Mark Jenner & Co Limited – Forensic Accounting Services

The “credit crunch” was named after the irresponsible lending practices by the banks and other financial institutions that were out of control when they reached their peak in around 2007. It had become possible for virtually anybody to approach a property developer and start buying properties without having any capital to invest. The driving force behind this was the ease with which the lenders would provide the money and the lack of control over who they would lend to. In the UK many property developers abused this credit glut and many even conspired with lawyers, surveyors and mortgage brokers to defraud the buyers and lenders of vast sums of money.

The USA has seen similar problems, with mortgage fraud again being one of the major contributors to the present downturn in the economy. In the late 80s and early 90s there was a similar crisis in the economy – albeit on a much smaller scale – with a collapse of confidence in the savings and loans system. The FBI geared up strongly following this in attempts to deal with the mortgage fraud and other financial crime that was firmly embedded within the crisis. A strike force based in 27 cities was staffed by more than a thousand FBI operators and forensic accountants, together with teams of federal lawyers to manage the resulting prosecutions. This thrust alone was responsible for over 600 successful convictions and confiscation orders amounting to $130,000,000.

Today’s financial downturn dwarfs its forerunner in the USA, as it does just about everywhere else in the world. In the USA the financial institutions have reduced their assets by an almost incomprehensible $1.2 trillion this time round. This is of course a massive reduction in value and one which crystallises the frauds and financial malpractices that were taking place almost unchecked. It compound problems in a crisis by, for example, causing investors to lose faith and requiring much higher returns from their investments – in this case the mortgage backed securities are the relevant investments that become expensive. The result is increasing interest rates and fees for bone fide borrowers who are chasing limited funds when compared to the previous glut.

What is mortgage fraud?

Mortgage fraud for profit is a planned attempt to remove equity from others for illegal profit. White collar criminals will purchase property using loans and then sell these properties on. If they inflate the value of the property borrowed, they can borrow more than the property is worth. Some times they will even borrow on fictitious property. This type of fraud usually operates in its various guises as a conspiracy to commit fraud between property developers, conveyance lawyers, mortgage brokers and property surveyors (property valuers). The victim can be either or both of the following:

1. The individual who buys an overpriced property using a mortgage and ends up with negative equity

2. The mortgage lender whose security does not meet the level of the amount loaned

Very often the mortgage lenders will pursue the individuals who owe them money even though they lent to them as a result of a fraud conspiracy or the sharp practice of the property developer. Many individuals can be bankrupted by this and in the end the mortgage companies also lose out.

Mortgage fraud can also be committed by a borrower, typically with the help of estate agents or property developers. In this way they are able to obtain a house that is perhaps more valuable than their situation would otherwise allow - they falsify their income in order to borrow more money. Although they do not qualify for a loan and are committing mortgage fraud, many of these types of borrowers happily service their loans and the mortgage lenders remain ignorant. It is only when the borrower is unable to repay a monthly installment or sell on to settle the loan that such fraud becomes apparent.

Trends in US Fraud

In the USA the FBI receives Suspicious Activity Reports as do the authorities in the UK – derived from the Department of Housing, the Urban Development Office and from the industry at large. However, a large part of the US mortgage industry does not have mandatory reporting and so the exact level of this type of fraud is unknown. The trends in those reports that are made do show an increase – for example during 2008, reported mortgage frauds were up 36% to 63,173 incidences.

It is a recognised fact that a financial crisis such as the current downturn will expose fraud schemes that had been thriving during the former boom years. As the financial markets deteriorate, fraud come to light – witness the number of Ponzi schemes (such as the Bernard Madoff scam) we are learning about seemingly daily!

The FBI investigated 566 major corporate frauds in 2006 – rising to some 2000 in 2008.  These frauds include mortgage frauds, accounting fraud and insider trading. The increases are apparently stretching the FBI’s white collar crime resources.

The mortgage frauds seen include scams such as equity skimming and property flipping, where the fraudsters use corporate shell companies and corporate identity theft to appear bone fide followed up by threats of bankruptcy proceedings and foreclosure on clients and individuals to trick householders and investors to release their assets.

The FBI is gearing its approach to detecting and prosecuting mortgage and other forms of financial fraud which are seen to be a currently emerging threat to the stability of the US economy. Specialist software has been developed to detect incidence of property flipping in some hard hit areas such as Baltimore and Washington – searching databases for companies and persons showing patterns of property flipping (i.e. back-to-back purchases and sales or successive sales with very different sales prices over a short time). Undercover operations and wire taps are being used to good effect also, thus allowing criminals to be caught “in the act”.

The problem with mortgage fraud is that, as in the UK, many US property developers simply took advantage of the ease with which credit could be obtained. Put this alongside human greed to make large sums of money very easily and many investors previously lost any caution when entering the property investment business. They would buy property unseen, to rent out or sell on, relying on the fact that the values of property were bound to increase – as history had shown property does increase but there are “blips” and cycles that need to be accounted for. There are commentators that are currently saying that property prices will not rise for another 10 years! The successful property speculator will plan for this, only paying market value or less and certainly not relaying on the hype that was circulated by many of the property development companies during the boom years.

Read these other articles on mortgage fraud:

Don’t Always Blame The Conveyance Process For Mortgage Fraud

Mortgage Fraud in the Buy to Let Market

This article is grateful for facts and information presented by Mr J Pistole of the FBI in a statement before the House Committee of the Judiciary on 1 April 2009.

