John H. Kleindienst
How the Harris County DA’s Office investigates cases of mortgage fraud
By now most of us have heard about mortgage fraud as it sweeps across the great state of Texas and our nation. Most investigators dread the thought of dealing with the mountains of paper evidence that a mortgage fraud case involves, but as Texas peace officers, we must do our best to investigate mortgage fraud so those involved will be held accountable for their crimes. Methodically examining the paper transactions for false information and distilling the results into a case that can be presented and properly handled by a jury is the key.
What is “credit for sale” mortgage fraud? Generally, it is the use of any false or misleading information or documentation to obtain a loan to purchase real estate. For the most part, people commit mortgage fraud to obtain a large sum of money in a very short time. However, a small number of people get caught up in pursuing “the American dream” of making money, and they get sucked into what they thought was the opportunity of a lifetime—but is really fraud.
Our office receives telephone calls alerting us to possible cases of mortgage fraud weekly; these calls come mostly from the Texas Department of Saving and Mortgage Lending and from “straw buyers”—people who have been talked into helping with a fraud scheme but are left holding the bag (more on them later). Our goal is to investigate the cases that involve a large number of properties that are flipped by a so-called investor. We must stop the large volume of flips to bring it under control in the shortest time possible. Our office investigates 35 to 45 large cases a year, and lately that number has increased.
Participants in mortgage frauds are typically the investor, buyer, real estate agent, mortgage broker, appraiser, and title company. Here is a general outline of how a mortgage fraud takes place.
Anatomy of mortgage fraud
1) An “investor” locates a target property and purchases it at or near market value, say, $250,000.
2) This “investor” obtains a false, vastly inflated appraisal of the property for, say, $500,000, from a crooked appraiser in cahoots with the “investor.”
3) A “straw buyer” is recruited with promises of no financial responsibility for the deal or the property and payment of an upfront lump sum payment, say, $10,000. This person is usually a bystander who is unaware of the fraudulent scheme but probably should know better because of the promise of quick money.
4) Closing occurs with the “straw buyer” purchasing the home at the (falsely) inflated price. The closing documents generally contain a variety of false statements: The “straw buyer” may lie about his income and expenses, his marital status, and his intent to occupy the house as his primary residence.
5) The lender funds the purchase to the “investor” and issues the loan to the “straw buyer.”
6) The “investor,” as the seller, receives the proceeds of the transaction ($500,000) with a net profit of $250,000.
7) The “investor” may or may not pay the promised amount to the “straw buyer.”
8) The “investor” drops out of sight after a few months of making the mortgage payments or trying to lease the house to a renter.
9) The lender seeks payment from the “straw buyer” when the monthly mortgage payments become delinquent, but the buyer can’t afford the payments or sell the house because its value was vastly inflated.
10) Foreclosure sale of the property at rock-bottom price.
Who is affected by mortgage fraud?
Everyone! Foreclosures lead to instability in America’s financial markets as mortgage-backed securities fail to perform. The inflated sales prices increase the property taxes we pay for our own homes. Your county appraisal district typically uses the sales price of real estate in your neighborhood to determine your home’s appraisal value. If you live in a neighborhood where mortgage fraud is occurring or has happened in the past and the property value is inflated, your property value in turn will rise and you will pay higher property taxes based on the falsely inflated value. As the mortgage fraud scheme unravels, lenders are left holding a large number of inflated home loans, and suddenly no one is making the payments. The lenders will try to get rid of those houses and are willing to sell them at a price below the going market rate.
One direct result of lenders taking large losses in their investments are fluctuations of returns for entities, such as our retirement accounts, which are invested in the mortgage industries. And finally, a legitimate homeowner in a neighborhood where houses were purchased through fraudulent transactions and then sold at severely reduced prices will have to sell at a price lowered to compete with those foreclosures and fire sales—possibly at less than the honest buyer originally paid. These are just a few of the ways mortgage fraud affects us all.
Obviously, an “investor” who buys a $250,000 home from a legitimate seller and sells the same home in a matter of days for $500,000 is interested in making a large sum of money in a short time. The “straw buyer” is typically a hard-working person who believes that he is being presented with his big break. The sales pitch from the “investor” to the straw buyer goes something like the following:
“My investment company has been buying a lot of houses that are for sale below the market value. Right now we are asset-rich but money-poor from buying all of these houses. Do you have good credit? If you do, I am willing to help you buy one of these below-market homes at the true market value, which we will have appraised. I know all the people at the real estate office, the appraiser, the mortgage broker, the title company, and the insurance company. I will make sure everything is handled, including the down payment and closing costs. I will be with you throughout the whole process. After you buy a house, I will give you your equity money upfront. I will make the monthly payments, pay all the taxes, take care of the property maintenance, and rent the property out. We’ll hold onto the property until the market value increases, and then we’ll sell. I’ll pay you the original price you paid, minus the equity you received upfront and any other fees I had to pay.”
