The Treasury Inspector General for Tax Administration, or TIGTA, issued last month a Report, entitled The Internal Revenue Service’s Bank Secrecy Act Program Has Minimal Impact on Compliance, which sets forth a decidedly dim view of the utility and effectiveness of the current Bank Secrecy Act (“BSA”) compliance efforts by the Internal Revenue Service (“IRS”).  The primary conclusions of the detailed Report are that (i) referrals by the IRS to the Financial Crimes Enforcement Network (“FinCEN”) for potential Title 31 penalty cases suffer lengthy delays and have little impact on BSA compliance; (ii) the IRS BSA Program spent approximately $97 million to assess approximately $39 million in penalties for Fiscal Years (FYs) 2014 to 2016; and (iii) although referrals regarding BSA violations were made to IRS Criminal Investigation (“IRS CI”), most investigations were declined and very few ultimately were accepted by the Department of Justice for prosecution.

Arguably, the most striking claim by the Report is that “Title 31 compliance reviews [by the IRS] have minimal impact on Bank Secrecy Act compliance because negligent violation penalties are not assessed.”

A primary take-away from the Report is that an examination program lacking actual enforcement power is, unsurprisingly, not very effective.  The Report also highlights some potential problems which beset the IRS BSA Program, which include lack of staffing, lack of planning and coordination, and delay. Although the Report’s findings clearly suggest that what the IRS BSA Program really needs are resources and enhanced enforcement power, the repeated allusions in the Report to a certain purposelessness of the current BSA examination regime nonetheless might help fuel the current debate regarding possible AML/BSA reform, with an eye towards curbing regulatory burden.

The Report made five specific recommendations to the IRS for remedial steps. We will focus on four of those recommendations, and the findings upon which they rest:

  • Coordinate with FINCEN on the authority to assert Title 31 penalties, or reprioritize BSA Program resources to more productive work;
  • Leverage the BSA Program’s Title 31 authority and annual examination planning in the development of the IRS’s virtual currency strategy;
  • Evaluate the effectiveness of the newly implemented review procedures for FinCEN referrals; and
  • Improve the process for referrals to IRS CI.

Overview of the Report

TIGTA conducted its audit to “evaluate the impact of the IRS’s compliance efforts related to its delegated authority under the BSA.” It reviewed a statisically valid random sample of 140 cases that the BSA Program closed out of a total of 24,212 in FYs 2014 through 2016.

The Report first provided an overview of the Treasury Department’s current BSA regulatory framework. The BSA empowers the Secretary of the Treasury to require financial institutions and certain businesses to file reports documenting a wide variety of transactions to create and maintain “a financial trail for investigators to follow as they track criminal activities and assets.” The Treasury Department has delegated to the IRS the authority to, among other things: (1) enforce the BSA’s criminal provisions; (2) examine certain nonbank financial institutions, such as casinos, check cashers, and virtual currency exchanges; and (3) examine compliance by businesses with filing the Form 8300 (which must be filed when over $10,000 in currency, as defined, is accepted in the course of a trade or business in regards to a single transaction or more than one related transaction). The IRS Small Business/Self-Employed Division conducts BSA compliance activities through its Speciality Examination function, which has a dedicated BSA Program.

The Report explained that the IRS’s BSA examiners conduct these examinations of nonbank financial institutions and can make criminal or civil referrals for violations. The examiners refer cases involving potential criminal activity to IRS CI. Under the IRS’s referral standards, the examiners refer civil cases involving Title 31 recordkeeping and reporting violations to FinCEN where the violations are potentially willful or significant. In contrast, cases with “minor” violations – described by TIGTA as “technical, minor, infrequent, isolated, or nonsubstantive” – are not referred to FinCEN. Notably, however, FinCEN has the ultimate – and sole – authority to impose Title 31 civil penalties, including for minor violations, although the the IRS may impose BSA civil penalties regarding Form 8300 violations. The Report does not deal with the BSA’s Report of Foreign Bank or Financial Accounts, or FBARs, which the IRS also enforces, and which have served as the engine of the IRS’s undisclosed offshore account enforcement campaign.

