Compliance. Yuck! Everyone hates the whole compliance thing, but we all must admit, whether we like it or not, it is just going to get worse and not better. When I owned my stores in CA and OR from 1996-2012, I had no idea any of this stuff ever existed. By 2013 I had started a business to help others understand and it has now blossomed into 39 states and Canada!
Title 31 audits (the IRS likes to refer to them as ‘exams’) are occurring with an alarming rate and should have everyone reading this at least paying attention. While these are not “tax” audits, they can lead to them quickly if you are not careful. Nobody wants a “tax” (Title 26) audit. So, what do you need to know?
Title 31 is the U.S. PATRIOT ACT and as pawnbrokers you fall under this act because you are considered a financial institution. You are a bank after all, and many states use their banking regulators to monitor and license pawnbrokers. You then get to follow the same rules as banks. To add to this, you are also considered a ‘high risk’ industry by FinCEN which is the Treasury watchdog and enforcement arm. (FinCEN stands for Financial Crime Enforcement Network.) They set the rules and they DO enforce them. Fines levied by FinCEN can be business ending, and since pawnbrokers are supposed to have had AML programs in place and operational since 2005, they have little tolerance for ignorance, real or feigned.
So, what exactly is a Title 31 Exam? It is an exam of your Anti-Money Laundering program. You will get a notice 30 days ahead of time letting you know you have been selected for an exam. Included with the letter will be a three-page document listing all of the items they will need you to have ready to go for the special day. The first several will be requested digitally prior to the actual review so they can do some homework before they arrive. At the very top of the list is a copy of your AML program.
Question for you. If you do not have an AML, how are you going to send it digitally? On top of that, an audit will go back 6 months to look at your AML program and the systems you have in place in support of that program. How do you prove to their satisfaction that you had a functioning program when in fact you did not? The answer is you do not. And there you are, standing naked in front of the IRS begging for a second chance and trying to explain to them that you had no idea you were required to do this stuff even though the laws have been in place for much of it since George W. Bush was in office.
Exams do not actually take much time when the examiner is on site, but the preparation will set you back several hours, and in some cases depending on the size of your operation(s), days. You will need to provide employment records, training documentation, any 8300 and SAR forms you filed, any workpapers (reports and tracking info to show why you did or did not file 8300 forms and SAR’s), bank statements, and purchase records for the 6 month period in question.
On the day of the review, I highly recommend that you meet the examiner with your treasure trove of documents off-site. I also recommend that you have someone other than yourself sitting there trying to answer questions on your behalf. These exams are new to many IRS folks and they are trying to figure them out. You will be too nervous to answer questions correctly and see what path they are leading you down. You may walk right into a tax audit if you answer something innocently but incorrectly. By the way, your CPA is not the best person for these reviews. They are proficient in Title 26 but NOT Title 31. While they may be well-meaning, I am aware of at least one exam that went south in the last 18 months because of this scenario.
So, what exactly do you have to have in place to pass this exam?
- A written program based on the risks inherent in your unique business and its geographic location for the potential to have money laundering or other nefarious activity take place. The program is to be custom (not a template) and a living, breathing document that is part of the culture of your operation.
- A designated compliance officer in charge of the whole thing. In addition, if you are an entity, then you need to provide a statement from the top echelon that shows support for the program and the compliance officer at the very least.
- Routine documented training, provided at these three times:
- Within 30 days of hire for new staff that are required to know the information
- Every year for all staff as a refresher
- Any time there are substantive changes on a federal level
- An annual independent review of your program to determine how well it is working, how up to date it is, and how well it is incorporated into the DNA of the company. Independent means “not you”, and it should be someone who is certified in this stuff.
While this sounds ominous, it is not. Because much of what the IRS folks are looking for does not happen routinely in our industry, your goal is to paint a clear picture for them of what actually does happen in your company. While this may be very little, that is important for them to see. In other words, you can say that you have not filed any 8300 forms ever, but your examiner will need to verify that. Better for you to hand them reports you have already looked at that support your statement than having them digging through your computer. Unless, of course, you want the IRS person digging through your computer…
You will need to be tracking any transactions that are large for your operation to make sure there are no trends or patterns that may lead a reasonable person to believe that money laundering could be occurring under your nose.
