Independent Sales Organizations (ISOs) and Money Services Businesses (MSBs) are involved in financial services. Still, their roles, regulatory requirements, and risks related to money laundering can differ significantly. When it comes to commercial financing, the distinction between a Commercial Financing ISO and a Commercial Financing MSB becomes more evident through the services they provide, the regulatory framework governing them, and how they handle deposits.

Commercial Financing ISO

A Commercial Financing ISO primarily serves as an intermediary between businesses (merchants) and financial institutions, providing access to credit or loans and facilitating payment processing services. In commercial financing, like MSBs, ISOs connect businesses with financial products such as merchant cash advances (MCA), equipment financing, and business loans. They typically work with acquiring banks and financing companies to offer services like:

• Merchant cash advances (MCA): Providing businesses with a lump sum of capital in exchange for a percentage of future credit card sales.

• Factoring: Purchasing a business’s accounts receivable at a discount and providing immediate capital.

• Loan brokerage: Matching businesses with lenders for various types of commercial loans.

ISOs should NOT handle sums of cash directly or hold deposits; instead, they should facilitate the movement of funds and financing between merchants and lending institutions.

Regulation of ISOs in Commercial Financing

Commercial Financing ISOs operate under a framework governed by banking regulations, payment network guidelines (e.g., Visa, Mastercard), and acquiring banks. However, because they should not directly deal with the transmission or deposit of funds, ISOs are less likely to fall under the stricter Anti-Money Laundering (AML) regulations that MSBs face.

ISOs are subject to the Corporate Transparency Act’s beneficial ownership information reporting requirements. There are two types of reporting companies: domestic reporting (DRC) and foreign reporting (FRC). Both involve corporations and limited liability companies. Both must file a document with a secretary of state or similar office. The difference is that a DRC is created by filing its documents, while an FRC is formed under the law of a foreign company and has to file documents to register to conduct business in the U.S.

Nevertheless, ISOs can risk inadvertently facilitating money laundering if they partner with business fronts for illicit activities or take custody of deposits while waiting for applicant paperwork. For example, a fraudulent merchant could use the financing provided by an ISO to funnel illegal funds into the legitimate financial system. ISOs must conduct Know Your Customer (KYC) procedures, but they are not subject to the same level of scrutiny as MSBs.

Commercial Financing MSB

On the other hand, a Commercial Financing MSB is a business that provides more direct access to financial services, particularly those that involve the transmission of money or exchange of currency. In the realm of commercial financing, MSBs offer ISO services plus:

• Wire transfers for businesses, particularly for international transactions.

• Foreign currency exchange for companies that need to convert large sums of money for trade or investment purposes.

• Issuance of prepaid instruments or stored value cards that businesses can use.

Unlike ISOs, MSBs should carefully steer the actual transmission and exchange of money. This practice puts them in a higher-risk category for money laundering activities, as they are directly involved in the movement of funds, especially across borders.

Regulation of MSBs in Commercial Financing

MSBs are heavily regulated under the Bank Secrecy Act (BSA). They must adhere to stringent AML and Countering the Financing of Terrorism (CFT) rules. They are required to:

• Register with FinCEN (Financial Crimes Enforcement Network).

• Establish robust AML programs, which include customer due diligence (CDD), transaction monitoring, and suspicious activity reporting (SAR).

• Implement KYC policies to verify the identity of customers and prevent illicit activities.

• Grasp fluctuating international sanctions policies.

MSBs can handle significant cash and cross-border transactions, making them particularly attractive to money launderers. For example, they can facilitate the purchase of commercial equipment for developing countries. Criminals can use MSBs to move illicit funds across jurisdictions, making it difficult for authorities to trace the origins of the money.

How Taking and Holding Deposits Can Result in Money Laundering

 ISOs and MSBs can be exploited for money laundering, but the risk is more pronounced for MSBs because they can handle actual funds. Money laundering involves disguising the origins of illicit money, often by passing it through legitimate financial services to make it appear clean. Deposits can be the first step in the money laundering process for ISOs, especially for MSBs.

Money Laundering Process

Money laundering generally follows three stages:

1. Placement: This is the stage where illicit funds are introduced into the financial system. Criminals can deposit illegally obtained cash or proceeds into an MSB under the guise of a legitimate transaction. For example, a business could deposit large sums of money into an MSB account, masking the funds as business revenue.

