All lenders need to know that there is no such thing as preventing fraud or being fraud-proof. If you think you are fraud-proof, this opens you up to careless behavior and more fraud. What you should focus on is thinking about resisting fraud, and thereby remaining vigilant against it.
All discussions about fraud should begin with understanding exactly what it is and what it is not.
There are four elements that must occur for the act or omission to be a fraud:
- The fraudster must have made a false representation to the victim, and made that representation as if it were a statement of fact;
- The false representation must have been known to the fraudster to be untrue at the time of the representation;
- The fraudster made the representation for the purpose of inducing the victim to rely or act upon that representation; and
- The victim did rely or act upon that representation and did so to their detriment.
Additionally, the false representation need not be an overt statement or action. A fraudster may also make a false representation by omission, that is, staying quiet or leaving something out when they should have made an actual representation.
Fraud is, in short, a false statement (or lack thereof) passed off as fact, known to be untrue, to get the victim to rely upon it, which they did, and suffered damages as a result.
Now that we understand what a fraud is in theory, we will dive into some examples of fraud in our industry.
Asset Rental
Asset rentals are when cash or other assets are temporarily placed in the borrower’s account to qualify for the mortgage loan. These assets are not really owned or controlled by the borrower but by another individual or entity that lets the borrower use those assets to make the appearance of a large asset pool.
This is a fraud because the borrower represents to the lender that the money in the account is owned and controlled by them and done to induce the lender into thinking the borrower has more cash on hand than they really do.
Looking for a longer history of bank statements and identifying large, out of place, or context deposits, as well as comparing it with income from tax returns and asking follow up questions to the borrower about where the money came from, can help catch this fraud.
Fake Down Payment
When a Borrower who makes fake, fictitious, or forged documents (potentially including others in the scheme) to meet the Loan to Value (LTV) requirements, this constitutes a fake down payment.
Other than doing your best to spot suspicious documentation and follow up on them, this fraud should not make it through the closing since the title agent or escrow company should confirm that the actual down payment funds are already accounted for and held for the closing.
Ensure proper follow-up communication with the closing agent, whomever or whatever it may be, to confirm their receipt of the buyer/borrower’s down payment.
Fraudulent Appraisal
Fraudulent appraisals may occur when borrowers team up with an appraiser who also commits fraud by falsifying information or intentionally providing inaccurate information in the appraisal.
It is a best practice for a lender to order its own appraisal through a trusted appraisal management company. It is also wise to have your own in-house appraiser or other person trained to review appraisals and raise red flags if issues are found.
Fraudulent Documentation
Any use of forged, falsified, or incomplete documents intended to mislead is considered fraudulent documentation.
Experience is really the only way to develop a healthy and more accurate filter for fraudulent documents. When using inexperienced staff, have multiple layers of review, and instruct them to be overly suspicious and slow down. As always, follow up with a borrower or other provider of the suspicious document to ask questions.
Examples include:
- Fuzzy/out of focus text
- Mismatched size or font of text in certain areas or throughout
- Conflicting dates, names, and terms
Forged Power of Attorney
Powers of Attorney witness requirements differ from state to state, but generally the more witnesses the better. Always insist upon confirming the validity of Agent’s authority with the Principal directly.
Then, check to see how broad the authority is because a limited POA specific to the property in question is likely more legitimate than a broad, loosely defined Power.
Finally, always make sure to ask questions such as, why is the POA necessary? Typically, POAs are for those who are physically or mentally incapacitated. Otherwise, operational control of a company can and should be done by resolution.
And, never forget that with all forgery, you need to check for similar signature styles.
Fraudulent Use of Shell Company
Shell companies are used to disguise and hide the true nature of ownership, control, and location of assets. They generally show a fictitiously long business existence (buying an older shell company with an established “history”).
In this example, the borrower will typically have mysterious transactions in the sale or acquisition of the company or equity interest, or a multi-layered ownership by other entities rather than natural persons.
The best one can do here is to ask questions and for more documentation. If you cannot piece together its history, chain of command, or ownership, there may be a problem.
Equity Skimming/Stripping
Equity skimming/stripping consists of inflating appraisal and/or selling price to get a bigger loan and more cash than the property is worth. This includes inflating sales price through multiple prior transactions between entities, all controlled by the same individual(s) for increasing value, creating a false sales history with an inflated price to get a larger loan.
A best practice is to check county records for the recent sales transactions and who was involved. You can also usually check with the secretary of state for the ownership information of the companies you see in the transaction history. You may not wish to investigate all 50 states, but the company is usually in the state the property is in or a handful of other states, such as Delaware, Wyoming, or Nevada. If successive companies have the same or related owners, that is a red flag.
Straw or Nominee Borrower
When an individual with a stronger or preferable financial background is the borrower, even though this individual has barely any connection and control of the loan, proceeds, or project, this is known as a straw or nominee borrower. They may be removed or replaced quickly and at will and are sometimes paid for their services.
Ask the borrower details about the loan transaction. Be sure the person with the better financial background is at least one of the individuals signing a personal guaranty. If they are not willing to make a guaranty, that should raise a red flag.
False Rental Assets
A borrower can fake a multitude of information and documents to make the property seem income-producing from rentals, such as:
- Occupancy rate
- Current occupancy status
- Future occupancy status
- Lease terms or leases themselves
- Existence or non-existence of Landlord – Tenant disputes
An appraiser or another 3rd party inspector could confirm occupancy and lease terms and even speak with tenants to better understand the conditions. As always, be suspicious.
Third Party Fraud
New Wire Instructions
In this scenario, a fraudster will have hacked into either a wire-recipient’s or wire-sender’s email to monitor a conversation regarding a potential wire transfer. Upon sending the recipient’s wire instructions, the fraudster will hijack that email, change the wire instructions to reflect their own account information, and then send the email to the wire-sender so they will pay the fraudster instead via the use of new/alternate wire instructions.
Most of the time, the wire instructions are altered only in the details of the account, and not the rest of the document or email to seem legitimate. Occasionally, though, the fraudster will send additional information indicating that the wire instructions did indeed change but that this is normal. Sometimes, the fraudster will also change the contact information so that if a wire-sender were to call to verify, they would call the fraudster, who would verify only the fraudulent instructions.
To mitigate this risk, always confirm wire instructions by phone. Only call the number you received when you first had a relationship with the title company; not the number you were given at the end, as this may have been intentionally changed. Ask to speak with the specific person you have been corresponding with, not just anyone who picks up the phone. Ensure you get confirmation in writing that wire was sent (and get copy of Fed Reference Number), to be confirmed again later in writing when received.
This fraud is typically not done in a vacuum, and they are most likely working with the borrower on the scheme. If the title company is acting too friendly, respectful, submissive, or complaisant to the borrower’s requests, treat this with suspicion, especially if this is the first time working with either of them. However, Title companies are not immune to fraud by a 3rd party fraudster.
Take Note
You should note that nowhere in the suggestions for any of these scenarios did it say, “this will prevent the fraud”. These suggestions can only help catch some fraud or can help resist fraud. These are but a small sample of types of fraud common in our industry, and every instance has its own complicated facts, so tread carefully.
In this industry, as in others, there will always be an element of reliance upon others and their representations. If a document or a story sounds fishy or too good to be true, it very well may be. Always ask questions. The more a fraudster is required to lie, the more likely they will make a mistake, and the truth will come out. We can only do our best to resist fraud. It is up to you to put up the fight.
Geraci’s Banking and Finance attorneys have many years of experience reviewing loan files and detecting red flags for fraud. We are available to review whole loan files, a subset of documents, or generally for questions on any type of fraud issue. Please reach out with any concerns or questions.
