It's never a good sign when television's most popular crook targets your industry, but Home Box Office (HBO[R]) gangster Tony Soprano's real estate scams are just a case of art imitating life. In the real world, organized crime--including gangs and drug dealers--attracted by 2006's projected $2.46 trillion origination market (according to the Mortgage Bankers Association [MBA]), see mortgage fraud against lenders as a market ripe for expansion. [??] "Those numbers are targets for the bad guys," says Rhonda Heilig, supervisory special agent for the Federal Bureau of Investigation's (FBI's) financial institution fraud unit. [??] Georgia Attorney General Thurbert E. Baker agrees. "We're seeing dealers leave the drug trade for what they consider a safer alternative. The profit potential is at least as high, and they're less likely to get a bullet in the head.... The bottom line for many of you is that your businesses are being robbed," Baker warns. [??] Over the past decade in Chicago, gang leaders have purchased apartment buildings and obtained cash-out refinance loans that experience early payment default (EPD), all the while collecting Section 8 rents, the Chicago Tribune reported. In a series of articles, the paper explained how one reputed gang leader acquired the South Side building on the corner where he sold drugs and used it to support his operations, house members and launder drug profits. [??] In Atlanta last year, the scene was more suburban when property flippers let gun-toting drug dealers move into a property they targeted in a neighborhood where homes sold for as much as $1 million. [??] Fraud is also moving directly into mortgage shops. "Fraud-for-profit rings recruit insiders, and send them to your agencies and to come work for you, and into call centers so they can steal identities," Heilig explains.
At the same time law-enforcement officials are broadcasting Be-On-the-Lookouts for new entrants into the mortgage fraud field, they're including two unpleasant follow-up warnings. First, mortgage fraud against lenders may be growing, but it's pretty far down the FBI's to-do list (it's priority No. 7, to be exact). Second, lending money without checking property value and borrower income is like leaving your wallet open on a towel at the beach while you go swimming--in either case, you're not going to get a lot of sympathy when you're robbed.
If your firm doesn't verify income, the FBI may not deem you a victim. "We're starting to look more and more at willful blindness among financial institutions," says Stephanie Woods, assistant general counsel to the FBI's legal forfeiture unit. "We're starting to see some flagrant oversight in some of these fraud cases. No one cared to check [income] before they gave out a lump-sum payment."
Unless the mortgage banking industry expends more energy to self-police, fraud will increase, predicts Barry McLaughlin, special agent in charge of the Midwest region of the Office of Inspector General (OIG) at the Department of Housing and Urban Development (HUD). "It's when your competitors cross the line between salesmanship and fraud that we'd like to get the call," McLaughlin explains. "The first step in cleaning up the industry is for honest lenders to step up and report."
Despite those sobering messages, lenders can take some steps to make their business unattractive to crooks. If those tactics don't work, there are ways to make your fraud cases easier to prosecute. And it may be easier to go after fraudsters in the future, thanks to increased suspicious-activity reporting as well as legislative solutions that are on the horizon. MBA, meanwhile, continues to lobby legislators to fund additional investigators and prosecutors to attack fraud against lenders at the state and federal levels.
Only the worst
"Mortgage fraud is the fastest-growing white-collar crime affecting the United States today," says Karen Spangenberg, chief of the financial crimes section of the FBI's criminal investigative division. The FBI estimates about 80 percent of all mortgage fraud is fraud for housing, while 20 percent is fraud for profit, most commonly multiple loan transactions at multiple institutions. "Due to limited resources, the FBI targets fraud for profit," says Spangenberg.
And it targets only big-ticket fraud. "You can't investigate everything," says Heilig. If your loss is less than $100,000, it's unlikely the FBI will pursue the case, but a local prosecutor or the state attorney general may, she adds.
The problem with local prosecutors is that unless you're in a jurisdiction where law enforcement has handled mortgage fraud before, you may end up working with a prosecutor who's more familiar with bank robbers than mortgage robbers. Early in her career, Heilig was a special agent assigned to white-collar crime in Las Vegas. During her first exposure to mortgage fraud, she actually called Freddie Mac and asked to speak to Mr. Mac.
