Mortgage loan fraud, on the decline after the Great Recession due to more intense monitoring by lenders and regulators, is again on the rise, this time with an electronic emphasis. In its emails to customers, Great American Title warns:
EMAILS ATTEMPTING TO INDUCE FRAUDULENT WIRE TRANSFERS ARE COMMON AND MAY APPEAR TO COME FROM A TRUSTED SOURCE. YOU SHOULD NEVER TRANSMIT NONPUBLIC PERSONAL INFORMATION, SUCH AS CREDIT OR DEBIT CARD NUMBERS OR BANK ACCOUNT OR ROUTING NUMBERS, SOCIAL SECURITY NUMBERS, DRIVER’S LICENSE NUMBERS BY EMAIL OR OTHER UNSECURED ELECTRONIC COMMUNICATION.
Federal Investigation of Loan Fraud
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 or liabilities in order to purchase a home, and “fraud for profit,” which occurs when mortgage professionals defraud a lender in order to collect fees. More on federal law and enforcement below.
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 they file; they do, however, make occasional general statements about them 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 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.
Federal Law Applicable to Mortgage Crimes
Numerous federal criminal statutes apply in this area:
|False statement on a HUD loan
|18 U.S.C. § 1012
|1 year, fine, or both
|False statement to obtain credit
|18 U.S.C. § 1014
|2 years, $5,000, or both
|18 U.S.C. §§ 1341, 1343
|5 years, $1,000, or both
|18 U.S.C. § 1001
|5 years, $10,000, or both
|18 U.S.C. § 371
|5 years, $10,000, or both
|18 U.S.C. §1961
|20 years, $25,000, or both
|18 U.S.C. § 1956
|20 years, $25,000, or both
|Aggravated identity theft
|18 U.S.C. § 1028
|20 years, $25,000, or both
In addition to these crime-specific statutes, the government has a plethora of additional powers under 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 treasury department which administers and enforces economic and trade sanctions. There is no shortage of federal laws or enforcement bodies to address loan fraud and money laundering, whether domestic or international.
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. The truth is that the international financial system sits so solidly on a pedestal of illicit money that it would likely collapse without it.
Texas Law and Enforcement
At the state level, numerous general civil statutes can be brought to bear, notably statutory fraud and deceptive trade practices. More specifically, the Texas Residential Mortgage Fraud states: “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.” Penal Code Section 32.32(b). 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, Texas 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, “failure of a lender, mortgage banker, or licensed mortgage broker to provide [this notice] 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, even though fraud may be present.
The Residential Mortgage Fraud Act combines sections of the Finance Code, the Government Code, and the Penal Code to address loan fraud. The Act 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 as a formal entity in 2017, these agencies continue to share information and resources.
Examples of Loan Fraud
There are so many types fraud and conspiracy statutes that prosecutors have little trouble finding one that can be used against someone considered to be suspicious. Section 402.031 of the Texas Government Code (part of the Residential Mortgage Fraud Act) 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 or failure to act could be a violation with criminal consequences.
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 many of these schemes are inflated appraisals that create phantom equity, kickbacks that violate RESPA (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 mortgage loan fraud.
Many loan and real estate transactions, while not plainly illegal, fall into a gray area. The popularity of real estate investment seminars has added complex schemes and huge numbers of ambitious people to the field. 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 real estate investors should assume hostile intent. Say nothing and immediately contact a white-collar crime defense attorney.
One can be sympathetic toward the FBI’s attitude since lenders are not the only victims of loan fraud. It is easy to feel antipathy toward banks, but the damage goes well behind the lender. Most home loans are either securitized or sold, meaning that others in the chain of ownership (including pension funds and the like) may be subject to loss due to fraud. 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 ultimately gets the bill. Finally, if loan fraud results in a foreclosure, property values may fall so everyone in the neighborhood suffers. Mortgage loan fraud is not a victimless crime.
Temptations of the Real Estate Investment Business
A visit to the courthouse on foreclosure day is akin to watching sharks being fed at the aquarium. Notwithstanding the popularity of investor seminars, it is impossible for all these fledgling investors to become overnight millionaires. Intense competition in the real estate investment business can lead impatient and unethical investors to look for profits in ways that cross the line.
