Mark Jenner & Co Limited – Forensic Accounting Services

The incidence of mortgage fraud appears to be increasing. Much of it has been coming to light as a result of the down turn in the property market that accompanied the current general economic down turn or “credit crunch”. When property values reduce to below the level of the mortgage that has been advanced on it the lenders begin to sit up and take note.

One of the pivotal areas within the whole property business is the conveyance process. This is where two firms of solicitors will represent the seller and the buyer respectively and ensure that money is transferred properly in return for the title to the property.

Most people look to pay as little as possible for the speediest conveyance possible. 99 times out of a 100 this probably works well enough. However, property law is complex and when things go wrong they are usually the unusual issues that many swift sale transactions would overlook. This is why for larger more expensive properties, even though the process is essentially the same, the conveyance fee is higher because of the higher risk of losing more money.

The buyer’s solicitor will take receipt of mortgage funds and documents that the sale process relies upon, such as valuations and certificates of building regulation compliance. The solicitor manages the whole process and is uniquely positioned to be able to vet the process for fraud. Indeed, all solicitors have an obligation to “know your client” for the purposes of anti money laundering regulations 2007 and to report any suspicious financial activity they come across.

A typical mortgage fraud will involve a property company either selling in its own right or acting as agents for property holding companies. They will inflate the property prices based upon the rental incomes that they say can be obtained from the properties. There is no law to stop them doing this. If a glossy brochure says that a three bedroom student flat costs £250,000 and allege that each room can earn £90 per week – then this indicates a return on investment of 5.6%. This would be an acceptable return in the property business (there is no standard as it varies from region to region, property to property). However, it does rely on the landlord letting all three rooms out for 52 weeks of the year and achieving the required £90 rent.

If the property was sold as bricks and mortar at an auction it might sell for £150,000. However, the valuation provided by the surveyor to the mortgage company will be based on the rental income and possibly on similar properties that the same development company has been selling nearby. When property prices were increasing this practice can be overlooked. When prices are plumetting and people try to realise their assets the overvaluation is discovered.

The conveyance process should spot this practice. The valuation used for the mortgage, arranged by the property company, should not be relied upon and any solicitor worth his or her salt will say that an independant valuation should be carried out. Any savvy potential investor will want to get a feel for property values in the area that they are buying anyway.

Where a problem arises is when the property sales take place in London with a lot of glossy marketing hype and the properties being sold are, for example, in the North of England. During the early 2000s there was a surprising amount of spare capital and credit available (as everybody has now come to realise) and individuals were mopping up buy to lets on 100% mortgages without even visiting them first. It is hard to believe but everybody was riding the wave of success and were blind to the possibility of a property crash.

In some cases solicitors were being appointed by the property developers on behalf of the buyers. They were happy to take the business, 100s of transactions a year at £600 per time. The trouble is that they were not looking for overvaluations, turning a blind eye to the gifted deposits (thus facilitating 100% mortgages). In short, a few conveyance firms were a party to the mortgage fraud. Developers, solicitors and surveyors conspired in what was much more than sharp business practice to ensure that by the time that the property values crashed in about 2007/08, many buyers lost their investments and went deeply into negative equity. The mortgage companies that were involved in the property company that I investigated lost on average £63,000 on each and every property where they advanced loans (there were several 100s of properties in this one case) thus they felt the impact of a very large multi million £ mortgage fraud!

Firms were shutting down in 2009 ahead of their October PII renewal (the Law Gazette)

Many conveyance firms have felt the pinch as a result of the greed of a few. All firms must have professional indemnity insurance in place that covers them for fraud amongst other things. Such is the increased incidence in mortgage fraud that these firms have faced severe hikes in their PII cover. For example one firm reported an increase of 550% to £110,000, some 25% of turnover! Some firms have been shutting their doors to conveying business and some have even gone into administration to avoid paying the bill when due.

The Labour government has been criticised widely for the huge raft of legislation it has introduced in its 12 or so years of reign. Much of it has been lengthy and often arguably unnecessary. The burden of regulation on any business attempting to obtain business loans and trying to struggle through the current down turn has increased and is significant.

However, there must be credit in the attempts being made to improve the anti-fraud and white collar crime framework within the UK. The Proceeds of Crime Act 2002 introduced what some say are draconian powers of confiscation for the authorities to use. Draconian they may be but that is fair enough when they are used against the ones they were designed for – the organised criminals with the obvious trappings of unearned income. There can be some criticism when the letter of the law is used to attempt to obtain large sums from petty criminals with default sentences when they can’t be paid.

One bit of legislation that makes you wonder who is actually writing these laws is the Fraud Act 2006. I know that many of the regulatory authorities that I work with are a bit dubious about this Act. Those police officers and prosecuting lawyers tell me that they were happy with the Theft Acts and the Common Law offence of conspiracy to defraud. The Fraud Act was meant to codify these and other areas - and it may be that using it will require a few more years of testing through the courts.

I did note in the Fraud Act that some Companies Act style amendments were contained within it, whereby the prohibition on directors loans, quasi loans, credit transactions and related transactions had been abolished and replaced by a requirement for shareholder approval. Breaches are no longer criminal offences and the de minimis level for needing shareholder approval has increased from £5,000 to £10,000.

My first impression is that this will lead to a huge increase of petty frauds in the £5 to £10,000 range.

New legislation, Fraud Reporting Centres and Strategic Fraud Authorities are fine and to be admired. However, it is no substitute for investment at the sharp end. We need stronger regional police economic crime units who all have access to fraud investigation and experienced forensic accounting resources. This is really where a public and private sector liaison would work, and was one of the ideas behind the various regional fraud fora that have been established around the UK.

If a person is defrauded he or she must present a clear cut case to the authorities. It is no good shouting “fraud” – it needs investigating and presenting clearly. Of course this is a hurdle that many victims fall at and the fraudster escapes to ply his trade again somewhere else. Those that do investigate, even employ their own forensic accountants to build a financial case to present to the authorities, can be equally at a disadvantage if they get the investigation wrong.

Say for instance a company decides to investigate a £9,000 director loan that is thought to be defalcation by the director. The director is not committing a crime under the Fraud Act - the matter will likely be civil. Therefore the police will not be interested and it will be hard to recover such unauthorised borrowing. There are still difficulties with more substantial “borrowings”. Say £50,000 is missing and this time it is fraud. The culprit is not presenting a defence of taking the money as a loan – he is simply denying the matter. The Defendant may argue that he was simply seeking tax relief by exploiting timing differences in respect of any payments received, and that he was planning to pay the money back next fiscal year!

Any accusations made during an investigation will not help, the director may simply leave citing constructive dismissal and the business may end up paying out as much and more than it had already lost in compensation awarded by an employment tribunal.

The point is that if the police are to enlist the help of the private sector in the fight against fraud, funded by the victims, then they should have sufficient resources employed to monitor and assist with the private sector enquiries. This will enable them to be carried out properly and in a way that will result in a successful prosecution for the authorities, civil asset recovery for the victims and/or justified and successful confiscation proceedings that will help to fund both the authorities and the out of pocket victim.