Mortgage Loan Fraud and Money Laundering

by David J. Willis J.D., LL.M.

Introduction

Mortgage loan fraud, on the decline after the Great Recession due to more intense monitoring by lenders and regulators, is again on the rise. Purchase-money loans generally have a higher potential for fraud (specifically in the application and documentation process), largely because there are more commission-driven individuals in the loan supply chain who under pressure to close no matter what.

At the federal level, the FBI investigates and prosecutes criminal loan fraud, particularly where mortgage industry professionals and insiders are involved. The FBI uses two categories: “fraud for housing,” which occurs when a single borrower misrepresents assets and/or liabilities in order to purchase a home, and “fraud for profit,” which occurs when mortgage professionals act collectively to defraud a lender to collect fees.

For the most part, the FBI works on the basis of suspicious activity reports (“SARs”), of which thousands are filed each year, mostly by banks. Banks are not allowed to reveal or even discuss the SARs that they file; they do, however, make occasional public statements, such as this one by HSBC in 2020 issued in response to an investigation by BuzzFeed and the International Consortium of Investigative Journalists: “The goal of any financial crime compliance programme is to detect and prevent financial crime. One way we do that is through transaction monitoring and sanctions screening. Each month, we screen over 689 million transactions across 236 million accounts for signs of money laundering and financial crime. In addition, we screen approximately 131 million customer records and 40 million transactions monthly for sanctions exposures. During 2019, we filed almost 50,000 suspicious activity reports to law enforcement and regulatory authorities where we identified potential financial crime. . . . In August 2019, we became the first bank to introduce a system that will automatically screen all our trade finance transactions for potential signs of financial crime.” In other words, algorithms now screen virtually all bank transactions, large and small, for indicators of suspicious activity. When these are detected, SARs are automatically generated and sent to the federal government.

Mortgage Loan Fraud and Money Laundering: Applicable Law

In addition to the usual civil statutes that may be violated (statutory fraud, deceptive trade practices, etc.), numerous federal criminal statutes may be involved:

Federal CrimeLawPenalty
False statement on a HUD loan18 U.S.C. § 10121 year, fine, or both
False statement to obtain credit18 U.S.C. § 10142 years, $5,000, or both
Mail/wire fraud18 U.S.C. §§ 1341, 13435 years, $1,000, or both
Concealment18 U.S.C. § 10015 years, $10,000, or both
Conspiracy18 U.S.C. § 3715 years, $10,000, or both
Racketeering18 U.S.C. §196120 years, $25,000, or both
Money laundering18 U.S.C. § 195620 years, $25,000, or both
Aggravated identity theft18 U.S.C. § 1028 20 years, $25,000, or both

In addition to the foregoing crime-specific statutes, the government has a plethora of additional and ancillary powers pursuant to the USA Patriot Act, the Trading with the Enemy Act, the International Emergency Economic Powers Act (authorizing the president to regulate international commerce after declaring a national emergency), and more. There is also The Office of Foreign Assets Control (“OFAC”) located in the U.S. Department of the Treasury which administers and enforces economic and trade sanctions. There is no shortage of federal laws to address loan fraud and money laundering, whether domestic or international.

At the Texas state level, the Residential Mortgage Fraud Act amended Penal Code Section 32.32(b) to state: “A person commits an offense if he intentionally or knowingly makes a material false or misleading written statement to obtain property or credit, including a mortgage loan.” If the value of the property or amount of the loan exceeds $200,000, which is the case with the median-priced family home, then the offense is a first-degree felony punishable by 5 to 99 years in prison and a fine of $10,000.

Also, Finance Code section 343.105 requires that lenders and mortgage brokers give the following notice in 14-point type to residential borrowers at closing:

WARNING: INTENTIONALLY OR KNOWINGLY MAKING A MATERIALLY FALSE OR MISLEADING WRITTEN STATEMENT TO OBTAIN PROPERTY OR CREDIT, INCLUDING A MORTGAGE LOAN, IS A VIOLATION OF SECTION 32.32, TEXAS PENAL CODE, AND DEPENDING ON THE AMOUNT OF THE LOAN OR VALUE OF THE PROPERTY, IS PUNISHABLE BY IMPRISONMENT FOR A TERM OF 2 YEARS TO 99 YEARS AND FINE NOT TO EXCEED $10,000.