The Report emphasized that this framework means that businesses that engage in minor violations of the Title 31 recordkeeping and reporting violations – even repeated ones – face no meaningful consequences. Yet, despite this lack of civil penalty authority, the IRS’s BSA examinations have consisted almost entirely of Title 31 compliance reviews. These reviews comprised 87 percent of the planned workload closures for FYs 2014 through 2016.  The Report provided this summary of the IRS’s planned and actual Title 31 examinations for FYs 2014 through 2016, by primary financial service type:

As noted, the Report observed that, in exchange for $39 million in penalties assessed by FinCEN for FYs 2014 through 2016, the IRS incurred associated costs of approximately $97 million. This comparison does not suggest that the government is enjoying an excellent monetary return on its investment, or that the BSA Program is being run at maximum efficiency.  Nonetheless, any type of enforcement effort presumably attain a degree – not subject to monetary measurement – of compliance which occurred because of the general deterrence effect of enforcement. i.e., but-for the perceived threat of a BSA enforcement program, industry would have complied less than it did.

Findings and Recommendations for Improvement

As noted, TIGTA made five specific recommendations to the IRS for remedial steps. We will discuss four of those recommendations:

  • Coordinate with FINCEN on the authority to assert Title 31 penalties, or reprioritize BSA Program resources to more productive work;
  • Leverage the BSA Program’s Title 31 authority and annual examination planning in the development of the IRS’s virtual currency strategy;
  • Evaluate the effectiveness of the newly implemented review procedures for FinCEN referrals; and
  • Improve the process for referrals to IRS CI.

Authority to Assert Title 31 Penalties

First, TIGTA recommended that the IRS coordinate with FINCEN on the authority to assert Title 31 penalties or reprioritize BSA Program resources to more productive work. This is the only recommendation with which the IRS disagreed.

TIGTA emphasized in its Report that there are “no real consequences to deter noncompliance” under the current regulatory framework for “minor” Title 31 violations. Despite FinCEN’s authority to impose civil penalties of up to $500 per violation for negligent recordkeeping and reporting requirements, the agency assessed zero penalties for minor violations in FYs 2014 through 2016. This chart shows the types of BSA penalties assessed for FYs 2014 through 2016:

TIGTA explained that IRS standards caution against referring minor violations to FinCEN. Instead, the IRS refers only those cases that have a “significant” or “willful” BSA violation or defiency, such as “systemic or pervasive BSA compliance program deficiencies, [or] systemic or pervasive recordkeeping violations.”

But because the IRS lacks authority to impose civil penalties for violations, the Report states that businesses that repeatedly violate Title 31 recordkeeping and reporting requirements generally receive only a Letter 1112, Notification of Apparent Violation, if the violations are all “minor.” (If a BSA examiner finds that the violations are technical, minor, infrequent, isolated, or nonsubstantive then the examiner can issue a Letter 1112 to the entity; this letter is how a BSA examiner closes a case if the business being examined committed a minor violation. If no Title 31 violations are found, the BSA examiner issues a Letter 4029, Bank Secrecy Act No Change Letter). In the course of its audit, TIGTA spoke with BSA examiners that expressed their frustration with the IRS’s lack of enforcement power. Two examiners described their compliance reviews of minor violations as a “waste of time.”

The Report underscored this apparent futility by describing its findings concerning the 105 sample cases that closed with a Letter 1112 and no civil penalty. These cases involved a total of 383 Title 31 violations. In 41 of these cases, the businesses previously violated Title 31 in FYs 2011 through 2016. TIGTA estimated that these cases could have resulted in total penalties of $191,500 and, projecting this estimate to the total population size of 24,212 closed cases, estimated that the IRS and FinCEN declined to impose an estimated total of $33,118,557 in potential civil penalties over FYs 2014 through 2016. TIGTA warned that “some type of enforcement needs to be considered [for these violations] to ensure compliance and deter financial crimes, money laundering schemes, tax evasion, and other illicit activity.”

In the course of its audit, TIGTA spoke with BSA examiners that expressed their frustration with the IRS’s lack of enforcement power. Two examiners described their compliance reviews of minor violations as a “waste of time.”

As noted, the IRS disagreed with this recommendation, apparently because FinCEN intends to retain its authority to impose Title 31 penalties in order to seek consistent application of penalties across agencies, and because providing the IRS with Title 31 penalty authority would require a regulatory change. TIGTA was not persuaded by this explanation, stating that it remained concerned that the only internal compliance tool available to the IRS for Title 31 violations is a warning letter, and observing that “it was clear that many [BSA Program employees] believe that penalty issuance authority would be an important improvement for the program. We plan to discuss our concerns about this with officials in the Department of the Treasury.”

