Fraud Advisory 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 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.

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.

Prevention is better than cure – would seem to make sense in the case of fraud as it is in the case of your health. Fraud can cause a company to lose a great deal of money, or worse collapse completely. A company collapse due to fraud can be avoided by putting in a few measures that would greatly reduce the risk of fraud can cost far less than this.

The first step to take is for a company to accept that it is at risk from fraud and the attention of the fraudster. Many organisations fail to even accept this, then are surprised to find a black hole in their finances of several £100,000s. They do not believe that any of their trusted staff could be a fraudster. Accepting that fraud is a very real risk is the first stage – deciding that fraud is not acceptable is the next.

A company must tell all its staff, and often customers and suppliers as well, that it does not tollerate fraud. This is the fraud policy. It can be set out in a document which is circulated to all staff. Big corporations will publish a glossy booklet, a small business can photocopy a simple typed page. The important point is to communicate that fraud is not accepted and if discovered, action will be taken. This in itself can have the effect of greatly reducing the risk of fraud happening.

The next critical step in preventing fraud is to ensure that any previous complacency does not creep back in. This means that all systems are reviewed on a regular basis for weaknesses to fraud. Auditors often review accounting controls once a year at the annual audit – this is not enough nor is it frequent enough. Accounting controls designed to keep a financial reporting system working well are not designed for preventing the determined fraudster. For example a control that requires two signatures on a document can easily be circumvented by collusion.

By understanding how an accounting control can be circumvented efficient measures can be introduced to ensure that the risk of this happening is low, and if it should, it will be discovered sooner rather than later. This takes a different mindset to that of an auditor, that of a fraud expert, such as a forensic accountant or fraud investigator is of course ideal.

There is no doubt of the commitment of the present UK Labour Government to the Proceeds of Crime Act 2002 and its intended use to cripple organised and career criminals. It has been applied in the field now for a number of years and is becoming a routine process in many cases.

So routine in fact that prosecutors do not bother to prepare a comprehensive Section 16 Statement anymore it seems! The Section 16 Statement are statements of information that provide the reasons, but not necessarily the evidence, for applying criminal lifestyle assumptions to a defendant’s assets. The Statement will set out the level of criminal benefit based on the crimes that have been committed and on the assumptions that other activities are also criminal. The Statement may also indicate the assets that the defendant has to satisfy any confiscation order and even give an indication, again not necessarily with evidence, of any assets thought to be hidden away.

With such a broad remit for indicating what is benefit and what may be available as realisable assets to satisfy the order it is clear that the prosecutors are simply setting out some of the information they have, regarding the defendant. This is on the basis that are adequately covering the likely scale of any order. In effect they are seeking to do enough to ensure that the defendant loses all he has, but are not bothering to be comprehensive in their approach.

This approach does happen in practice. Unfortunately, although it may deliver draconian but possible deserved justice for some, it creates a somewhat unfair situation for other defendants. For example take the case where a defendant has been convicted of trafficking drugs, has not kept details of any financial transactions and in all likelihood has not paid any tax on any legitimate work he has been undertaking as a cover for his drug dealing. If only one or two of the defendant’s bank accounts are analyzed and demonstrate adequate transactions to ensure the ensuing confiscation order is large enough, then the defendant will lose everything and no doubt the prosecution will argue justice has been served.

Compare the last case to another, where a businessman has been caught defrauding his employer by substantially inflating his corporate expense account for a number of months running, by several £1000s. He is caught, convicted and must serve a prison sentence as punishment for theft. Of course he will also have to pay back the money though subsequent confiscation proceedings. If he is technically deemed to have a criminal lifestyle, the prosecutor will throw the book at him, preparing a Section 16 Statement that will seek recovery of not only the money that he stole, but everything he owns and ever transacted going back 6 years. When all the receipts into the bank accounts over 6 years are totted up, this “benefit from general criminal conduct” can reach huge sums. The scale of such an assumed level of benefit, if awarded against the defendant as a confiscation order, can never be paid back. The unfortunate defendant would have to serve a default sentence having more years added to his original penalty.