You will need to be checking all pawn and buy customers against the OFAC SDN list. This is a list of 15,000+ names that evolves almost daily. Fines are ridiculous if you give these folks money. Most pawn systems today will offer a way to check these. One charges for the service (I cannot get them to stop…) which is absurd since it is a federal mandate, but the rest offer something. It is your job to make sure you are paying attention to these. The argument that, “I never get any hits” is fine, but you must be able to prove this! Each software company provides this in different ways. Just because you pay a lot for your software by the way does NOT guarantee they do compliance stuff correctly. Compliance is not glamorous and it is not a huge selling point, so some of them have just put a mediocre solution together that in many cases is 50% there and then you get to push or pull it across the finish line.
You will need to be able to demonstrate that you have ‘know your customer’ and ‘enhanced due diligence’ protocols in place. Now the good news here, is that pawnshops overall do a stellar job here. Think about it. In most shops, before the customer ever hits the counter, they are explaining why they are in the shop again. We know, or think we know, their whole life story. To the extent that story never changes, AND nothing about the activity of the customer seems to contraindicate their story, you are fine. BUT you need to have trained your staff what to do if that story changes, AND you need to be able to prove that to the IRS examiner.
They will ask you about your ability to source inventory. In laymen’s terms, that means you must tell them where a ring they pick out of the case came from. If you have an inventory number that ties to a loan or buy number, you are in good shape. If you like to generate unique numbers and it will be hard to explain to that examiner where the item came from and most importantly, how much it cost, you may be walking right into a tax audit. If you are one of those stores that uses your pawn software only to manage the pawns and buys and you have a separate system for inventory, this is your warning to really consider how that looks to the IRS examiner. The old days of operating out of a cigar box…that will get you shut down now.
That is a solid amount of information and all around just the Title 31 AML exam. When it comes to compliance, this is the piece that must be intact and functioning. It is not enough to purchase the program and let it sit on the shelf. I have seen fines levied for $10,000 for folks who did that. That is one expensive AML program! In addition to the AML program, there are many more federal items, and we will not even go into ATF stuff. The other two biggest federal compliance pieces are TILA (Truth in Lending Act) and the MLA (Military Lending Act).
You need to have a reasonable system in place for identifying whether a customer is an MLA covered borrower. You do NOT have to run every single name against the Department of Defense website as was initially reported and to some degree I still stumble upon. You must make sure that your software prorates the military APR to a DAILY rate based on 36%/year. One major software company does not have this box checked in their settings and if you keep it that way you are overcharging these customers! You must provide a written AND oral disclosure of the Military APR since the contract language on the back will not line up with what was printed on the front. Burrell offers a great product just for this purpose (11-5560). Use it. You will need to retain ALL pawn tickets for 5 years from the date of final disposition. This is not read as 5 years from the date you wrote the ticket.
TILA is more about the statements on your contract and your understanding that a signed contract is EVERYTHING in a court of law. Make darn sure that your contract matches your systems and your laws. When the dust settles, whatever is on your contract will rule. When was the last time you actually read your pawn contract anyway? If you use a national company to produce your tickets like Burrell, Apperson, and Technology Media Group for example, then your tickets are likely in great shape. However, if you have gone the cheap route and used a local printer, I would take a serious look at that ticket and make sure you are covered. By taking a serious look I mean having someone who knows what they are doing and understands TILA requirements to look at that ticket.
Fun stuff, right? If you use someone who knows what they are doing to help you out, it is really not too difficult. But remember the old Fram marketing slogan, “You can pay me now…or you can pay me later”? It applies here. Your best bet is to have this in place 6 months before you get your Title 31 letter from the IRS, not after. Feel free to reach out if you want help!