I/WE, THE UNDERSIGNED HOME LOAN APPLICANT(S), REPRESENT THAT I/WE HAVE RECEIVED, READ, AND UNDERSTAND THIS NOTICE OF PENALTIES FOR MAKING A MATERIALLY FALSE OR MISLEADING WRITTEN STATEMENT TO OBTAIN A HOME LOAN.

I/WE REPRESENT THAT ALL STATEMENTS AND REPRESENTATIONS CONTAINED IN MY/OUR WRITTEN HOME LOAN APPLICATION, INCLUDING STATEMENTS OR REPRESENTATIONS REGARDING MY/OUR IDENTITY, EMPLOYMENT, ANNUAL INCOME, AND INTENT TO OCCUPY THE RESIDENTIAL REAL PROPERTY SECURED BY THE HOME LOAN, ARE TRUE AND CORRECT AS OF THE DATE OF LOAN CLOSING.

The borrower must sign this notice. However, “[f]ailure of a lender, mortgage banker, or licensed mortgage broker to provide a notice complying with this section to each applicant for a home loan does not affect the validity of or enforceability of the home loan by any holder of the loan.” Tex. Fin. Code Sec. 343.105(d). So the loan is valid without the notice, but it may still constitute fraud.

The 2007 Texas Residential Mortgage Fraud Act changed the legal landscape at the state level. The Act amended certain sections of the Finance Code, the Government Code, and the Penal Code to address mortgage fraud. It also created a Residential Mortgage Fraud Task Force under the direction of the attorney general, which includes a range of state officials—the consumer credit commissioner, the banking commissioner, the credit union commissioner, the commissioner of insurance, the savings and mortgage lending commissioner, the presiding officer of the Texas Real Estate Commission, and the presiding officer of the Texas Appraiser Licensing and Certification Board. Although the Task Force was abolished in 2017, the interlinked bureaucratic machinery remains, and these agencies continue to share information and resources.

Money Laundering and FinCEN

The Financial Crimes Enforcement Network (“FinCEN”) resides within the U.S. Treasury Department and is responsible for enforcement and rule-making in the area of money laundering, something that occasionally appears in real estate investing. Why? Because buying and selling real estate is probably the best way to legitimize ill-gotten gains other than using the services of a casino to transform questionable cash into clean cash—and a lot less risky. FinCEN imposes due diligence obligations on financial institutions, sometimes referred to as the “know your customer” or KYC rules. These have only expanded over the years, both in response to the Great Recession and as part of the worldwide effort to clamp down on international tax evasion. The “beneficial ownership rule,” effective in 2018, obligates banks to inquire into and report on who actually owns or controls the entities they deal with, specifically persons who (a) own 25% or more of the equity of any entity that is borrowing money, and/or (b) have significant control or management responsibility with respect to the entity. This clearly impacts an asset protection strategy that seeks to achieve anonymity (or even a low profile) for principal investors in a borrowing entity. And, of course, any attempt to avoid or evade disclosure under the beneficial ownership rule is now a federal crime.

Geographic Targeting Orders (GTOs)

FinCEN is granted authority under the Bank Secrecy Act to issue geographic targeting orders as to specific areas of the country where it believes money laundering is occurring in the luxury real estate market. Past GTOs have applied to the Miami area, Manhattan, Los Angeles, and even San Antonio. They are supposed to be short-term in duration (up to 180 days) but can be easily extended. The focus is on transactions involving a registered entity such as a corporation or LLC (the target here is shell companies formed offshore) that purchase properties for over $3 million without a bank loan using cash or check (GTOs do not currently include transactions accomplished solely by wire transfer, even if the wire transfer originates from a bank in The Cayman Islands or some other tax haven). A title company involved in such a transaction must complete and submit FinCEN form 8300 which requires disclosure of the identity of the purchaser and any beneficial owner controlling 25% or more of the equity involved. The title company must also obtain valid government-issued identification from the parties. Not surprisingly, about a third of transactions targeted by GTOs involve persons or entities that were previously the subject of suspicious activity reports.

Impressive as FinCEN’s efforts are, they fall significantly short of capturing all cash purchases of U.S. luxury properties by shell companies. As mentioned, wire transfer transactions are not subject to GTOs. Also, what if a title company is not used to close the transaction? Obviously there is no FinCEN form 8300 generated. As a result of these loopholes, the United States is widely considered to be an oasis of opportunity when it comes to laundering ill-gotten cash using real estate.