Today, Heilig is working with MBA to streamline prosecution of mortgage fraud, and is confident enough to tell the Mr. Mac story. Her advice to lenders is twofold: Document your case and organize your documents. "If you do an interview, document it. Two years down the road, if you don't document, it didn't happen," Heilig advises.
Second, organize the hundreds of pages in your loan files. Give prosecutors a synopsis, backed by well-organized documentation laying out your case. "Your investigators put a lot of time into [a case], and if you package it properly I will be able to process it much faster and prosecute [it much faster]," she says.
How many frauds cause significant losses to lenders and how much fraud is really out there? The answers depend on whom you ask. Measuring mortgage fraud is a bit like measuring the prevalence of autism in children: Everyone goes to a different specialist for help, industry participants disagree about how to count cases and some folks are still ashamed to admit it's even happened.
One method of measurement is suspicious-activity reports (SARs) filed by federally regulated financial institutions, says John Arterberry, deputy chief, fraud section, criminal division of the Department of Justice (DOJ). "It's a critical tool that gives us a window into the threats your institutions face every day. Our resources are becoming more and more thinned out. It helps us target those resources in a way that makes us much more effective," he says.
In fiscal year (FY) 2002, bankers filed 5,623 mortgage-fraud-related SARs (see Figure 1). In FY 2005, that number rose to 21,994. The annual dollar losses of reported mortgage fraud increased from $293 million in FY 2002 to more than $1 billion in FY 2005 (see Figure 2). However, due to mergers and acquisitions, the number of mortgage banking firms owned by federally regulated institutions shifted as well.
Between FY 2003 and FY 2005, the number of pending fraud cases handled by the FBI rose from 436 to 721, according to DOJ. The number of pretrial diversions and convictions fell from 256 in FY 2003 to 170 in FY 2005, DOJ reports.
The Mortgage Asset Research Institute Inc. (MARI), Reston, Virginia, which tracks mortgage fraud, believes SAR filings are up because of increased fraud rather than an increase in the number of institutions required to file SARs. "When the FBI says SARs are X percent higher, our position is we have no doubt that mortgage fraud is continuing at least at that pace," says Nick Larson, assistant vice president for product development at MARI.
Federal officials who analyze SARs, including Thomas Fleming, acting assistant director of the Department of the Treasury's Financial Crimes Enforcement Network's (Fin-CEN's) Office of Regulatory Policy, suspect SARs filings are on the rise because institutions are getting better at identifying suspicious activity, mortgage-lending volume has increased, and maybe, there's more fraud.
SARs for you, too
The federal government is thinking about expanding the number of mortgage bankers not owned by regulated financial institutions who must file SARs. Before taking action, FinCEN will issue a Notice of Proposed Rulemaking explaining which entities would be covered by a proposed rule change, as well as the new requirements for affected companies. FinCEN will not make any changes without first collecting comments from MBA and other industry participants, promises Fleming.
The federal government may not be doing everything it could to track fraud--but then again, lenders aren't, either. Companies have focused on the origination side--fraud prevention and detection--but how many firms know exactly how much fraud finds its way into their loans?
To benchmark industry practices, New York-based PricewaterhouseCoopers LLP (PwC) periodically conducts a fraud roundtable and survey for consumer finance clients. Three years ago, mortgage fraud wasn't a top concern of executives, says Peter Pollini, a Boston-based senior manager in PwC's Consumer Finance Group. In a recent PwC survey, 83 percent of executives ranked fraud as a top-10 issue.
"Most companies are using between five and six [fraud-prevention] tools, but there's not a tremendous amount of consistency among the tools they're using," Pollini says.
The challenge for companies is growing the capacity to analyze and understand which losses are fraudulent and which aren't. "It's not that companies don't want to know [the cost of fraud], it's that they traditionally don't have the data or processes to know," says Pollini.
"Most losses are realized in the servicing area. If a loan goes through the REO [real estate-owned] process, is liquidated and you take a $50,000 loss, not having a process to segment fraudulent vs. non-fraudulent loans will limit your ability to quantify your actual fraud losses," he says.
