[New] Originator Fraud: Crimes Of Opportunity & Crimes Of Desperation

BY KEITH GRIFFIN, LONE STAR LO SENIOR EDITOR

Mendrygal, a partner at Locke Lord LLP in Dallas. Here is an edited version of their discussion.

Q: There are some stats showing increases in property fraud, which ultimately leads to mortgage fraud. Are you seeing increases in mortgage fraud in Texas?

Not yet, but it is only a matter of time. The fraud I see tends to be complex, and often involves sophisticated fraud rings and/or industry insiders. These cases generally take longer to bubble to the surface because they are hard for lenders and law enforcement to detect and unravel. In addition, because of the various forbearance programs that have been in place for the past few years, we have not had the opportunity to see some of the tell-tale signs of fraud, such as early payment defaults. Over the past few years, and up until a few months ago, the conditions were ripe for fraud. We had a hot housing market in many parts of the country, involving a combination of high demand and moderate supply, low interest rates, rapidly increasing housing prices, and bidding wars. As a result of those conditions, some buyers and sellers had the opportunity to play some games.

Now that the forbearance programs are being lifted, payment defaults and foreclosures are going to start to occur. Lenders and regulators are going to begin studying those loans to understand what happened, and some fraud is going to be detected. Everything was frozen in time for a while. Now comes the thaw.

Q: Is mortgage fraud driven by a bad economy? With a recession of some scope predicted for 2023, will there be increases in mortgage fraud?

People who study financial fraud believe there are two major categories - crimes of opportunity and crimes of desperation. The hot housing market prior to and during the pandemic meant that a lot of houses were in circulation, which created plenty of opportunity. If we enter a recession, particularly if interest rates remain high and housing transactions low down, we could see a shift away from crimes of opportunity and see more crimes of desperation.

Crimes of desperation can come in different flavors. I see it on the lender side when people who are paid on volume or commission get themselves into financial trouble. That boat payment they agreed to during the hot market weighs heavily when the market goes cold. Thus, some insiders start to do bad loans. On the borrower side, a recession combined with high interest rates makes it much more expensive to get into that house that they have had their eye on. Some borrowers will end up saying whatever they need to say to get into that house (or stay in their existing home). In the end, I’m not sure if the total volume of fraud will increase year-over-year in 2023, but we might see a different flavor of fraud.

Q: Where is fraud a more prevalent issue? The borrower or the lender?

Statistically speaking, there is much more fraud on the borrower side. But it is often way more serious on the lender side. Fraud by lenders and other industry insiders can be incredibly difficult to detect because they know how these deals work. They know what the certain borrower documents should look like to minimize scrutiny. They know which underwriters and processors are more diligent. They know the loan amount thresholds that trigger different treatment in the pipeline. And they know that they can put their reputation on the line with their co-workers to push certain deals through the pipeline before the fraud is detected. As a result, insider fraud can last a long time and, once it is detected, can result in law enforcement scrutiny on the entire company, not just the co-conspirators.

A majority of lenders are honest, hard-working people, obviously. But how does one spot the bad actors among fellow lenders who might be taking shortcuts?

There is no perfect solution, but my best trick is data analytics and, specifically, inward-facing data analytics. I see companies with robust and smart outward-facing analytics that they use to assess risk and detect fraud by borrowers. But many of these companies spend much less time studying what is happening within their castle walls. In nearly every insider fraud case that I deal with, there was a clue in the data. Often, the biggest red flag is some significant change in a loan officer’s business patterns. For instance, how did that loan officer go from eight to 48 loans in a single month? Or, why did that loan officer go from working exclusively in these zip codes and go exclusively to a new zip code? Or, why did that loan officer shift from single-family homes to multi-family properties? Is there a good explanation for what happened? There might be, but someone needs to ask and decide whether the answer makes sense. particularly when it comes to foreign nationals attempting to move funds to the United States to invest in real estate and using straw borrowers to do so. using those outward-facing analytics that we just talked about. In the company’s files, is the employer’s address or phone number associated with any other loans? Does the same bank account number appear in any other loan files? Do we have other loans on the same street with similar employers or bank accounts?

I should be clear about something – I appreciate that trends are much more difficult to detect in real time than they are after the fact. But inward-facing data analytics will often help you notice aberrational shifts in the quantity, quality, location, or types of loans being originated by your loan officers.

How can originators protect against mortgage fraud?

I originally got involved with mortgage sector fraud cases back in 2005, when I was a brand-new lawyer. Back then, the fraud was heavily slanted toward traditional borrower fraud – falsified bank statements, verifications of employment, etc. In the past 18 years, not a lot has changed. I do see more occupancy fraud these days,

The biggest difference is that the same borrower fraud schemes have become more sophisticated. Whereas fraudsters used to create amateurish fake bank statements and have their friend pretend to be a supervisor at work, the false documentation has become far more sophisticated and difficult to detect. The documents look authentic. In a few days’ time, you can set up a faux website for a faux business.

So how do you detect fake documents? I encourage lenders to try to talk to the borrower at least once during the process. Don’t read a script – have a real conversation.

If your Spidey sense starts to tingle, there is probably a reason for that. That’s usually a good time to start

In legalese, “design and implement an effective compliance program.” In plain English, “hire smart people and give them the budget and resources to aggressively detect and prevent fraud, which might have the ancillary benefit of saving the company’s bacon.” There are a lot of great compliance products out there, but be careful about buying something off the shelf and assuming that it will work for every business. Someone needs to sit down and assess where your particular risks are and then hire a knowledgeable and adequately-resourced compliance and fraud prevention team that is empowered by senior management to do the job.

This department is your corporate life insurance policy. They’ll catch a lot of fraud, and even if something slips by, it shows that the company is trying to be a good corporate citizen. Most companies are wise to this, but I still see quite a few companies in the mortgage sector that hasn’t invested in any personnel who are tasked with doing the types of fraud detection activities that I talked about above. In a worst-case scenario of insider fraud, those are the companies that have to sweat bullets.