Investors should avoid schemes 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 to understand, it may well involve fraud. If a transaction 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.
Giving documents creative names does not help because courts typically look to substance over form. Judges and juries may not understand the technicalities of mortgage finance but they intuitively understand fraud. They know a hustler when they see one. Here are some other tip-offs that one is dealing with a 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 fill in 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 Great Recession, 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.
Before the recession, 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 even real estate investors who do business by email and wire transfer. The FBI reports that about one billion dollars of closing funds are the object of criminal intent annually, 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 may have unobtrusive beginnings; often there is an apparently harmless email (ostensibly from the seller) to the escrow agent, giving notice of a last-minute change in wire instructions and providing new bank account information. The closing is then funded and money wired to the new bank is immediately moved elsewhere, which means the money is likely gone forever. 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 law offices 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) by the FBI. Title companies, banks, and even real estate lawyers are under continual attack. Many real estate 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 names of seller and buyer, a property address, and a file number. The email asks that you review attached closing documents. Sometimes the email comes from a sort-of familiar address with just one or two letters slightly altered. And, of course, it’s always urgent. Once you click on a malign attachment like this the trouble begins.
Title companies and law firms are occasionally berated by outraged parties who claim that the process of double-confirmation and verification is holding up a closing or even killing the deal. This is unfortunate but inevitable. Sensible lawyers and title companies will not allow themselves to be liable 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. Wire instructions should be verified by phone before funding. Staff should be thoroughly trained in these and other authentication procedures.
Broad Legal Liability for Fraud
Mortgage loan fraud seldom occurs as the result of an isolated actor. More than one perpetrator is usually involved. As a result, conspiracy (fraud’s sister crime) is the catch-all allegation 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 conspiracy charges—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. Even an email can connect you to an underlying conspiracy. RICO is available not just for criminal prosecutions but to civil plaintiffs as well.
Using conspiracy charges, any person with actual knowledge (not just the primary wrongdoers) of the fraud can be indicted for a felony criminal offense, all the way down to the notary. The required culpable mental intent need not be proven directly but can be inferred from the circumstances, a relatively light burden for prosecutors.
Prosecutions are not limited to fraud and conspiracy charges. There are related prosecutions for 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 evading taxes on foreign-sourced money. The purchase was successful. However, Manafort later applied for a cash-out refinance and stated on his loan 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. Not satisfied with merely transforming untaxed income into (apparently) legitimate loan proceeds, Manafort also wanted to gain future income from the property. This runs afoul of the adage “You can make money being a bull, and you can make money being a bear, but you can’t make money being a pig.”
The Proposed “Enablers Act”
Not yet law as of this writing, the Enablers Act is a bipartisan measure introduced in the House of Representatives as a response to the Pandora Papers. It would amend the Bank Secrecy Act’s definition of financial institutions to add: (1) investment advisors; (2) art and antiquities dealers; (3) attorneys and notaries involved in financial activity or related administrative activity on behalf of another person (e.g., a client); (4) a trust company or service provider including persons who assist in forming business entities or providing such entities with a registered office or address (this clearly includes business and corporate attorneys and anyone acting as a registered agent); (5) CPAs; (6) public relations firms; and (7) third-party payment services, including payment processors, check consolidators, and cash vault service providers.
The proposed law would impose due diligence “know your customer” obligations and other compliance requirements on “gatekeepers” which would include establishing BSA/AML compliance programs and filing of SARS in suspicious cases.
If passed, the Enablers Act will forever change the life of an individual real estate practicioner. Every professional involved in real estate transactions, likely including real estate investors, would be made unofficial agents of federal law enforcement. This profound shift would be carried out in the name of achieving transparent and open markets worldwide. Problem, in business (as in diplomacy) not everyone wants the details of their transactions to be public. Legitimate concerns as to confidentiality in real estate transactions (supported by centuries of legal precedent) would go by the wayside.
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 suspicious parties or transactions. Much of fraud prevention is common sense. If you suspect fraud in a transaction, trust your instincts. Immediately remove yourself from involvement and report the activity. Always read documents thoroughly before signing them. Do not sign blank documents. Most basic of all, 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.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. 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.
Copyright © 2024 by David J. Willis. All rights reserved. Mr. 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.