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States Take Action to Combat Mortgage Closing Fraud
By Elizabeth C. Yen (Admitted in Connecticut only)

Recent state developments indicate a heightened attention to various ways of reducing the risk of mortgage-related fraud, including the risks that mortgage loan settlement agents or their employees will misappropriate mortgage loan proceeds or that mortgage loan proceeds checks and funds transfer authorizations will be dishonored post-closing.

For example, Maryland recently amended its title insurance producer statutes to require licensed title insurance producers to exercise control over funds entrusted to them when they provide escrow, closing, or real estate settlement services. (See Maryland Chapter 361 of the Acts of 2009, Senate Bill 86, generally effective June 1, 2009.) With limited exceptions (primarily for funds entrusted to law firms and title insurance companies), persons with signing or disbursement authority over such trust funds in Maryland, and persons with authority to approve wire transfers of such funds, must be licensed title insurance producers. This Maryland legislation helps make title insurance producers more directly accountable for misappropriation of mortgage loan proceeds that might be facilitated by non-licensed employees of title insurance agencies. The legislative history indicates that the Maryland Insurance Administration (MIA) investigated a significantly larger number of complaints against title insurance producers in 2008 than in prior years (the 496 title insurance-related complaints investigated by the MIA during the first 11 months of 2008 exceeded the total number of such complaints investigated by the MIA in the years 2005 through 2007 combined, and accounted for over 70% of all complaints investigated by the MIA during 2008). The MIA found instances of mismanagement or misappropriation of escrow funds totaling more than $5 million in 2008.

Regrettably, access to trust accounts holding mortgage loan proceeds, whether by licensed title insurance producers, lawyers, or title insurers, will inevitably occasionally create irresistible misappropriation opportunities that no amount of legislation or regulation can completely prevent. For instance, a former assistant treasurer of the Connecticut Attorneys Title Insurance Company (CATIC), pled guilty in 2003 to embezzling over $2 million from her employer between 1998 and 2000 to help cover the costs of constructing an ice arena co-owned by her and her then husband. Additionally, in 2006, a Connecticut lawyer pled guilty to embezzling over $600,000 from his clients’ trust account to cover credit card debts largely incurred as the result of gambling. The U.S. Department of Justice press release for this matter indicates that CATIC reimbursed a portion of the embezzled funds (presumably because the lawyer was an approved agent for CATIC and covered by an insured closing letter issued by CATIC to various mortgage lenders on his behalf). Neither of these occurrences would have been prevented by legislation such as that recently enacted in Maryland.

Taking another approach to strengthen the legitimacy and availability of mortgage loan proceeds, Indiana recently enacted a law generally requiring funds of $10,000 or more entrusted by a party to a title insurance producer to take the form of a wire transfer or automated clearing house or similar funds transfer – all such funds must be unconditionally and irrevocably credited to an account of a licensed title insurance producer. This legislation was apparently requested by the Indiana Association of Realtors, Indiana Land Title Association and representatives of the mortgage lending industry, in large part due to the increasing prevalence of counterfeit bank checks that might initially be processed and paid, but that will eventually be dishonored and reversed (potentially several weeks after the closing has occurred).

Interestingly, this Indiana legislation would not have stopped one recent mortgage fraud conspiracy involving over 100 fraudulent purchase-money mortgage loans, and totaling over $12 million, on properties located in the Indianapolis area. An August 2009 Department of Justice press release, announcing indictments against Robert A. Penn and Kevin M. Lafavers in connection with this scheme, indicates that “false loan applications, appraisals, and other fraudulent documents were … submitted to the lenders. The lenders, relying upon the false statements in the loan packages, issued the loans. The loans were funded via wire transfers of money from the lenders to a title company, which the scheme participants used to assist them in preparing false closing documents and issuing title company checks. At the time the loans closed, the properties sold for the fraudulently inflated sales price, and the fraudulently obtained loan proceeds were shared by scheme participants. The sellers were paid the amount they had negotiated to receive, and the co-conspirators shared the excess proceeds.” October 2009 press reports indicate that Mr. Penn and Mr. Lafavers have pled guilty to wire fraud; as part of Mr. Penn’s plea he apparently admitted to fraudulently buying over 130 properties for a total of over $16 million. The government estimates the fraud loss to mortgage lenders in this case to be $6.9 million.

Meanwhile, recent state S.A.F.E. Act legislation and the Nationwide Mortgage Licensing System (NMLS) may make it easier for states to disapprove a mortgage loan originator’s license application if another state has previously disapproved the originator’s application for cause. For example, the Connecticut Department of Banking (the Department) disapproved a mortgage loan originator’s license application in August 2009 for failure to disclose a 1990 Connecticut criminal conviction for one felony count of credit card theft, and two felony convictions (one in 1987 and one in 1991) relating to possession of narcotics. In addition, the applicant failed to disclose convictions for 22 misdemeanor larcenies between 1982 and 1993. (This application would have been denied even if these criminal convictions had been fully disclosed by the applicant, since the S.A.F.E. Act generally precludes individuals convicted of felonies involving fraud, dishonesty, or breach of trust from being licensed as mortgage loan originators. A license application also may be denied if the applicant fails to demonstrate “financial responsibility, character and general fitness so as to command the confidence of the community and to warrant a determination that the mortgage loan originator will operate honestly, fairly and efficiently.”) The Department similarly denied a mortgage loan originator license application in March 2009 because the applicant failed to disclose two 1996 convictions for attempted murder. The NMLS facilitates the sharing of information about the status of mortgage loan originator applications among the various states, so the results of the Connecticut criminal history investigations undertaken by the Department could potentially be used by other jurisdictions as a basis for declining license applications from these individuals in the future.

Similarly, the National Insurance Producer Registry (established in 1996 by the National Association of Insurance Commissioners or NAIC) may help states share information about title insurance producer license applicants. In an attempt to standardize how state insurance regulators will treat criminal histories of such applicants, the NAIC recently issued guidelines concerning the impact prior criminal convictions should have on a license application. These guidelines supplement NAIC’s previously issued guidelines to state insurance regulators concerning 18 U.S.C. Section 1033(e), which generally requires individuals who have been “convicted of any criminal felony involving dishonesty or a breach of trust,” or of a federal offense involving the business of insurance, to obtain the specific “written consent of [the] insurance regulatory official authorized to regulate the insurer” pursuant to Section 1033(e), as a condition of engaging “in the business of insurance or participat[ing] in such business.” (An individual convicted of a felony covered by Section 1033(e) who participates in the business of insurance without obtaining the required written consent from the appropriate insurance regulator is committing a new felony under Section 1033(e).)

These and other multi-pronged state efforts at tightening individuals’ access to mortgage loan proceeds, combined with industry’s own self-help anti-fraud measures, should help reduce mortgage fraud, although the compliance costs associated with these measures will inevitably be passed through to consumers.

Elizabeth Yen is a partner in the Connecticut office of Hudson Cook, LLP. Basis Points readers can reach Elizabeth at 203-776-1911 or by email at eyen@hudco.com.

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