If you’re planning to purchasing a house with a mortgage, you must ask yourself, “how much house can i afford?”. This is because how big and expensive a house you can afford depends on your home loan amount. Once you find a house that befits your affordability, shop around to obtain a suitable home loan. However, you must keep in mind that there are various fraudulent lenders who can scam you by not disclosing fees upfront and then charging you more in the long run. So, you must gather knowledge about the various mortgage frauds and the ways by which you can prevent them.

Different mortgage scams and ways to avoid them

Some of the common mortgage scams and ways by which you can prevent them are:

*Appraisal fraud: Some fraudulent lenders inflate the value of your home and compel you to obtain a larger loan amount. These lenders don’t care about your affordability and their motive is to make you pay more as monthly payments. So, when you’re finding an answer to “How much house can I afford?”, hire an independent appraiser to verify the value of your property and accordingly determine whether or not you can afford the loan amount required to purchase it. In this way, you can prevent getting scammed to obtain a mortgage that you cannot afford.

*Not mention certain fees: Some scammers will not mention fees like appraisal fees, credit check fees, etc., upfront and include them in the total cost in such a way that it becomes difficult for you to realize that you are being charged unreasonably. To prevent getting scammed, you must ask the lender to provide you with a detailed breakdown of all the costs associated with your home loan.

*Lock your rate when market rates are high: Generally, there is a lag between the time you submit an application for the loan and when the interest rates are locked. Fraudulent lenders will misguide you to lock the rates when market rates are high claiming that they will rise even further. But in reality, the market rates will fall soon. So, you must check the market rates yourself before locking the interest rate on your loan.

When you’re obtaining a mortgage from a particular lender, check the ratings given to it by the Better Business Bureau (BBB). Lenders with high BBB ratings are generally reliable and offer good quality service.

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.

A fraud can be uncovered in a number of different ways. A good example is by a whistle blower who who might inform his managers that a colleague has been fraudulently stealing from the company. Such a corporate fraud will need to be investigated in order to prevent further losses, find out how it happened in the first place and to try to recover the stolen assets. Other frauds come to light when business owners review results at the end of an accounting period and discover that something is amiss. Frequently a fraud will only come to light when a company enters insolvency proceedings and is subjected to the scrutiny of the Insolvency Practitioner. Sometimes it might be the fraud that has caused the company to fail.

A specialist fraud investigator is needed when financial anomalies are discovered and it is very common for the victim company to enlist the assistance of a qualified forensic accountant experienced in fraud investigation. Such a person will be accredited to investigate a fraud and may be a Chartered Accountant or a Certified Fraud Examiner with possibly other qualifications – together with many years of experience dealing with such fraud cases.

Every fraud is different. There are different characteristics to be found between bank fraud, supplier fraud and mortgage fraud. Even within these categories there are many possibilities because the fraudster is very resourceful in seeking out new and different weaknesses in a business. Therefore, one of then most important attributes a good fraud investigator can have is a flexible approach, an inquiring mind and a tenacious approach to the work he specialises in.

Rather than jumping feet first into an investigation the fraud investigator will approach the corporate fraud by first determining what the victim organisation wants to achieve. The last thing a publicly quoted company will want is adverse publicity as this might affect its share price badly. Therefore, there may be constraints on the scope of any investigation and the victim might be prepared to accept a lesser solution to its problem rather than receive the publicity.

Normally the priority will be to get the money back or the victim company might want to make an example of the fraudster as a lesson to others. If it only wants to get its money back it may not want law enforcement involved. A police fraud investigation might disrupt the business or cause its reputation to be damaged and there is no guarantee that the business will achieve any of its own priorities. For example a bank might want to sack the employee and stem the leak of losses, and not want the general public to know that it had allowed a fraudster to work in its midst.

The forensic accountant or certified fraud examiner (a member of the Association of Certified Fraud Examiners) will want to agree the desired outcome of the matter with management and develop a fraud investigation strategy based upon the organisation’s own fraud response plan. It may be possible to interview the whistle blower early on to get a quick “heads up” into what was going wrong before beginning a detailed analysis of the accounting records, interviewing staff and making other expensive enquiries often outside the organisation. In some circumstances it may be necessary to carry out a preliminary covert fraud review, in the evening or during the weekend when employees are not present.

For the actual mechanics of the investigation the forensic accountant will most likely want to follow the trail of the stolen money. “Follow the money” will be the primary goal in such a forensic audit as this will provide not only a chance of getting the money back, but also evidence of why and how the fraud took place.

The losses need to be quantified exactly, with evidence showing how they occurred. In a fraud, this evidence is crucial as the complexity of financial transactions can obscure what has happened and cause the matter to become protracted. If the victim is unable to demonstrate the loss clearly, the perpetrator is more likely to escape punishment or having to return what he has stolen. Any forensic accountant’s report must be able to distill the facts and demonstrate the problem in a simple and coherent way.

This is because the expert accounting evidence must be presented clearly, for use in negotiations, arbitration or otherwise used in litigation. It may also assist in any criminal action that might take place, either alongside the civil fraud investigation or in response to a report submitted after the forensic fraud investigation. Sometimes, the police will not investigate a matter unless there is a clear presentation of the situation such as normally produced during a forensic examination of the accounting records following a fraud.