What about all those SARs, reputedly filed at the rate of 10,000 per day? As a practical matter, banks make the required reports and then go ahead and do the transactions anyway. In the end, only a tiny fraction of SARs are investigated by the government.

Globally, in spite of regulatory enforcement, fraud and money laundering are on a trillion-dollar tear. Shady activities and dark money remain a profitable, even essential, business for the big banks. The truth is that the international financial system sits so solidly on a pedestal of illegality that it would likely collapse without it.

Examples of Mortgage Loan Fraud

Let’s return to the subject of mortgage loan fraud and its impact on real estate investors. There are so many definitions of fraud in various statutes that prosecutors have little trouble finding one that can be used against an investor. The Residential Mortgage Fraud Act added another by amending section 402.031 of the Government Code, which now defines fraud as “any act that constitutes a violation of a penal law and is part of an attempt or scheme to defraud any person.” Moreover, this section imposes an affirmative duty to report fraudulent activity to “an authorized governmental agency” if “a person determines or reasonably suspects that fraudulent activity has been committed or is about to be committed.” Loan officers, escrow officers, realtors, and attorneys all have this duty. Compliance results in immunity for the reporting individual. Failure to comply makes one a potential co-conspirator. Examples of fraudulent schemes include flipping based on false loan applications and inflated appraisals (this category does not include buying property at a bargain price and then selling it for fair market value for a profit, which is entirely legal); nominee loans using the name and credit of straw buyers; equity skimming in “subject to” transactions; phony second liens to contractors who never perform any work; “silent seconds” that involve concealing the loan of a down payment to a borrower, when the down payment was supposed to come from the borrower’s own funds; concealing other indebtedness of the borrower; the use of fictitious or stolen identities; and “stop foreclosure” schemes that mislead homeowners into paying fees and signing the property over to a crooked investor. Common to most of these schemes are inflated appraisals that create phantom equity, illegal kickbacks (payments not shown on the closing statement), and falsified loan applications.

One can be reasonably sure that loan fraud has occurred when it is clear that a lender would not have made a particular loan if it had known all the facts, and the lender was prevented from knowing the facts by means of misrepresentation and concealment. Putting it another way: inducing a lender to make a loan based on false pretenses is fraud.

Many real estate transactions, while not plainly illegal, fall into a risky gray area. The popularity of no-money-down investment programs and guru seminars has added huge numbers of people to the investment game and resulted in intricate get-rich-quick strategies. The FBI attitude toward these schemes (and to real estate investors generally) is openly disdainful. One official was heard mocking real estate entrepreneurs as “entremanures.” So if the FBI comes calling, even legitimate investors should assume the FBI’s intent is hostile. Saying nothing and immediately contacting a white-collar crime defense attorney is probably the best course or action.

One can nonetheless be sympathetic toward the FBI’s attitude, since the lender is not the only victim of mortgage loan fraud. It is easy to feel antipathy toward banks, but most home loans nowdays are either securitized or sold, meaning that others in the chain of ownership (including pension funds and the like) may be subject to loss. Also, many loans are sold to Fannie Mae, Freddie Mac, and Ginnie Mae, which are quasi-public entities. If there is a loss connected with these loans, it is the taxpayer who gets the bill. Finally, if loan fraud results in a foreclosure, then that has the potential to depress property values, so everyone in the neighborhood suffers. Mortgage loan fraud is definitely not a victimless crime.

Temptations of the Investment Business

A visit to the courthouse on foreclosure day is akin to watching sharks being fed at the aquarium. The problem, of course, is that it is impossible for all fledgling investors to become overnight millionaires. Real success involves hard work over time. Unfortunately, intense competition in the real estate investment business can lead impatient and unethical investors to look for profits in ways that cross the line.

Legitimate investors should avoid investment plans that sound too good to be true, either to the investor or homeowner. Programs that ask a homeowner to sign incomprehensible documents with weird names often involve fraud. If a deal is just too complicated for the average person to understand, it may well involve fraud. If it involves several people signing interests back and forth to one another and not recording anything, it is probably fraud. Payments made off the closing statement are almost certainly fraud.

