Earlier this month Transparency International UK published a report entitled “Corruption on Your Doorstep: How Corrupt Capital Is Used to Buy Property in the UK.” The Britain-specific recommendations are part of TI’s broader “Unmask the Corrupt” campaign, a call by TI, and echoed by others, to establish public registries of beneficial ownership. A similar call to unveil the individuals behind the shell corporations used to buy luxury condos in Manhattan garnered a lot of attention stateside during last month’s New York Times “Towers of Secrecy” series on the city’s high-end property market (see here, here, here, here, here, and here). The anticorruption rationale for mandating disclosure of real property beneficial ownership seems straightforward: As both the TI-UK report and the NYT series argue, buying real property in New York and London is an appealing way to launder stolen funds, because high-end real estate purchases allow a corrupt actor to inject millions of dollars into the legitimate market without having to deal with pesky anti-money laundering regulations, completing the purchases through shell companies that disguise the true beneficial owner. Requiring public disclosure of the beneficial owners of real property would in theory have two related benefits: First, requiring purchasers to reveal beneficial ownership information up front would dissuade some from using real property as a means of laundering money, and second, if law enforcement authorities have ready access to this information, it will make it easier to instigate and conduct investigations, as well as to seize assets later on.
Indeed, transparency in real property beneficial ownership seems like the kind of thing all anticorruption advocates should support, which is why it may seem a little counterintuitive when I say TI and others are taking the wrong tack. Pushing for central public registries of beneficial ownership of real property will not likely achieve the two objectives, and may have serious drawbacks. Here’s why:
Regulating the whole for the few does not make good policy, and in this case is probably politically infeasible.
Both TI-UK and the NYT throw out a lot of statistics that are convincing from an anticorruption perspective, but they don’t do much in terms of putting that perspective into perspective. As TI points out, over 75% of UK properties which since 2004 have been investigated as the suspected proceeds of corruption used offshore shell companies to mask their owner’s identities. A 2013 investigation into London’s One Hyde Park, at that time the world’s most expensive residential building, revealed that nearly 80% of properties had been purchased through shell companies registered abroad. The NYT series focused in large part on the Time Warner Center (TWC), a luxury building overlooking Central Park in which over 60% of owners had purchased their condos under a cloak of anonymity, and at least 16 of whom had been at some point subject to government investigation. It’s clear that corrupt actors view high-end real estate in stable, metropolitan cities as a great way of laundering money. But when we look at the real estate market as a whole, and the frequency with which individuals choose to use shell corporations to purchase properties for perfectly legitimate reasons, the picture changes dramatically. It’s true that 16 foreign nationals who have at some point owned TWC property have been subject to government inquiries, but there are 192 condos in the TWC and they change hands frequently. In London, TI reports that 113 of the 144 London properties which have over the past 10 years been investigated as being suspected proceeds of corruption were registered to shell corporations rather than individuals, but this is out of the over 40,000 London properties held by foreign companies. In the words of the Director of Operations for the Metropolitan Police’s Proceeds of Corruption Unit, “the percentage of properties purchased via illicit money is tiny in comparison to the legitimate trade, but the values are huge.”
Even assuming we significantly underestimate the annual purchases of real property through corrupt funds—which is probably true—the shell company purchases of real property using illicit funds is still likely a very small segment of the overall shell company purchases of real property. The ratio is important for two reasons: 1) regulating the whole as a means of regulating a small segment is rarely the most effective means of addressing a problem; and 2) more importantly, the non-corrupt interests which benefit from shell company privacy, particularly in the US, make the establishment of a central registry disclosing real property ownership politically infeasible. People choose to use shell companies to purchase property for numerous reasons, including limiting exposure to lawsuits, avoiding double taxation, easing multiparty transactions, and inheritance and investment strategies. Foreign registration often affords exemption from capital gains taxes and in some jurisdictions companies can be created in as little as two days. The establishment of full transparency of beneficial ownership of real property amounts to a curtailing of benefits for all individuals who opt to use corporate vehicles to purchase property in order to target a very small segment using these vehicles for corrupt purposes.
This being said, some progress has been made on these issues over the past two years. The UK and EU should soon both have legislation requiring that domestic companies identify their beneficial owners. The US has noticeably been dragging its feet, though the U.S. Treasury has proposed plans to require financial firms to collecting beneficial ownership information from clients. However, it is not clear that these requirements, which focus on registration of foreign companies (UK and EU) and financial firms (US) will directly affect real property purchases, which are often cash transactions conducted by agents with no incentives to perform any due diligence other than making sure all the money adds up. If the anticorruption world wants to see more immediate change, they’d be well advised to design more targeted efforts. An example of such a recommendation was made just last week by the Stolen Asset Recovery Initiative, which called for the financial disclosure requirements for politically exposed persons (PEPs) to be amended such that any disclosure of assets must include properties owned through legal entities or for which the PEP is the beneficial owner. Though this reform would be limited to public officials required to submit financial disclosures, it also it is the kind of targeted regulation which could prove both more effective as well as more politically tenable as it targets a much smaller subset of real estate purchases, and a subset composed of people more likely to be engaged in corruption.
