Mortgage Fraud

For well over a decade, and prior to the recent explosion of mortgage fraud investigations and prosecutions, Houston Criminal Defense Attorney, John T. Floyd, has represented individuals and businesses charged with, or under investigation for, criminal activity associated with the mortgage loan industry.  Mr. Floyd has been relied upon and quoted in national news publications and on financial news networks for his experience and expertise in the mortgage fraud arena.

Sub-Prime Housing Collapse:

Mortgage Fraud Major Target for Law Enforcement

 

The FBI reports that “the increased reliance by both financial institutions and non-financial institution lenders on third-party brokers has created opportunities for organized fraud groups, particularly where mortgage industry professionals (“insiders”) are involved.”

The FBI has consolidated all its “mortgage fraud” programs in its Financial Institution Fraud Unit in an effort to protect the impact the mortgage lending industry and housing market have on the nation’s economy. Mortgage fraud investigations have dramatically increased over the past five years. The agency reports that every mortgage fraud scheme involves some type of “material misstatement, misrepresentation, or omission relating to the property or potential mortgage relied on by an underwriter or lender to fund, purchase or insure a loan.”

The potential for fraud is evident by the amount of money involved in underwriting the housing industry over the past decade. The Mortgage Bankers Association reported that an estimated $2.37 trillion will be made in mortgage loans in 2006. Through Suspicious Activity Reports (SARS) filed by federally-insured financial institutions and Department of Housing and Urban Development Office of Inspector General (HUD-OIG), the FBI compiles data on mortgage fraud as well as gathering additional data from the mortgage industry itself. The FBI cites the difficulties faced developing mortgage fraud cases:

“A significant portion of the mortgage industry is void of any mandatory fraud reporting. In addition, as initial mortgage products are repackaged and sold on secondary markets, the sale of the mortgages, in many cases conceal or distort the fraud, causing it not to be reported. Therefore, the true level of Mortgage Fraud is largely unknown. The mortgage industry itself does not provide estimates on total industry fraud. However, based on various industry reports and FBI analysis, Mortgage Fraud is pervasive and growing.

“The FBI investigates Mortgage Fraud in two distinct areas: Fraud for Profit and Fraud for Housing. Fraud for Profit is sometimes referred to as “Industry Insider Fraud” and the motive is to revolve equity, falsely inflate the value of the property, or issue loans based on fictitious properties. Based on existing investigations and Mortgage Fraud reporting, 80 percent of all reported fraud losses involve collaboration or collusion by industry insiders.”

Fraud for Housing is illegal actions by the borrower motivated by the desire to acquire and own a home under false pretenses. This type of fraud is usually committed by a borrower making misrepresentations about income or employment history in order to qualify for a loan.

Fraud for Housing is almost misdemeanor compared to the predatory lending practices that affect borrowers in Fraud for Profit cases. “Predatory lending typically effects senior citizens, lower income and challenged credit borrowers,” reports the FBI. This type of lending forces borrowers to pay sub-prime or higher interest rates, exorbitant loan origination/settlement fees, and unreasonable service fees in some states. These predatory lending practices frequently force borrowers to default on their mortgage leading to foreclosure or force them into unfavorable refinancing.

There are many, and varied, mortgage fraud schemes, some enormously complex as the one outlined by the Second Circuit in Amico (cited below). Because of a sudden explosion of sophisticated mortgage fraud scheme in recent years, the FBI and the mortgage industry found itself behind the eight ball and were forced to accelerate their joint efforts to identify fraud trends and educate the public about them. The two most recent trends are listed below:

• Equity skimming – a tried and true method involving use of corporate shell companies, corporate identify theft, and the use or threat of bankruptcy/foreclosure to dupe homeowners and investors.
• Property flipping – a well-known but increased method involving an educated criminal element that uses identity theft, straw borrowers, shell companies, and industry insiders (to conceal their methods and override lender controls) to purchase properties and artificially inflate their value through false appraisals. The inflated valued properties are then repurchased several times for higher prices by associates of the “flipper.” Following three or four “sham sales,” the properties are foreclosed on by victim lenders

The FBI since 1999 “has been actively investigating Mortgage Fraud in various cities across the U.S. The FBI also focuses on fostering relationships and partnerships with the mortgage industry to promote Mortgage Fraud awareness. To raise awareness of this issue and provide easy accessibility to investigative personnel, the FBI has provided points-of-contact to relevant groups including the Mortgage Bankers Association (MBA), the Mortgage Asset Research Institute, the Mortgage Insurance Companies of America, Fannie Mae, Freddie Mac, and others.