Some perpetrators believe that giving their documents creative names will exempt them from the law. The problem for con artists who dream up these documents is that courts look to substance over form, and prisons are now offering long-term housing to these clever folks. Juries may not always understand the technicalities of mortgage finance but they intuitively understand fraud. Here are some other tip-offs that you may be dealing with a real estate con artist:

“This is a great investment! You’ll make great money with no effort.”
“There’s no need to talk to a lawyer. These are all standard forms.”
“Just sign this blank loan application here. We’ll do all the paperwork.”
“We put the property in your name. You’re totally secure.”
“We pay all the costs and you get half the profit! Easy money!”
“We’ll pay you a bonus at closing. You’ll have cash in your pocket and instant equity.”
“We’re going to manage and sell the property and then split all the profits with you.”
“God has sent us to give you abundant wealth.”

The Straw Buyer Scheme

The straw buyer scenario was more common before the bust, but it is becoming fashionable again. Here’s how it works:

1. A crooked investor generally looks for two categories of homes, those owned by distressed sellers who are behind on payments and new-home builders who have unsold inventory that is draining them because of the interest carry.

2. The perpetrator recruits straw purchasers/borrowers who are willing to allow their names and credit to be used in exchange for an up-front, off-the-closing statement kickback (often $10,000 or more) and then buys the property in their names. The note, deed of trust, and other loan documents, including an affidavit of intent to occupy, are all signed by the straw purchasers at a title company closing that appears legitimate.

3. A real estate broker accomplice may be involved to make this easier and eventually collect a commission from a “client” the broker never met, never obtained a buyer’s representation agreement from, and never gave an IABS to.

4. A mortgage broker accomplice submits a fraudulent loan application and supporting documents that show the straw buyer as having significantly higher income than is actually the case.

5. An appraiser accomplice inflates the value of the property, often by $100,000 or more.

6. The amount of the loan applied for exceeds the true market value of the house.

7. A title company may be complicit in this process in order to facilitate a smooth closing with no questions.

8. All the various accomplices and co-conspirators get paid large fees at closing, either on the closing statement for vague and unspecified charges, or off the closing statement altogether.

9. The house is placed on the market but does not sell because its value is grossly inflated.

10. The lender forecloses, taking a loss (part of which is passed on to HUD or a mortgage insurer) and ruining the credit of the straw purchaser. By then, the con artists have left with profits in hand.

Looking closely, it is clear that the whole transaction has been concocted so that the co-conspirators can generate large up-front fees for themselves, something that should always set off alarm bells.

Interestingly, straw buyers often allege that they were wronged. They even file lawsuits. It is difficult to feel sorry for them, however, since they willingly signed blank documents and gladly received an under-the-table payoff at closing. They cooperated in the fraud and benefited from it.

In the past sub-prime lenders were complicit in this process. Eager to make loans and collect fees, many did not supervise the underwriting process as thoroughly as they should.

Email and Wire Fraud

This is a growing area of potential risk and liability for title companies, escrow agents, lawyers, and yes—even real estate investors who do business by email and wire transfer. The FBI reports that nearly one billion dollars of closing funds were the object of criminal intent in 2017, meaning that criminals attempted to divert or actually succeeded in diverting this amount from pending closings. Consider the magnitude and audacity of this. Wire fraud usually has small, unobtrusive beginnings; often there is an apparently harmless email (ostensibly from the seller) to the escrow agent, informing of a last-minute change in wire instructions and providing new bank account information. The closing is funded and funds which are wired to the new bank are immediately moved elsewhere, which means the money is likely gone forever. Conclusion: any emailed instructions concerning the electronic transmission of funds, particularly changes in those instructions, should be viewed skeptically.

Knowledgeable escrow agents (or anyone handling and wiring funds, including attorneys and their staff) are now refusing to accept such email changes in funding instructions, requiring either a telephone confirmation or even demanding that the seller come in person to the office and confirm the change.

It all begins with hacking into a victim’s email, called an “email account compromise” (EAC) in the trade. Title companies, banks, and real estate lawyers are under continual attack. Many law firms receive attempted EACs each day. Some of them are laughably foreign in origin and syntax; but others appear legitimate, at least on the surface. They provide the name of a seller or an address to a certain property and state that closing documents are attached for review. Sometimes the email comes from a familiar address, but with just one or two letters slightly altered. And, of course, it’s always urgent. Once you click on the attachment, you’re done.