The straw buyer, swayed by the possibility of making a lot of money for nothing, ignores the warning that “if it looks too good, it is probably not real” and agrees to the deal. I have seen educated and experienced people, including a law enforcement officer, fall into the trap: The home is purchased at a price that is vastly inflated (a crooked appraiser helps here), the straw buyer’s upfront costs are handled by the “investor,” the mortgage company funds the new loan to the buyer, and all appears to be well. However, the “investor” eventually doesn’t make the monthly payments, skips out on property taxes and maintenance, and the property is never rented out. The mortgage company looks to the straw buyer left holding the bag, and the home ends up in foreclosure due to non-payment. Guess whose credit is trashed?
Mortgage fraud of this type requires two separate real estate transactions: 1) the legitimate or good sale, and 2) the mortgage fraud or “flip” sale. Contact all of the following people to obtain their records for the property you are investigating. These records are full of valuable information.
Here are the common property transaction documents and mortgage industry acronyms
1) Settlement Statement: HUD 1
2) Uniform Residential Loan Application: 10-03
3) Verification of Employment: VOE
4) Verification of Rent: VOR
5) Verification of Deposit: VOD
6) Occupancy Affidavit
7) Marital Status Affidavit
8) Title Policy
9) Residential Sales Contract
10) Assignment of Rights and Notification, and
11) Special Warranty Deed
Examples of all of these documents are on www.tdcaa.com; just search for “mortgage fraud.” As you examine the documents listed above, look for the following indicators that point to potential mortgage fraud:
1) Fax cover sheets. Are the company names different but show the same address and telephone numbers? It is highly suspicious to have entities such as a property management company, an employer, an investment company, a home remodeling company, and a mortgage company all using the same style of fax cover sheet, telephone number, and fax number.
2) Fax headings on documents. Look for fax headings from the same company where the dates and times do not fit the purchase time period—these are caused by cutting and pasting efforts to create documents.
3) Signatures. Do they appear to be signed by the same individual? I have found signatures for the seller and buyer that were clearly generated by the same person on almost every document for one transaction.
4) Correction fluid (Liquid Paper or Wite-Out). Look for documents in the mortgage broker and title company files that have been changed by using correction fluid, photocopied, then marked “original.”
5) Cut-and-pasted items. I have found title polices, bank statements, and financial statements that were cut and pasted or scanned and then altered by computer.
6) HUD 1. Examine this document for all dates and fees paid POC (Paid Outside of Closing—beware because fraudulent transactions will often list a lot of POC costs that are not legitimate), and what fees the seller and buyer paid. Is the earnest money recorded on this document? Did the buyer have to pay any money at closing? Did the “investor” attend the closing? Did the seller sign before or after the buyer? Who selected the title company? Item No. 210, for example, in mortgage fraud cases, typically shows a zero amount which is incongruent with the earnest money listed in the sales contract. This payment with the sales contract will often be done with a bogus check. Also, watch for a HUD 1 with no costs due for the seller; this will happen where the seller is taking credits for items such as taxes that should be paid at closing but are not.
7) Compare all documents. Is the information the same on all the documents (i.e., the 10-03 from the broker or title company compared to the 10-03 from the lender?) This is where to look for any changes made to the documents by comparing them to documents from other sources.
8) VOE. Is the information and income correct? Call the phone number on the VOE to verify information such as employment dates, salary, and whether the person who signed on behalf of the employer really exists.
9) VOR. Is the information and monthly rental fees correct? Call the phone number on the VOR to verify the information provided such as rental dates, rental amount, and whether the person who signed on behalf of the company exists.
10) VOD. Compare the bank records. Does the deposit and/or bank account balance match? Call the phone number on the VOD to verify the information provided such as account number, account holder, and whether the person who signed on behalf of the bank exists.
11) Occupancy Affidavit. Which box is marked: primary, secondary, or investment property? Typically the straw buyer marks the “primary residence” box but never intends to move into the property.
12) Marital Affidavit. Is the buyer married but shows himself to be single so his wife will not have to sign the closing documents? In my experience straw buyers frequently indicate they are single and never inform their spouse about their purchase.
13) Title Policy /”Schedule A”. See how the property is conveyed from the seller to the buyer (“investor” as Trustee/ Assignee for Mr. Seller, which is typically done when the “investor” actually has not taken title of the property yet). In many mortgage fraud cases, the title policy has been altered on “Schedule A” after it was issued, either by correction fluid or cut-and-paste.
14) Sales Contract. Does it show earnest money being deposited with the listing agent? If so, check for a receipt and a copy of the check. Did any of the agents discount their commission? Frequently the sales contract will show earnest money paid by the buyer, but it was never actually paid or was done with a counterfeit check. The buyer’s agent gave a 2-percent rebate to the buyer after closing and the agent was then paid by the seller.