BSA Examination Planning and Virtual Currency

Second, TIGTA recommended that the IRS “should leverage the BSA Program’s Title 31 examination authority by incorporating its annual examination planning into the IRS’s overall virtual currency strategy.” As we have blogged (here and here), FinCEN regards virtual currency administrators or exchangers as subject to the BSA because they represent money services businesses, or MSBs. As MSBs, virtual currency exchanges must register with FinCEN and maintain an adequate AML program, file SARs when appropriate, and comply with other BSA obligations. Despite the attention devoted to virtual currency in government press releases regarding regulatory requirements and enforcement risk, and although “IRS officials have acknowledged that virtual currency poses a threat to tax administration[,]” TIGTA clearly regards the IRS as having an anemic BSA examination program in regards to virtual currency.

According to TIGTA, “[t]he BSA Program has not prioritzied virtual currency exchanges in its workplan and is not even meeting its planned case closures on virtual currency Title 31 examinations.” Indeed, for FY 2017, the IRS actually closed only six of only 12 planned exam closures. TIGTA also criticized IRS because, despite the IRS declaring in March 2014 that virtual currency represents property subject to taxation, “there has been little evidence of coordination within the IRS to identify and address noncompliance issues for transactions involving digital currencies” and thereby reduce tax noncompliance and the significant annual Tax Gap.

Evaluation of Review Procedures

Third, TIGTA recommended that the IRS “evaluate the effectiveness of the newly implemented review procedures for FinCEN referrals.” This is because TIGTA “found that referrals to the FinCEN were significantly delayed during the IRS policy analyst review process, with minimal referrals resulting in civil penlaty assessments.” There are only six policy analysts who are responsible for reviewing the referral packages to FinCEN sent by IRS BSA examiners, and those analysts labor under numerous procedures.

The Report discusses significant delays in the process, perhaps best summarized by this chart:

According to the Report, “one BSA examiner who has submitted several referrals for the FinCEN expressed concerns that the policy analyst took too long to process the referral, while another BSA examiner, who had similar concerns, expressed an ongoing frustration with the policy analysts and questioned the value of their review.” Obviously, aside from the potential enforcement costs associated with such delays in specific cases, such delays can undermine institutional morale in subtle ways which degrade overall effectiveness, over time.

Further, once FinCEN receives a referral from the BSA Program, FinCEN then will make an assessment and propose a recommendation, and will either (i) assess a civil monetary penalty; (ii) issue a letter of warning; (iii) decline or close the case without contact; or (iv) return the case to the BSA Program for further work. “Figure ll [set forth below] reflects that FinCEN has assessed penalties on only six of the 80 cases submitted, and 49 of the 80 cases remain open as of December 31, 2017. When we interviewed FinCEN management, they stated that the main reason a referral may not be worked is due to the age of the referral.”

One enforcement bright spot: five of the 80 referrals submitted to FinCEN (out of an original 116 submissions) resulted in approximately $21 million in assessments. Ultimately, however, the Report concludes on this point as follows:

[D]elays [by the IRS] in submitting cases to the FinCEN, may not only require the FinCEN to request more information but also to possibly not consider a case for further civil penalty. This not only affects furture compliance from those taxpayers who are required to comply with BSA requirements also also expends the BSA Program’s limited resources to prepare referrals for which the FinCEN will not consider penalty assessment.

Process for Criminal Referrals

Finally, TIGTA recommended that the IRS “should work with [IRS] CI to review the BSA criminal referral criteria and ensure that written procedures and policies are in place and being followed to maximize efficiency and enhance BSA referrals to CI to prevent unnecessary resources from being expended on referrals that will not be given consideration.” The Report observes that the IRS – rather than FinCEN – may impose BSA civil penalties only on Form 8300 violations, which are also covered by the Internal Revenue Code.

The Report in part summarizes the elaborate and time-consuming process in which IRS civil personnel may make a criminal referral to IRS CI, which – if it accepts the referral – will investigate and then either decline or make its own criminal referral to the Department of Justice (“DOJ”), which then also will investigate and either decline or ultimately pursue criminal charges.

