under Title 26, restitution could only have been ordered to the Internal Revenue Service. The government is also able to seek forfeiture of the funds that constitute proceeds of the mail fraud and money laundering offenses, an additional punishment that is not available for tax offenses. As part of his plea agreement, Hu agreed to pay at least $1 million in restitution to the Illinois Department of Revenue and to entry of a forfeiture judgment in an amount to be determined by the court at sentencing.

United States v. Xiaojun illustrates well how Tax Directive No. 128 provides federal prosecutors with significantly more leeway in charging offenses in what are viewed as traditional tax cases. No longer confined to the criminal offenses enumerated in Title 26, federal prosecutors can significantly increase the pressure on defendants by charging mail fraud and money laundering, seeking longer sentences and extracting substantial financial penalties by requiring defendants to pay both restitution and forfeiture. Prosecuting state sales tax fraud is no longer the exclusive domain of state authorities.

Downward Trends: Tax Offenders Often Receive Below-Guideline Range Sentences

As a result of his guilty plea, Hu was facing a possible prison sentence of 41 to 51 months as calculated under the applicable Sentencing Guidelines. Since the Supreme Court ruled in United States v. Booker, 543 U.S. 220 (2005), that the sentencing guidelines are no longer mandatory and binding, the applicable guideline range is but one of numerous factors that sentencing judges must consider in fashioning an appropriate sentence pursuant to 18 U.S.C. § 3553(a). Other considerations are the nature and circumstances of the offense and the history and characteristics of the defendant. After taking account of these factors, as well as the advisory guidelines range, the sentencing judge imposed a significantly below-guideline sentence, of one year and a day. With credit for good-time served, Hu will likely serve only 10 and one-half months in prison.

Far from aberrational, the sentence imposed on Hu fully comports with recent trends in tax fraud cases. According to the United States Sentencing Commission, in fiscal year 2015, 648 offenders were sentenced for tax fraud offenses.[2] Nearly two-thirds of those defendants were sentenced to imprisonment, with the average sentence being 17 months in jail. However, nearly half of those offenders received a sentence below the applicable Sentencing Guidelines range. And the percentage of below-range sentences — commonly referred to as “downward variances” — is steadily increasing, from 41.8 percent in FY 2011 to 49.2 percent in FY 2015. The average sentence for tax offenders has also decreased over the past five years.

Notably, the Northern District of Illinois — the judicial district in which Hu was prosecuted — had the most tax prosecutions of any district in the United States during FY 2015. That district also served as the venue for one of most significant downward variances in a tax case ever granted by a district court judge. In United States v. Ty Warner, the defendant pleaded guilty to evading about $5.6 million in federal income taxes.[3] Warner, who gained fame as the creator of the Beanie Baby toys, had secret Swiss bank accounts in which he hid over $100 million. Based upon the amount of taxes evaded, Warner faced a sentence of 46 to 57 months under the sentencing guidelines. Notwithstanding the significant tax loss, the district court judge imposed a sentence of probation — a downward variance of virtually unheard-of magnitude — based upon what it considered to be an exemplary lifetime of charitable good works by Warner as well as the fact that the defendant was a first-time offender who posed a low risk of recidivism.

The sentencing judge’s decision to grant a substantial downward variance to Hu was undoubtedly influenced by several important considerations. By pleading guilty, the defendant accepted responsibility for his misconduct — always an important factor at sentencing — but demonstrated further acceptance by making full restitution to the state of Illinois of all sales taxes evaded, nearly $1.1 million, prior to sentencing. In addition, the judge ordered Hu to annually perform 200 hours of community service for two years following his release from prison, reflecting a growing judicial trend toward considerations of alternatives to incarceration.