“The FBI has also been working to establish broader SAR reporting requirements for mortgage lenders who do have adequate protection under the current safe harbor provisions. The FBI is collaborating with the mortgage industry and Financial Crimes Enforcement Network (FinCEN) to create a more productive reporting requirement for Mortgage Fraud. The FBI has also been working with the FinCEN to promote an efficient and effective method of identifying and reporting fraudulent mortgage activity affecting non-federally insured mortgage institutions.”

While there are many different mortgage fraud schemes, the FBI is focusing its primary efforts on weeding out those supported by industry insiders. The agency works closely with both individual lenders and national associations such as MBA, Appraisal Institute, National Association of Mortgage Brokers, and the National Notary Association to identify and target these insiders. This close cooperation with lenders has proven invaluable to the FBI. In 2003 the agency worked with Real Estate Owned properties from lender inventories to initiate an undercover operation in Jacksonville, Florida. Ten months later the FBI, armed with seven warrants, arrested a mortgage broker named J.R. Parker and a closing attorney named Dale Beardsley in connection with a mortgage fraud scheme. In October 2005 both men were convicted of conspiracy, mail fraud, and wire fraud– and the government seized two homes valued at $1 million each, six luxury cars, and secured a money judgment in the amount of $14 million. The FBI tries to employ the same model of cooperation with local financial institutions across the country to make mortgage fraud cases.

The FBI reports that a “regional analysis of suspicious activity reports (SARS) indicating Mortgage Fraud violations indicates the West region of the U.S. led the nation with 35.9 percent of Mortgage Fraud-related SARs filed during FY 2006. The Central, Southeast, and Northeast regions had 24.7, 22.6 and 16.9 percent respectively of Mortgage Fraud related SAR filings. However, FBI pending cases indicated that the Central region had the majority of Mortgage Fraud cases with 33.3 percent during 2006. The West, Southeast, and Northeast had 26.7, 27.2 and 12.8 percentages respectively. FBI pending cases by region are consistent with Mortgage Asset Research Institute (MARI) reporting which indicated that five of the top ten Mortgage Fraud affected states in 2006 were located in the Central region.” The following is a yearly listing of the number of mortgage fraud SARS received and the dollars lost in millions:
Mortgage Fraud:

• Fiscal year 2002 – 5,623 [$293]
• Fiscal year 2003 – 6,936 [$225]
• Fiscal year 2004 –  17,127 [$429]
• Fiscal year 2005 – 21,994 [$1,014]
• Fiscal year 2006 – 35,617 [$926]

Commercial Loan Fraud:

• Fiscal year 2002 – 1,764 [$1,010]
• Fiscal year 2003 –  1,850 [$1,060]
• Fiscal year 2004 –  1,724 [$1,163]
• Fiscal year 2005 –  2,126 [$711]
• Fiscal year 2006 –  2,409 [$540]

False Statement:

• Fiscal year 2002 –  3,711 [$469]
• Fiscal year 2003 –  4,569 [$388]
• Fiscal year 2004 –  6,784 [$458]
• Fiscal year 2005 –  11,611 [$998]
• Fiscal year 2006 –  21,203 [$1,042]

The following is a list of mortgage fraud indicators compiled by the FBI and lender institutions:

• Inflated appraisals
• Exclusive use of one appraiser
• Increased commissions/bonuses – brokers and appraisers
• Bonuses paid (outside or at settlement) for fee-based service
• Higher than customary fees
• Falsifications on loan applications
• Buyers told/explained how to falsify the mortgage application
• Requested to sign blank application
• Fake supporting loan documentation
• Requested to sign blank employee or bank forms
• Requested to sign other types of blank forms
• Purchase loans disguised as refinances
• Requires less documentation/lender scrutiny
• Investors-short term investments with guaranteed re-purchase
• Investors used to flip property prices for fixed percentage
• Multiple “holding companies” utilized to increase property values