From a financial-exposure perspective, it's important to know if the frequency and severity of fraud is increasing or decreasing at your firm. Even with accurate fraud data, it's still a challenge to predict whether product changes and the evolution of fraudsters' tactics will make you more susceptible to fraud.
"The challenge in forecasting financial exposure is determining if we are comfortable that our historical activity is representative of what will happen in the future; have tracked our actual occurrence of fraud; have an adequate sample size; have determined what's changed in our process over time so that we're identifying new kinds of fraud; and have implemented controls that will reduce our frequency or severity," Pollini concludes.
To put it more simply, it's not enough to know how many instances of fraud you've prevented; you also have to know how many got through, because that's where your exposure lies.
Can you get it back?
Once your firm's money is gone, what can you do to get it back from the criminals who stole it? Don't rely only on restitution; go for asset forfeiture, too, recommends Woods.
"We in the FBI have no lawful authority to seize assets for restitution during the pendency of the criminal case. There is [often] nothing available at the end of the case--the criminal attorney will make sure of that," Woods quips.
Forfeiture rules, by contrast, can be an effective way to get back any property that can be found. They allow the restraint of the property before indictment, if the property is derived from a crime, based on probable cause. In fact, the FBI can serve seizure and search warrants at the same time, before the bad guys have a chance to hide or destroy assets.
To bolster your firm's chances of recouping losses, do your homework and turn it in. Do the crooks have other assets or accounts at your financial institution? Do you have an income-tax form from the perpetrator or an income-and-assets sheet from the loan application? Share those forms. The FBI doesn't often get to see Internal Revenue Service (IRS) returns, and borrower balance sheets establish that you performed due diligence during the lending process, Woods says.
Next, be ready to receive instructions. "We're going to send a notice letter to the victim. I can't tell you how many forfeitures are held up because we can't find anyone at the bank who cares enough to respond to [that notice]," Woods says.
Finally, when filling out the petition for remission (an assertion that you owned what you were robbed of), don't exaggerate your loss. "In mortgage fraud cases, one of the biggest problems we have is that the loss is this exorbitant amount," says Woods. Break down your figures and stick to actual out-of-pocket losses, adding in compensation you receive from insurers.
If you can't find your firm's money today, go for a money judgment based on the amount of profit the crooks gained from their crime. "That allows us to collect any of their assets to apply to the money judgment," Woods explains.
The FBI has found jackpots of money hidden for years, including gold bars buried in backyards and, once, bags of money tied into oak trees in a suspect's yard. That stash became apparent only after the leaves fell off the trees.
Going forward, several factors could influence the level of fraud that mortgage bankers will face. Legislatively, MBA is seeking $6.25 million in dedicated funding for 30 new FBI field investigators and two new, dedicated prosecutors at the Department of Justice to coordinate the prosecution efforts of the U.S. Attorney's office. Another $750,000 is needed to support the operations of FBI interagency task forces in areas with the 15 highest concentrations of mortgage fraud against lenders, MBA has told Congress.
Beyond that, if mortgage bankers want legislative change, they've got to ask for it, says Georgia Attorney General Baker.
"Too often we've seen a reluctance to get involved," says Baker. "We've got to have mortgage lenders around the nation coming forward and sharing information. We need your considerable political clout in convincing Washington, D.C., and Congress to make monies available not just at the federal level, but at the state level, so we can fight this problem."
MBA is also working with the FBI to come up with a streamlined process for handling mortgage fraud cases. "One of the things we're striving to do is work with the industry and train ourselves, so my guys can go out there and hit the streets and know what they're doing," says Heilig.
In addition, MBA is supporting the re-introduction of a federal mortgage-fraud bill proposed by Sen. Barack Obama (D-Illinois) last year. "We can thank Sen. Obama for raising the consciousness of Congress," says Arthur Prieston, CMB, chairman of the Prieston Group, Novato, California. The Stop Fraud Act (S. 2280) creates a national standard for prosecution, calls on lenders to report fraud, would fund a national ineligibility list and would allow prosecution of attempted as well as committed frauds. (The rather unwieldy full name of the legislation is Stopping Transactions which Operate to Promote Fraud, Risk and Underdevelopment Act.)