15) Assignment of Rights and Notification. Has this document been filed with the County Clerk’s Office, and if so, when? In fraud cases an Assignment of Right and Notification is typically used but is never filed at the County Clerk’s Office.
16) Special Warranty Deed. If a home is sold by the lender due to foreclosure, the lender typically issues a Special Warranty Deed. Why was this document used rather than a General Warranty Deed? Was the deed recorded with the county clerk? Whose name is on the deed? In a small number of mortgage fraud cases the seller never conveys the property to the buyer. On a legitimate transaction, a General Warranty Deed is issued to the buyer.
A sampling of fraudulent documents such as those described above are available on the TDCAA website at www.tdcaa.com. Search for “mortgage fraud.”
It is important to remember that the people involved in mortgage fraud have access to computers. My investigations have uncovered bogus bank statements, W-2 and 1099 forms, tax returns, rental contracts, VOEs, VORs, and VODs that were produced via the computer. Those involved in mortgage fraud will do whatever it takes to get the loan funded.
You’ve unearthed fraud—now what?
What happens after you have gathered all the above documents, examined them, and discover that mortgage fraud has occurred? That mound of paperwork is not the end of the job. The next step is to prepare flow charts and spreadsheets to condense the volume of documents and demonstrate how and where the fraud occurred. If you are lucky enough to have a financial analyst in your office, this part is his job.
Finally, it is time to present your investigation to your assistant district attorney who will decide what offense and which participants should be charged. Consider the following violations of the Texas Penal Code:
(1) §32.32, False Statement to Obtain Property or Credit.
(2) §34.02, Money Laundering.
(3) §71.02, Engaging in Organized Criminal Activity.
Do not forget the Code of Criminal Procedure, Chapter 59, Forfeiture of Contraband, which is an effective way to stop the criminal enterprise. When you locate the bank accounts of those involved in mortgage fraud or any other criminal activity, you should file a court order to seize them, as they hold the profits from the criminal enterprise and could ultimately be awarded to your office for use in future investigations.
The following departments and/or agencies have assisted with expert opinions and witnesses:
• Texas Department of Savings and Mortgage Lending, www.sml.state.tx.us
• Texas Real Estate Commission (TREC), www.trec.state.tx.us
• Texas Appraiser Licensing and Certification Board (TALCB), www.talcb.state.tx.us, and
• the lender.
Use the following to obtain information and/or certified documents as evidence:
• Comptroller of Public Accounts—Corporation Search and Certification of Franchise Tax Account Status, www.window.state.tx.us
• Secretary of State—Corporations and Filing Searches, www.sos.state.tx.us
• The District Clerk’s Office—Civil Lawsuits, naming your targets.
• The County Clerk’s Office—Real Property Records for all suspect properties and assumed names for all of your targets.
It is easy to look at mortgage fraud cases and think that they are just too overwhelming to handle. Begin at the beginning and be methodical in your examination. Try to prove that it is a legitimate transaction and you will begin to see the discrepancies. Do your best—we owe it to our profession, our district attorney, and the prosecutors who present our cases in court, but most of all, to the citizens of the great state of Texas.
Editor’s note: In the 80th Regular Session, the Texas legislature passed HB 716 to combat mortgage fraud. Among its many changes, the bill increased the statute of limitations on money laundering and false statement to obtain credit from three to seven years. See CCP art. 12.01 for more information.
Entities to contact
The legitimate sale
Original seller: what was property worth and what was the list price. A common response is “$500,000! I couldn’t get $260,000 and took the offer of $250,000.” Did the seller meet the buyer? Where and how? Were real estate agents involved? What title company?
The title company: a copy of its General File, aka “GF Number,” including copies of all checks and/or wire transfers involving the property in question.
The real estate agents/brokers: both the seller’s and buyer’s agents. Get copies of the listing, all contracts, and earnest money checks.
The mortgage fraud/flip sale
The lender: usually this file will contain most of the records listed below. Compare these documents with others you obtain from other sources.
The title company: a copy of the General File, aka “GF Number,” including copies of all checks and/or wire transfers involving the property in question.
The real estate agents/brokers: both the seller’s and buyer’s agents. Get copies of the listing, all contracts, and earnest money checks. In some cases you’ll find the real estate agent creates a new listing to increase the sales price to accommodate the inflated false appraisal.
The mortgage broker: get all of her records. This is where you will find the largest number of fraudulent documents.
The title insurance company: a copy of the title insurance to the property.
The appraisal: from the appraiser or the lender’s file. It will show the inflated property value. Look at the comparable appraisals from the same neighborhood, construction, and home size.
The county appraisal district: these records document property values through the years and prior ownership. Compare these values to the value on the fraudulent appraisal. You can also compare the values of surrounding properties.
The county clerk: pull each deed, lien, assignment, or any other document filed in this office for the property.
All bank accounts: belonging to the person(s) involved in the mortgage fraud. Follow the money trail and you’ll find any others who are involved.