Mortgage fraud has contributed significantly to the housing market collapse in 2006/2007. Home owners were driven by a “fool’s gold” belief that their homes were worth than they actually were, and lenders were eager to underwrite “risky” loans to those who wanted a piece of the “housing boom.” It created a climate ripe for fraud. In addition to the equity skimming and property flipping schemes, the FBI has listed other popular mortgage fraud schemes prevalent in record years:

• Silent second – the buyer of a property borrows the down payment from the seller in a non-disclosed second mortgage leading primary lender to believe borrower has invested own money by concealing the second mortgage from primary lender.
• Nominee loans/straw buyers – borrower’s identity is concealed through use of nominee who allows borrower to use nominee’s name/credit history to apply for a loan.
• Fictitious/stolen identify – fictitious/stolen identity used on loan application, often by applicant who has stolen someone’s identity, personal ID information, and credit history.
• Inflated appraisals – acting in concert with borrower, appraiser provides lender with misleading appraisal report inflating property value.
• Foreclosure scheme – homeowner is identified as being at risk to default on loan or already in foreclosure, and schemer leads homeowner into believing he can save home with deed transfer and up-front fees. The schemer then re-mortgages the home or pockets the up-front fees.

Air loans – a non-existent loan where there is no collateral. A broker generally invents borrowers and properties, maintains accounts for payments, and has custodial accounts for escrows. Broker sets up office with telephones for employer, appraiser, credit agency, etc. for verification purposes.

Mortgage fraud is defined, and prohibited, in 18 U.S.C.A. § 1014:

“Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way the action of the Farm Credit Administration, Federal Crop Insurance Corporation or a company the Corporation reinsures, the Secretary of Agriculture acting through the Farmers Home Administration or successor agency, the Rural Development Administration or successor agency, any Farm Credit Bank, production credit association, agricultural credit association, bank for cooperatives, or any division, officer, or employee thereof, or of any regional agricultural credit corporation established pursuant to law, or a Federal land bank, a Federal land bank association, a Federal Reserve bank, a small business investment company, as defined in section 103 of the Small Business Investment Act of 1958 (15 U.S.C. 662), or the Small Business Administration in connection with any provision of that Act, a Federal credit union, an insured State-chartered credit union, any institution the accounts of which are insured by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, any Federal home loan bank, the Federal Housing Finance Board, the Federal Deposit Insurance Corporation, the Resolution Trust Corporation, the Farm Credit System Insurance Corporation, or the National Credit Union Administration Board, a branch or agency of a foreign bank (as such terms are defined in paragraphs (1) and (3) of section 1(b) of the International Banking Act of 1978), or an organization operating under section 25 or section 25(a) of the Federal Reserve Act, upon any application, advance, discount, purchase, purchase agreement, repurchase agreement, commitment, or loan, or any change or extension of any of the same, by renewal, deferment of action or otherwise, or the acceptance, release, or substitution of security therefore, shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both. The term ‘State-chartered credit union’ includes a credit union chartered under the laws of a State of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States.”

59 C.J.S. Mortgages § 123 (2007) sets forth the following circumstances under which “mortgage fraud” may be perpetrated in a civil law context and the requirements necessary to establish fraud in a criminal case:

• The mortgagor is the subject of fraud when the mortgagee has knowledge about, and participates in, the fraud.
• The owner of land is the subject of fraud when, by misrepresentation or concealment, he executes a mortgage without being fully and truly informed of the circumstances and would not have executed the mortgage absent the misrepresentation or concealment.
• The individual attacking a mortgage allegedly secured through fraud must prove all the essential elements of fraud.
• The essential elements of fraud under 18 U.S.C. § 1014 are (1) making a false statement or report on any application commitment or loan, (2) knowing that such statement is false, and (3) for purpose of influencing in any way action of any bank the deposits of which are insured by Federal Deposit Insurance Corporation. See: United States v. Nelson, 485 F.Supp. 941 (W.D. Mich. 1980).
• A mortgage is not invalidated by fraud which causes no injury, and so long as the mortgage accomplishes what the parties intended, it is valid and the mortgagor bound by it even though he was misled as to its nature or effect.
• A misrepresentation must relate to a material fact in order to constitute fraud necessary to invalidate a mortgage. Mere broken promises or unfulfilled predictions are insufficient.