The Report then sets forth some underwhelming statistics. Between FYs 2014 and 2016, the BSA Program submitted 40 criminal referrals to IRS CI. As of November 2017, 25 of those referrals were declined. Further, seven of the initially accepted cases had been declined later, leaving only five ongoing IRS investigations and three still-pending cases that have been forwarded to the DOJ for possible prosecution. A review of memorandums from IRS CI explaining the declinations revealed “two common themes for rejection”: (i) failing to satisfy DOJ priorities regarding the types of cases that the DOJ will pursue, because the DOJ desires cases with jury appeal that will lead to significant sentences; and (ii) money laundering activity was not clearly evident or the business owner potentially could invoke ignorance of the law as a defense, “such as a first examination or an apparent language barrier.”

A review of memorandums from IRS CI explaining the declinations revealed “two common themes for rejection”: (i) failing to satisfy DOJ priorities regarding the types of cases that the DOJ will pursue, because the DOJ desires cases with jury appeal that will lead to significant sentences; and (ii) money laundering activity was not clearly evident or the business owner potentially could invoke ignorance of the law as a defense, “such as a first examination or an apparent language barrier.”

Regardless of whether TIGTA is correct that enhanced critieria and written procedures will “prevent unnecessary resources from being expended on referrals that will not be given consideration,” the apparent takeaway from the Report, at least from a legal practioner’s standpoint, is that the average federal prosecutor currently is expressing little to no interest to IRS CI in pursuing criminal cases involving businesses subject to IRS BSA examinations, particularly in cases involving “pure” regulatory violations and no evidence of criminal proceeds having been transacted/laundered. The reasoning may be that a putative defendant could have a viable mental state defense. Alternatively, or in addition, the reasoning may be that federal prosecutors just do not perceive it as being worth the time and effort to prosecute small- and medium-business owners in a relatively complicated case for possibly intentional but “mere” regulatory BSA offenses (and BSA regulations can be opaque) because juries are perceived as being disinclined to convict such defendants. And, even if a jury did convict, judges are perceived as being disinclined to mete out substantial prison sentences. Ultimately, the statistics from the Report suggest that, as of approximately one year ago, three fiscal years of IRS BSA examinations across the country have yielded only three potential criminal cases still being considered by the DOJ for possible prosecution.

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Mary K. Treanor

treanorm@ballardspahr.com | 215.864.8131 | view full bio

Mary focuses her practice on white collar matters and complex commercial litigation. She advises clients on BSA and AML matters, including government and internal investigations. She also counsels financial institutions on SAR filings and confidentiality requirements.

treanorm@ballardspahr.com | 215.864.8131 | view full bio

Mary focuses her practice on white collar matters and complex commercial litigation. She advises clients on BSA and AML matters, including government and internal investigations. She also counsels financial institutions on SAR filings and confidentiality requirements. Prior to joining Ballard Spahr, Mary worked for a Washington, D.C. law firm, representing clients in market manipulation and failure to supervise enforcement actions brought by the CFTC and FERC. She also advised financial institutions on compliance with the Dodd-Frank Act and corresponding agency regulations.

Peter D. Hardy

hardyp@ballardspahr.com | 215.864.8838 | view full bio

Peter is a national thought leader on money laundering, tax fraud, and other financial crime. He is the author of Criminal Tax, Money Laundering, and Bank Secrecy Act Litigation, a well-reviewed and comprehensive legal treatise published…

hardyp@ballardspahr.com | 215.864.8838 | view full bio

Peter is a national thought leader on money laundering, tax fraud, and other financial crime. He is the author of Criminal Tax, Money Laundering, and Bank Secrecy Act Litigation, a well-reviewed and comprehensive legal treatise published by Bloomberg BNA.

He advises corporations and individuals from many industries against allegations of misconduct ranging from money laundering, tax fraud, mortgage fraud and lending law violations, securities fraud, health care fraud, public corruption, Foreign Corrupt Practices Act violations, and identity theft and data breaches.  He also advises on compliance with the Bank Secrecy Act and Anti-Money Laundering requirements.

Peter spent more than a decade as a federal prosecutor before entering private practice, serving as an Assistant U.S. Attorney in Philadelphia working on financial crime cases. He was a trial attorney for the Criminal Section of the Department of Justice’s Tax Division in Washington, D.C.