Two important lessons can be learned from the government’s case against Hu. First, the prosecution of sales tax fraud no longer falls solely within the purview of state authorities. Tax Division Directive 128 permits federal prosecutors to charge mail fraud, wire fraud, and even money laundering based upon a scheme to avoid paying state sales tax, exposing a culpable business owner to significantly longer jail sentences than could result from prosecution by state prosecutors under state law tax statutes. Second, below-guideline range sentences continue to be a feature that distinguishes tax cases from other white collar offenses. Nearly half of all tax offenders receive a sentence below the applicable range specified in the Sentencing Guidelines. This trend may be attributable to the view, held by some, that tax crimes are less serious than other types of white collar offenses, or to a general distaste for the formulaic approach to sentencing reflected in the Sentencing Guidelines, or both. In any event, tax offenders who accept responsibility for their misconduct by pleading guilty and making full restitution, and who have otherwise lived a commendable life and been productive members of society, can take comfort in the fact that their odds of receiving a below-range sentence are favorable, even if they are charged with fraud or money laundering offenses rather than straightforward tax charges.

Reprinted with permission from Law360. (c) 2016 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

[1] See United States v. Hu Xiaojun, No. 16-cr-316 (N.D. Ill.).

[2] United States Sentencing Commission, “Quick Facts – Tax Fraud Offenses” (August 2016).

[3] See United States v. H. Ty Warner, No. 13 CR 731 (N.D. Ill.).

On November 30th, a federal district court in California entered an order authorizing the IRS to serve a John Doe Summons on Coinbase Inc. seeking information about U.S. taxpayers who conducted transactions in virtual currency. In the court’s order, U.S. Magistrate Judge Jacqueline Scott Corley found that there is a reasonable basis for believing that virtual currency users may have failed to comply with federal tax laws.

There are no allegations by the Department of Justice that Coinbase has engaged in any wrongdoings in connection with its virtual currency exchange business. The IRS uses John Doe summonses to obtain information about possible violations of tax laws by individuals whose identities are unknown.  This John Doe summons directs Coinbase to produce records identifying U.S. taxpayers who have used its services, along with other documents relating to their virtual currency transactions.

Virtual currency is a digital representation of value that functions in the same manner as a country’s traditional currency.  There are nearly a thousand virtual currencies, but the most widely known is Bitcoin.  Because transactions in virtual currencies can be difficult to trace, taxpayers may be using them to hide taxable income from the IRS.

Bitcoin was launched in January 2009 by a person or persons under the pseudonym of Satoshi Nakamoto. Bitcoin is a digital currency that is maintained by a distributed network of computers and does not having the backing of a government. Bitcoin transactions are visible on the Bitcoin network but the identity of the participants are encrypted. Coinbase, a virtual currency exchanger headquartered in San Francisco, was founded in 2012 and offers “wallet” services to its customers (online accounts for holding and trading Bitcoin). Coinbase currently maintains about 5 million “wallets” for its customers.

In Notice 2014-21, the IRS declared that virtual currencies that can be converted into traditional currencies are property for tax purposes. Consequently, a taxpayer can have recognizable gains or losses on the sale or exchange of virtual currency.

In response to the court’s authorization of the John Doe summons, Principal Deputy Assistant Attorney General Caroline D. Ciraolo, head of the Justice Department’s Tax Division, stated that “as the use of virtual currencies has grown exponentially, some have raised questions about tax compliance.” She went on to say that “tools like the John Doe summons authorized today send the clear message to U.S. taxpayers that whatever form of currency they use – Bitcoin or traditional dollars and cents – we will work to ensure that they are fully reporting their income and paying their fair share of taxes.”

“Transactions in virtual currency are taxable just like those in any other property,” said IRS Commissioner John Koskinen.  “The John Doe summons is a step designed to help the IRS ensure people doing business in the emerging economy are following the tax laws and meeting their responsibilities.”

The IRS may use any account information gathered from the John Doe summons to audit a taxpayer or mount a criminal investigation. The U.S. taxes income from all sources and payments received in Bitcoin or other digital currencies may be considered income. Furthermore, for digital currencies held in offshore accounts, Forms 8938 or FBARs may be required. For employers, the IRS has made clear that Forms 1099 must be filed for payments to independent contractors in digital currencies and that wages paid to employees in digital currencies must be reported on Form W-2 and are subject to withholding and payroll taxes. Failure to pay payroll taxes can lead to civil penalties and potentially criminal charges on the individual officers of a business.

If you own Bitcoin or any other digital currency, you should consult with a tax advisor to ensure proper tax reporting.