Mortgage fraud schemes in criminal cases are generally complex. The Second Circuit Court of Appeals in United States v. Amico, 416 F.3d 163 (2nd Cir. 2005) discussed such a scheme involving a number of individuals:

“Peters participated in a complex scheme to defraud federally insured banks and private mortgage lenders by using false information to obtain mortgages at inflated prices. In his role as a mortgage broker, Peters knowingly caused loan applications containing false information to be submitted to lenders. He also knowingly failed to report income on his tax returns and made material misrepresentations in his children’s applications for college grants…

”As for the defendant’s objection to the court’s application of the sophisticated means enhancement, U.S.S.G. § 2F1.1(b)(6)(C), there can be no doubt that the mortgage fraud scheme was highly complex. Peters’ counsel conceded before the district court that the scheme involved sophisticated means designed to prevent detection. These included the creation of false bank documents; the solicitation and creation of false appraisals; the creation of false blueprints; submission of false blueprints to town officials in order to inflate the assessment of comparable home values; collusion with the attorney representing many of the purchasers at closing; and other tactics designed to conceal the scheme…”

In a companion case involving some of the same individuals, the Second Circuit in United States v. Amico, 486 F.3d 764 (2nd Cir. 2007) elaborated further on the mortgage fraud scheme outlined above:

• “In December 2000, the Amico brothers, their father, Robert A. Amico (‘Robert Sr.’), Patrick McNamara, and others were charged in a multiple count indictment with conspiracy to defraud banks and private mortgage lenders by falsifying loan applications and misrepresenting the value of properties offered as collateral. The indictment also alleged that the defendants submitted false information on loan applications for borrowers, including themselves. The government alleged that Patrick McNamara, a mortgage broker, and Robert Sr., a builder, were the driving forces behind the scheme, which originated around 1993. During the course of the scheme, mortgages were obtained from various lenders on more than 100 homes based on false documentation. In many cases, the mortgage amounts were greater than the value of the properties being purchased. Some of the purchasers were apparently willing participants in the fraud, while others did not know that false information had been submitted on their behalf. At trial, Richard’s main defense was that he was not involved in the scheme and that he too had been misled by McNamara, who typically prepared false documents without Richard’s knowledge.” Id., at 767.

Edward M. Gramlich, a Federal Reserve official who wrote extensively about the housing/mortgage industry, put out early warning signals in May 2004 about a potential housing industry collapse when declared that “increased sub-prime lending has been associated with higher levels of delinquency, foreclosure and, in some cases, abusive lending practices.” As early as 2000, Gramlich was encouraging then Fed Chairman Alan Greenspan to increase “oversight” of sub-prime lending to no avail.

A new report from Congress’ Joint Economic Committee predicts 2 million sub-prime foreclosures by the end of 2007. Investors such as Merrill Lynch, who bought assets backed by sub-prime loans, have been forced to write-off many of the loans at staggering losses – $8.4 billion for Merrill Lynch alone. Greed fueled the sub-prime fiasco – in 2003 sub-prime lending accounted for only 8.5 percent of the value of mortgages in this country, but in 2005-06 during the peak of the housing boom sub-prime lending accounted for 20 percent of the total value of mortgages.

Just before his death from cancer, Gramlich wrote that the “sub-prime market was the Wild West. Over half the mortgage loans were made by independent lenders without any federal supervision.”

“Why are the most risky loan products sold to the least sophisticated borrowers,” Gramlich asked in his final paper. “The question answered itself – the least sophisticated borrowers are probably duped into taking these products [and] the predictable result was carnage.”