We should not ignore the real ramifications disclosure requirements may have on secrecy jurisdictions.
As a corollary to the legitimate domestic privacy interests which would militate against central public registries, the countries which specialize in setting up offshore corporations also have valid interests in maintaining attractive privacy rules. For example, more than 60% of 2011 government revenue in the British Virgin Islands was collected from company registration fees. The Premier of the Cayman Islands, another offshore hub, noted last December that, “[u]nless such registers become the new global standard and are being used by all major players – including the UK – [we do not] intend to go first and have our economies experimented with and potentially damaged. We see no need for a central registry that would increase cost to business and the country and also create a potential single data source, which motivated and skilled individuals could hack into for gain.” The majority of offshore corporations do not engage in money laundering, but do choose to register in secrecy jurisdictions. In restricting some of these countries’ comparative advantage, we should be aware of potential negative economic effects.
We may want to look closer to home.
The corporate beneficial ownership requirements in the UK draft legislation are based on corporate self-reporting. Applied to companies formed in order to purchase real property, the utility of this requirement decreases significantly. Companies purposefully formed to launder money through real estate will most likely simply misreport, or use corporate service providers (CSPs) known for more lax due diligence standards. Interestingly, according to a 2012 paper by researchers Michael Findley, Daniel Nielson, and Jason Sharman testing how likely CSPs were to follow international guidelines on collecting identity documents prior to setting up shell companies (summarized by Professor Sharman in his previous guest post), “against the conventional policy wisdom, those selling shell companies from tax havens were significantly more likely to comply with the rules than providers in OECD countries like the United States and Britain.” We may simply see a shifting of business from offshore havens which are more likely to follow regulations to major economies which are not. Either way, we may be no more likely to have companies set up to launder money actually submitting the names of beneficial owners.
A windfall of information may not lead to a windfall of change.
This may be rather obvious, but it’s worth noting all the same: Transparency in and of itself does not solve the problem; data still needs to be used to instigate and conduct investigations. In establishing a central registry for beneficial ownership of the entire real property market, as opposed to a more targeted approach, authorities will be faced with a windfall of information, most of which will be irrelevant to anticorruption efforts.
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If increasing transparency is not going to be fixing anything anytime soon, what to do? Both the NYT and TI-UK touch upon the issue of industry agent regulation, but generally treat it as having a limited role to play. One of the key aspects of money laundering through real estate is that it requires the participation of various professionals, including lawyers, accountants, escrow and real estate agents, as well as condominium boards. Each of these groups may be regulated, which would allow anticorruption agents to focus their efforts on the most effective pressure points while expending less political capital than would be required in taking on diverse privacy interests. At a minimum, real estate agents should face the following regulations:
- Any property purchase above a relatively low threshold should either take place through a financial institution with AML checks, or the real estate agents should be required to ascertain the identity of all beneficial owners involved in the transaction. This standard should be more politically palatable than a central registry as the threshold limits the number of real estate agents involved. Furthermore, whereas under the TI recommendation the onus to reveal the beneficial owners is placed on the company, this alternative proposal places that burden on a party with less incentive to disguise the proceeds of corruption, and who is well-positioned to verify the identity of both sellers and purchasers. Doing so—or, more likely, hiring someone else to do so—would be an additional financial burden, but would also be more likely to generate valid information and could be further targeted to affect the market segments most vulnerable to corruption (i.e. new luxury developments which are not primary residences in specific cities). More thought should go into where exactly the threshold level should be set, but a suggestion would be any real property with a value higher than the average value of properties investigated as proceeds of corruption over the past five years.
- Real estate agents should be obligated to immediately report any suspicious behavior to anticorruption authorities. Suspicious behavior would include cash purchases, property sold at unusually low or high prices, or other indications that the purchaser may be a high-risk individual. The requirement to report is important as it allows authorities to be informed of a transaction before it takes place.
To be sure, there may be other benefits associated with increased transparency in property ownership, particularly in cities facing skyrocketing inequality and woefully inadequate access to housing. But as an anticorruption strategy, attempting to create public registries to identify the beneficial owners of all real property is both a political non-starter and unlikely to have a significant impact. A better approach would be to impose—and strictly enforce—more targeted obligations obligations on the middlemen in potentially problematic transactions, especially real estate agents and CSRs.