Of course it is possible to defend such a situation. The defendant’s legal team would realise that whereas it would be necessary to repay the level of money stolen, it would be somewhat unfair to have to repay income earned legitimately over recent years. This is what an uncontested confiscation order would involve in such a case. Therefore, the defence must show to a civil standard of proof that his income other than the actual proceeds of crime was from legitimate sources.

This is where the forensic accountant would be called in. He will examine the Section 16 Statement together with all the defendant’s financial evidence (such as bank statements, business records etc) and demonstrate the legitimate nature of the income. This usually means that he must go further than the prosecutor because he will need to undertake a comprehensive review of everything – it is up to the defence to demonstrate the legitimacy of income or assets. To do this may mean examining accounts that the prosecutor has not bothered with, to show the source of all inter company transfers for example.

The big problem arises because the public funding of such cases is under threat. The public sector is having its budgets cut drastically by the Government in an attempt to redress the fiscal measures put in place to counter the pressure on banks over the past year or so. As an example the Legal Services Commission is losing some 5% of its current annual operating budget. It is reducing its spend on expert witnesses, i.e. the including the forensic accountants, by a disproportionately large amount – 20%. This is around £20 million less being spent on defence experts in the coming year.

The mechanics for doing this are being proposed in a current consultation paper regarding levels of experts’ fees. It is proposed that a forensic accountant will be paid between £47 to £100 per hour with the upper rate unlikely to be ever paid. For those that think that £100 per hour is a lot, remember this is the total cost – out of which must be paid pension, sickness, disbursements and the high cost of running a business. To put the rate into comparison, my work for my Masters Degree in Fraud Management showed that the average cost of a forensic accountant and of a police officer or member of the Court (clerk/manager etc) or of the Criminal Prosecution Service were broadly comparable. In fact the cost of putting an officer on the beat is a lot more than £100 per hour, let alone the cost of a detective in an economic crime unit.

If a well trained and experienced forensic accountant were to be paid £100 (assuming he or she can achieve this top rate) then they would be unable to remain in even a small firm of accountants as they would be unable to earn enough to fund their firm’s overheads. There is evidence that the Legal Services Commission see the solution as forcing the forensic accounting services into the hands of retired practitioners and “one man bands” who can survive (albeit barely) on the rates that are proposed. In a previous consultation paper about four years ago this very outcome was mooted as the way forward. At that time all that came out of the consultation perhaps was more determination by the public sector funding body to restrict and delay payments for experts.

As a fraud investigator who occasionally accepts the opportunity to tender for a white collar criminal defence case, I am finding that I no longer achieve the already low hourly rates I was using 10 years ago. Not only that, but many other forensic accountants who previously specialised in other areas such as business valuation and matrimonial disputes and turned their noses up at criminal defence work, are forgetting their scruples and tendering against those of us that have been carrying out the work for many years. When I do win work, I am not able to undertake such a broad review as in the past or undertake a fishing type investigation to see where an evidential trail leads, which may mean that aspects of a defence may be missed or at least not be as robust as they should.

The question being asked is where will it all lead? Will the good forensic accountants get priced out of the market? It is unlikely that they will leave regular employment in their droves to set up the sole practitioner firms envisaged by the Legal Services Commission. Will the mid tier and top tier firms return to their previous position of disdain for criminal defence work – finally being priced out the market completely? Will the white collar worker who gets caught with his hands in the till be able to defend himself from a totally unfair confiscation order?

Personally I see my work on criminal defence cases over the past decade or more being valuable experience. As an expert accountant specialising in fraud it would be hard to achieve the desired level of credibility before a court if all I had done is investigate and prosecute fraud. So now even if I focus more on catching the fraudster, defending a business against fraud and recovering stolen assets, when called to give evidence I can still draw on my past experience of criminal defence work when establishing my independence before the court.