Law firms and title companies are occasionally berated by outraged parties who claim that, by asking for double confirmation and verification, or perhaps as a result of a request that the party come personally to the office in order to deliver a change in financial instructions, they are holding up a closing or even killing the deal. This unfortunate but inevitable. Sensible lawyers and title companies will not allow themselves to be on the hook for lost closing proceeds because a party resists precautionary instructions or foolishly disregards risk. The best practice for title companies and closing attorneys is to have a written and posted policy that wire instructions are to be provided at the inception of the transaction, preferably from the client in person and in his or her own handwriting. Such instructions should not be subject to any change whatsoever without a personal visit by that party (with sufficient ID) to the office. Staff should be thoroughly trained in these and other authentication procedures.

Confidential financial information of any important kind should be sent only by encrypted email. Failing to do this, even if it involves extra cost, may provide a plaintiff with a cause of action for negligence if one is sued in the event of loss caused by fraud.

Broad Potential Liability for Fraud

Everyone involved in real estate sales and closings is a potential subject of scrutiny, and prosecutions are not limited to actual mortgage and bank fraud. There are also related prosecutions for conspiracy, mail and wire fraud, identity theft, and money laundering. An example of the latter is the 2019 mortgage fraud conviction of Paul Manafort, who formed a shell company to buy an expensive Manhattan condominium for the purpose of laundering money on which income taxes had not been paid. Manafort later applied for a cash-out refinance loan and stated on his application that his daughter lived in the condo. This was false, since the truth was that he was renting the property on Airbnb. Manafort’s classic error? Greed, of course. Not satisfied with merely transforming untaxed income into legitimate loan proceeds, Manafort also wanted income from the property, running afoul of the old Wall Street saying: “You can make money being a bull, and you can make money being a bear, but you can’t make money being a pig.”

Mortgage loan fraud seldom occurs as the result of an isolated actor. More than one perpetrator is usually involved. As a result, conspiracy has become something of a catch-all allegation that is available to both criminal prosecutors and civil plaintiffs. Even if it cannot be plausibly shown that a real estate investor directly engaged in unlawful or wrongful acts, he or she may nonetheless be forced to defend against charges or allegations of conspiring with others—which in terms of the legal consequences can be just as serious. The elements of civil conspiracy are (1) two or more persons (2) who have an unlawful or wrongful objective they intend to accomplish, (3) who have a meeting of the minds on the objective or course of action to be pursued, (4) followed by the occurrence of one or more overt unlawful or wrongful acts, (5) which result in damages as a proximate result. The king of conspiracy statutes is RICO (Title 18 of the U.S. Code) which targets a pattern of wrongdoing. Predicate crimes that contribute to establishing such a pattern include not just the obvious infractions of mail and wire fraud but can extend to mortgage loan fraud as well. Even an email can connect you to an underlying conspiracy. RICO is available not just for criminal prosecutions but to civil plaintiffs as well.

Any person (not just the primary wrongdoers) with actual knowledge of the fraud can be indicted for a felony criminal offense, all the way down to the notary. Moreover, culpable mental intent can be inferred from the circumstances, a relatively light burden for prosecutors.

Prosecutions are not limited to actual mortgage and bank fraud. As noted above, there are also related prosecutions for conspiracy, mail and wire fraud, identity theft, and money laundering. An example of the latter is the 2019 mortgage fraud conviction of Paul Manafort, who formed a shell company to buy an expensive Manhattan condominium for the purpose of laundering money on which income taxes had not been paid. Manafort later applied for a cash-out refinance loan and stated on his application that his daughter lived in the condo. This was false, since the truth was that he was renting the property on Airbnb. Manafort’s classic error? Greed, of course. Not satisfied with merely transforming untaxed income into legitimate loan proceeds, Manafort also wanted income from the property, running afoul of the old saying: “You can make money being a bull, and you can make money being a bear, but you can’t make money being a pig.”

Fraud Prevention for the Average Real Estate Investor

State and federal conspiracy laws cast a wide net. Accordingly, the most prudent approach is to keep one’s distance (and plenty of it) from any suspicious parties or transactions.

Much of fraud prevention is common sense. If you suspect fraud in a transaction, immediately remove yourself from involvement and report the activity. Always read documents thoroughly before signing them. Do not sign blank documents. Check out the people you’re dealing with. Be alert for irregularities. Follow instructions from title companies and closing attorneys. Ask questions about the fundamentals of the deal itself. If the answers are overly complex or outright ridiculous, consider walking away.

DISCLAIMER

Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well as we do not give tax advice. Reading this article does not make you our client. This firm does not represent you unless and until it is retained and expressly agrees in writing to do so.

Copyright © 2020 by David J. Willis.  David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.