A Foreclosure Fraud Primer

Written by Geoffrey K. Milne
on October 11, 2012 No Comments
Categories : Required Reading

12553_investigation A Foreclosure Fraud Primer REQUIRED READING: The foreclosure crisis has generated an extraordinary amount of discussion, debate and media coverage – much of it focused squarely on issues surrounding lending practices and default servicing strategies. The servicing industry has frequently found itself on the defensive in the court of public opinion, with a handful of high-profile management issues casting an unfortunate light over the vast majority of responsible and professional servicers.

What has remained largely under the radar – at least with regard to the popular media narrative – is the degree to which the increase in defaults and foreclosures has subsequently led to a significant spike in true foreclosure fraud. Perpetrated by everyone from unscrupulous borrowers to unethical opportunists promising too-good-to-be-true foreclosure ‘rescues,’ foreclosure fraud is a significant problem with potentially serious negative impacts for lenders, borrowers and servicers alike.

There are many ‘flavors’ of foreclosure fraud, but the three most common are loss mitigation fraud, loan modification fraud and foreclosure rescue fraud. Various forms of loss mitigation fraud or short sale fraud include everything from ‘flopping’ schemes aimed at defrauding lenders or bilking vulnerable homeowners, to predatory scammers pretending to be negotiators or unlicensed representatives collecting an up-front fee and failing to perform any actual services.

One increasingly popular variation on this theme is a form of short sale fraud wherein a borrower colludes with an appraiser and another associate to secure an artificially low appraisal and get the bank to green-light the short sale. The borrower's affiliate purchases the property and turns around and flips it for a higher price, splitting the profits with the borrower. In the current climate, it is unfortunately not always difficult to pressure an appraiser to come in with a lower appraisal. Broker price opinions or appraisals can sometimes be consciously or subconsciously influenced by the desire for repeat business.

Loan modification fraud is oftentimes no more complex than borrowers lying about their assets or misrepresenting their financial circumstances in order to effectuate a loan modification or a more favorable workout scenario. This kind of generic stated-income fraud, while extremely common, is thankfully relatively easy to detect and remedy if the bank does its due diligence.

The last of the three most common forms of foreclosure fraud is foreclosure rescue fraud. One of the toughest types of fraud to shut down – and one in which the aggrieved party is perhaps least likely to get a civil remedy – foreclosure rescue fraud typically involves self-proclaimed ‘foreclosure rescue’ companies or ‘foreclosure assistance’ entities that prey on vulnerable borrowers.

One common theme in foreclosure rescue scams is the presence of a straw borrower or ‘investor.’ Desperate borrowers who transfer the deed over to that third party with the belief that the ‘investor’ will be making the mortgage payments on the borrower's behalf will likely soon find themselves out on the street.

Meanwhile, the scammer either sells the property for a profit or walks away pocketing whatever fees/payments the borrower has been funneling to them. One of the unfortunate aspects of foreclosure rescue fraud is that localized or sporadic cases are rarely prosecuted or criminally pursued. And, typically, in instances where larger operators or more organized systemic fraud is occurring, federal authorities will need to step in – a process that can take an extended period of time as losses mount.

Enforcement challenges

With such an increase in foreclosure activity, along with the accompanying spike in logistical challenges associated with tracking and processing so many files, it is unsurprising that incidents of fraud have accelerated. Unlike origination fraud, which is a little cleaner and has more of a paper trail, many of these newly popular categories of mortgage fraud are more resistant to clear enforcement; civil remedies are somewhat tougher to pursue here.

In many instances, simply proving the existence of fraud can be difficult. Even a 10% value variable can be a significant sum, but is still within the margin of error in which scammers can muddy the financial waters enough to ensure proof of wrongdoing drifts back into the realm of plausible deniability. And on the criminal side, relatively scarce government resources are focused on the bigger fish, as it is simply not cost effective to ‘sweat the small stuff.’

Federal law enforcement tends to look at these cases in terms of the size of the dollar loss. Therefore, although there are places where lenders can report suspected fraudulent activity to the local/state grievance board or file a suspicious activity report, as a practical matter, unless there is a multi-property fraud or a pattern of fraud, it is unlikely that federal law enforcement will pursue prosecution.

Another contributing factor to the current fraud climate is an evolving regulatory climate. Consumer complaints about the delays in resolving loss mitigation decisions, combined with higher loss mitigation applications, put lenders in a difficult position – something that makes quality control and fraud identification more challenging than ever. In many cases, quality software and sophisticated systems can help accomplish those goals while remaining vigilant for fraud, but those resources are not available to all lenders and servicers.

With fraud on the rise and enforcement a challenge, the obvious solution is to reduce instances of fraud beforehand, utilizing best practices on the servicing end to protect all parties – lenders, borrowers and servicers – from the personal, professional and financial damages associated with fraudulent practices. Recognizing, avoiding and minimizing the damage from fraud on nonperforming loans is particularly important, as lenders that are already losing money on the deal are loath to double-down on that loss by taking another financial hit or being forced to pay litigation expenses. Transaction-driven best practices, ranging from comprehensive training and clear communication to due diligence and thorough documentary review, provide the most effective (and also cost-effective) way to reduce the frequency and dampen the impact of fraudulent practices.

Some of the more preventive best practices that servicers can pursue include the following:

Prioritizing training. It is vital to ensure that all personnel are fully trained and equipped to identify suspicious or potentially fraudulent activity. Make certain that all employees and professional partners understand precisely what steps to take and the procedural guidelines to follow in the event that they suspect fraud. Provide your team with processes, checklists, access to online resources, and an updated list of ineligible parties in the area who have committed fraud or have previously been suspected of engaging in unscrupulous behavior.

Performing due diligence. It is crucial to verify submitted information and cross-check whenever possible. In a short sale or loss mitigation proceeding, use the information submitted during the origination as a baseline for comparative purposes. Perform basic due diligence by doing things like comparing names on the purchase agreement and closely reviewing fax headers, proof of funds letters and current listing agreements. Do not hesitate to ask questions when information comes across as unclear or contradictory.

Avoiding shortcuts. In the current climate, dotting your i's and crossing your t's is more important than ever. When third-party facilitators are involved, make it a policy to contact the borrower directly to review documents and ensure that information is accurate. Ask for a copy of a current driver's license, and review tax returns and bank statements when appropriate, staying alert for address and income discrepancies.

Going the extra mile. Consider educating borrowers about how to protect themselves against the most common forms of loss mitigation fraud. When possible, work with outside vendors that may be able to design and deliver customized technical and training solutions that can improve efficiency and accuracy.

Protecting yourself. Maintain insurance through your vendors whenever possible. Cost-consciousness is important, and everyone wants to save money, but in the long run, the protection of insurance will more than pay for itself.

Using common sense. Always listen to what customers and professional partners are saying. All too often, signs of fraud were there in retrospect, but discrepancies simply slipped through the cracks. Be wary of loans that have gone into default shortly after closing. And, of course, promptly report suspicious activity to the agencies and local or federal authorities.

The vast majority of best practices do not involve complicated, sophisticated or unusual techniques. Instead, they simply require thoughtful, thorough and consistent execution of the basic principles of responsible servicing.

Geoffrey K. Milne is a litigation partner at Hartford, Conn.-based Hunt Leibert Jacobson PC. He can be reached at gmilne@huntleibert.com.

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