2. Layering: The deposited funds are moved around to obscure their origin. MSBs, due to their role in currency exchange and international transfers, are ideal vehicles for this stage. Money can be transferred across borders, exchanged into different currencies, or moved between accounts in a way that makes it difficult to trace.

3. Integration: Finally, the laundered money is reintegrated into the legitimate economy. The funds may purchase assets, invest in businesses, or finance other legitimate ventures. At this stage, it becomes nearly impossible to distinguish the laundered funds from legitimate money.

How MSBs Are Involved in Money Laundering

MSBs are more susceptible to money laundering internationally and domestically because they deal with the following:

• Large volumes of cash: Cash transactions are inherently difficult to trace. MSBs often deal with significant amounts of money for services like check cashing or remittances.

• Cross-border transactions: International money transfers are shared for MSBs, and they can be exploited by money launderers who want to move funds to jurisdictions with less stringent financial regulations.

• Anonymous transactions: Some MSB services, like prepaid cards or money orders, can be used without revealing the identity of the individual behind the transaction, making it easier to launder money.

MSBs are required by law to implement AML programs, including filing  Suspicious Activity Reports (SARs) if they detect potentially illicit activities. However, without strong internal controls, MSBs can become conduits for money laundering.

Money Laundering, FinCEN, and RICO Crimes

FinCEN’s Role in Combatting Money Laundering

The Financial Crimes Enforcement Network (FinCEN) plays a critical role in combatting money laundering in the U.S. FinCEN’s mission is to safeguard the financial system from illicit use by monitoring financial institutions, including MSBs, for compliance with the Bank Secrecy Act (BSA) and AML regulations. FinCEN requires MSBs to:

• File Suspicious Activity Reports (SARs) for transactions that may indicate money laundering.

• Conduct Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) to identify and verify clients’ identities.

Failure to comply with these regulations can result in significant fines, criminal penalties, and the closure of the MSB.

RICO Crimes and Money Laundering

The Racketeer Influenced and Corrupt Organizations Act (RICO) was enacted to combat organized crime in the United States. RICO allows individuals and businesses involved in ongoing criminal enterprises to be prosecuted. Money laundering is often connected to other organized crimes, such as drug trafficking, human trafficking, or fraud. Under RICO, businesses knowingly or unknowingly assisting in these activities can face serious consequences, especially in predicate situations.

Connection to RICO:

• MSBs that fail to screen customers or transactions adequately could inadvertently help criminal organizations launder money.

• Suppose an MSB or ISO is complicit in laundering money. In that case, they can be charged under RICO for participating in a criminal enterprise.

• RICO laws allow for severe penalties, including the forfeiture of assets obtained through illicit means and civil suits from victims of the crimes.

For example, a drug cartel could use an MSB to move illicit drug proceeds across borders. If the MSB fails to detect or report suspicious activity and allows the funds to be laundered, they could face prosecution under RICO laws.

Conclusion

While Commercial Financing ISOs and Commercial Financing MSBs operate within the financial services sector, their roles, risks, and regulatory requirements differ substantially. ISOs should primarily serve as intermediaries, facilitating business financing without directly handling funds. In contrast, MSBs can directly handle money transmission, currency exchange, and cash transactions, making them more vulnerable to money laundering risks.

Handling deposits can be hazardous for MSBs, as they are a vulnerable entry point for illegal funds into the financial system. To effectively tackle this issue, MSBs must enforce stringent KYC (Know Your Customer) procedures and implement robust transaction monitoring systems. Regular staff training and compliance audits are imperative to ensure MSBs are well-prepared to identify and prevent illicit activities. Staying abreast of regulations and best practices is crucial for MSBs to enhance their anti-money laundering efforts continually.

Commercial Financing Now ® is a Money Service Business (MSB) operating as a Non-Bank Financial Institution (NBFI) that abides by Anti-Money Laundering (AML) Regulations. These policies and procedures are internally published and meet reporting requirements while considering sanctions screening and transactional monitoring.

Commercial Finance Now does not provide tax, legal, or accounting advice. This post has been drafted for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before considering any tax treatments.