There are a few changes MBA would like to see before the legislation is re-introduced. The first involves private right of actions. "There is concern that plaintiffs in predatory lending cases might piggyback that bill to begin suits against lenders," explains Michael J.M. Brook, an attorney with Lanahan & Reilley LLP, Santa Rosa, California.
If any final version of fraud legislation applies to any entity that makes a misrepresentation to a borrower, including a lender, then a loan officer who misrepresents your product could be violating the statute, he says. "However, private right of action would assist lenders in recouping losses because they would be able to go after the brokers, appraisers, Realtors[R] sellers and anyone else involved in the schemes," Brook explains.
A second concern involves the secondary market. The Stop Fraud Act defines the mortgage lending process as signing, closing and funding a loan. If the process ends at funding, then secondary-market participants might not be covered. If a crooked correspondent originator has bad intent directed toward the loan purchaser rather than the borrower,
that fraud might not fall under the purview of the bill, Brook says.
A new class?
Rachel Dollar, attorney with The Dollar Law Firm, Santa Rosa, California, believes that class-action lawsuits over fraud may be on the horizon. Take a situation where a fraudster buys a house for $20,000, does minor cosmetic repairs and resells the property for $80,000 to a buyer who's been told the property is an excellent real estate investment, when in reality it won't rent for enough to cover the mortgage.
"In those schemes, it's conceivable that we could have increased class actions as the market softens," Dollar explains. "In a lot of places in the country, because the market has been rising there have been lower losses on these properties--especially out here in California. That's a difficult situation for lenders, because they're already bearing the brunt of the damage. Unlike predatory lending, where they're accused of making a profit, in these schemes they're already facing incredible damages."
How about cases in which loan officers assisted borrowers in preparing fudged documentation? Is that lender-sanctioned fraud?
That's an education issue with lenders. They need to educate loan officers and be vigilant about what comes through their books and who they do business with," Dollar says.
The risk of fraud lawsuits cuts across all kinds of fraud schemes. In a case where the fraud involves flipping a few houses, you may have a low number of plaintiffs--but the larger amount of damages per borrower may offset that.
"One of the ways that lenders might be able to reduce some of this is to remove fraudulent loans from their regular servicing channels, so they can work with borrowers before damages are actually incurred," Dollar says. "That helps the lender, because it avoids the high costs of foreclosure. By accepting deeds-in-lieu or short sales, the lender can help borrowers who have been victimized, and thereby avoid further damage to the borrower's credit as well as stem the mounting foreclosure costs and eventual losses that the lender incurs."
Of all the states, Georgia has done the most, legislatively, to deter mortgage fraud. Its Georgia Residential Mortgage Fraud Act defines mortgage fraud; allows prosecutors to use racketeering laws to go after fraudsters; and, perhaps most important, allows prosecution of those who make misrepresentations during the lending process.
"We don't have to wait until money is taken through fraudulent scams. Prosecutors can intervene as soon as the misrepresentations are made," Baker says.
One issue that remains unsettled in the Georgia statute is the same private right of action concern that lenders have about the federal fraud bill, says Brooks.
As president-elect of the Washington, D.C.-based National Association of Attorneys General (NAAG), Baker will bring the story of his state's experience in reducing mortgage fraud to a national audience of prosecutors. With more than 100 cases open or waiting to be open since the Georgia legislation passed in May 2005, the state has plenty of prosecutors on a first-name basis with Mr. Mac and Ms. Mac.
The problem with state-level initiatives is that you have to make your case so many times over. "Ninety-eight percent of our state legislators had never heard of mortgage fraud, and had no idea what mortgage fraud was or what to do about it," says Elmo "Mo" Thrash Jr., a lobbyist for the Mortgage Bankers Association of Georgia (MBAG) with McCalla, Raymer LLC, Roswell, Georgia. "Education on the state level is imperative if we're going to put a halt to it [mortgage fraud]," he says.
Notable notary changes
The National Notary Association (NNA), Chatsworth, California, has been pushing states for changes that would make mortgage fraud against lenders harder to commit. In California, any property transaction paperwork that is recorded must include a thumbprint and an electronically captured signature in the notary's journal. Some notaries also offer a Web-cam option to capture a photograph of the signer.
"Law enforcement loves it. It makes it easier to prosecute a crime or to determine when people have a false claim," says Steven Bastian, NNA's director of strategic planning.
A second idea NNA is backing is an electronic notary seal (ENS). "A physical notary device works as long as there's ink in the stamp. An ENS is registered in the National Notary Registry, and the state can control the seal. The lender can authenticate the seal in real time against the registry," Bastian explains. Pennsylvania is using the ENS digital certificate notary seal in four counties now, and will expand that program statewide within a year if all goes well.
NNA is also creating a program of best practices and standardization of notary education and certification, and training FBI field agents in a virtual-academy setting about the evidence notaries collect and preserve.
Working directly with MBA, NNA will require that all notaries using digital signatures use signatures that are accredited by the Secure Identity Services Accreditation Corporation (SISAC) and are MISMO[R]-compatible.
Blame the secondary market
Regardless of what does or doesn't happen legislatively, one of the most important factors influencing the level of fraud is one few people talk about: the secondary market.
"The problem of fraud is solvable, but brokers won't take fraud seriously until the secondary market makes them take it seriously," says Michael Pfeifer, managing partner of Pfeifer & Reynolds LLP, Orange, California.
"The secondary market has to build in the controls, and they've not done that with stated-income production. Particularly with automated underwriting, too many loan officers think if the system takes the information, they're done. If they have to come up with documentation, they'll do it somehow, later," Pfeifer says.
Like Dollar, Pfeifer believes fraud losses will increase in areas where real estate values fall. "We're going to see a lot of fraud become visible in areas where people haven't felt it because property values were increasing. Brokers ordered to repurchase bad loans have refinanced borrowers out of trouble. Now it's more difficult to do that. As property values level out and the broker can't refinance out, the losses are going to bite harder than they have in the past few years," he predicts.
If that scenario occurs, lenders that didn't create adequate fraud controls may find themselves facing lawsuits similar to those filed after the stock-market crash against corporations lacking financial controls, warns Jeffrey Taylor, chief executive officer of Digital Risk LLC, Dallas.
"What's going to drive this is similar to the post-stock market bubble. All of a sudden we had stockholder lawsuits over financial controls. You're going to see the same thing if public companies go bankrupt after originating billions [in mortgages]. You'll be asked where your fraud controls were and what you did to make sure loans performed," Taylor predicts. "What's going to be the floor on culpability? I don't know, but you're going to have to have had some fraud-control procedures in place."
Dona DeZube is a freelance writer based in Clarksville, Maryland. She can be reached at firstname.lastname@example.org.
Figure 1 Number of Mortgage-Related Fraud SARs Filed, Fiscal Years 1999-2005 (10/1/98-09/30/05, Nationwide) Number of SARs Received Mortgage Fraud Commercial Loan Fraud False Statement Fiscal Year 1999 3,088 979 2,122 Fiscal Year 2000 3,245 1,293 3,085 Fiscal Year 2001 4,210 1,374 2,973 Fiscal Year 2002 5,623 1,764 3,711 Fiscal Year 2003 6,936 1,850 4,569 Fiscal Year 2004 17,127 1,724 6,784 Fiscal Year 2005 21,994 2,126 11,611 SOURCES: DEPARTMENT OF JUSTICE, FEDERAL BUREAU OF INVESTIGATION Note: Table made from bar graph. Figure 2 Dollar Losses of Mortgage-Related Fraud SARs Filed, Fiscal Years 1999-2005 (10/1/98-09/30/05, Nationwide) Dollar Losses Reported ($ millions) Mortgage Fraud Commercial Loan Fraud False Statement Fiscal Year 1999 $581 $665 $679 Fiscal Year 2000 $156 $728 $502 Fiscal Year 2001 $264 $659 $502 Fiscal Year 2002 $293 $1,010 $469 Fiscal Year 2003 $225 $1,060 $388 Fiscal Year 2004 $429 $1,163 $458 Fiscal Year 2005 $1,014 $711 $998 NOTE: Dollars rounded to nearest millionth SOURCES: DEPARTMENT OF JUSTICE, FEDERAL BUREAU OF INVESTIGATION Note: Table made from bar graph.…