For years now the mortgage and real estate closing process has been largely viewed by some banks and lawyers as nothing more than a glorified signing party. Concerns about fraud, infidelity and negligence on the part of closing agents and the other professionals who play a part settlinga transaction have been voices in the wilderness. This has been true despite the fact that the concept of wiring funds to a closing agent who is largely unvetted, and allowing strangers to handle mortgage documents and disbursements without uniform standards seems counter to prudent business practices.
Today title underwriters, who have been primarily self-insured, have seen claims rise, profits dwindle and lawsuits by lenders and consumers stack up at courthouses around the Country. Eight Billion Dollars in damages from mortgage fraud have created a firestorm that the title industry simply cannot extinguish. Consequently, any notion that title underwriters can continue allow agents to bind them for acts of negligence and infidelity by closing agents requires radical readjustment and new thinking. Likewise mortgage lenders and consumers cannot continue to rely upon the closing protection letter as a form of insurance against losses from mortgage fraud. Quite frankly it is time for the title companies and their issuing agents to get out of the insurance business and for lenders to utilize third party sources for underwriting and insuring risks at the closing table.
It's All In the Numbers
Anyone connected to the mortgage and real estate industries is familiar with the numbers, but they are worth a reminder. The FBI has called mortgage fraud the number one white collar crime in America, and after terrorism has allocated more agents nationwide to investigating and fighting the crime than any other.
According to US Census Bureau statistics there are 5 Million existing home sales each year, another 6.5 Million new construction sales every year, and roughly 8 Million refinances that take place. The average loan size is approximately $175,000.00. Each of these loan transactions require a closing attended by a settlement agent, so that means that in 2008 lenders delivered about $350 Billion into the hands of settlement agents whom, for the most part, they met for the first time a few days before a closing.
In 2001 there were 4,696 reported cases of mortgage fraud resulting in losses of $769 Million, and by 2004 the number of cases had risen to 18,391 while losses grew to $885 Million. (FBI and Treasury Department Averages). Last year there were more than 60,000 cases of mortgage fraud reported to the FBI and they cost lenders an estimated $8 Billion. Since not all fraud is reported (not all federally regulated institutions file the mandated SARS reports and state regulated lenders have no such obligation) we can assume the actual loss numbers are much higher.
Fraud at the Closing Table
While fraud can take place in any part of the loan process, lenders are most at risk at the closing. Settlement agents, who are responsible to disburse the lender's money and to collect and record the deed, note and mortgage, are traditionally subject to little or no scrutiny. Agents can steal funds, aid fraud at closing or look the other way. Common examples the author has investigated have included instances when an agent documented non-existent buyer cash to close, permitted same day property flips, and when funds were accepted or disbursed to or from third parties not identified to the lender as formally connected to the transaction. Settlement agents can also act negligently, by failing to obtain the properly signed note, or to record the mortgage, thereby creating significant liability for lenders. Since settlement agents, including lawyers, are not legally required to carry liability insurance or fidelity bonds, and there is no standardized process in place to verify insurance coverage when a party to the closing does require it, lenders and consumers can have no faith they will recover their losses resulting from negligence or bad acts by settlement agents at closings. In the past lenders have taken the risk associated with the unregulated and unsupervised nature of the closing process because losses from fraud at closing had historically been a small percentage of overall mortgage fraud damages. That is why most lenders focused whatever spending they could allocate to fraud deterrence on front end fraud software, such as social security number verification, automated appraisal reviews and similar products. According to the National Mortgage Bankers Association, lenders spent approximately $1 Billion on fraud deterrent software to use in the origination and underwriting process in 2005 and 2006.
No one has done a real analysis of closing fraud loss figures in the past, but the author has spent the last several years focusing on the losses from closing fraud and has segregated the data after a careful analysis of public records, including reports of arrest and indictments and civil lawsuits involving claims of negligence and fraud by settlement agents.
According to the author's statistics, fraud at the closing represented 10-15% of the total losses experienced by lenders during the years from 2001-2007. In 2007 these losses totaled approximately $650 Million. Some highlights from the author's personal files of reported closing fraud activity include:
A Pensacola, Florida attorney who was disbarred and imprisoned in July 2007 for stealing more than $500,000 in mortgage proceeds;
A Missouri attorney who pled guilty in December 2007 to defrauding several banks out of $866,810.00 in mortgage proceeds through a series of fraudulent transactions with multiple conspirators;
A Florida closing agent sentenced in January 2008 to three years in prison for paying more than $1.2 Million in closing funds to co-conspirators without the bank's knowledge and authorization;
A Vermont title company owner pled guilty in Federal Court to fraud in diverting some of the proceeds of several mortgage loan closings to a co-conspirator costing the bank $250,000;
A group of Arizona real estate professionals, including a real estate broker, mortgage company loan officers and closing attorneys entered into a plea deal in April 2008 involving $4 Million in mortgage fraud damages to various lenders;
and A Montana real estate attorney was sentenced in Federal Court in October 2008 to four years and two months in federal prison without parole, and was also ordered to pay $866,810 in restitution for defrauding a bank by conspiring with others on fake contracts of sale to purchase properties.
The Inadequacies of the Closing Protection Letter
Other than faith in law enforcement, what can a lender do to reduce the risk of loss due to fraud or negligence at a closing? Every day when lenders wire millions of dollars into the trust accounts of attorneys and non-attorney settlement agents they have historically relied on the closing protection letter issued by title underwriters, through their agents, to seek recovery for their losses. These letters though provide no relief when a settlement agent engages intentional acts nor when an agent's negligence fails to rise to a non-curable cloud on title. Unrecorded mortgage?, the letter provides coverage against intervening liens. Fraudulently recorded cash to close on the HUD-1 in a straw buyer, fraud for profit scheme? As long as you can still foreclose, no coverage and no claim for lost interest or principal payments on the loan, cost to foreclose, cost to repurchase (i.e. premium recapture), etc. In the State of California, case law even supports the proposition that a closing agent has no legal or contractual obligation to report fraud at the closing even where the agent may personally witness suspicious or even fraudulent activity taking place.(1) In 1999, in Vournas v. Fidelity National Title Co., the California Court of Appeals held that settlement agents have "no duty to police the affairs of a lender," and have no obligation to "report fraud." Similar results were reached in the California decisions found in Axley v. Transnational Title Ins. Co. and Lee v. Title Ins & Trust Co.
In reality a closing protection letter does not act as an insurance policy against mortgage fraud at the closing table, and lenders are foolish to rely on them except as they apply to the validity of their lien. Furthermore, there is no national standard for issuing closing protection letters, which are typically issued by title agents and who, because of business relationships with settlement attorneys and others, have a conflict of interest in evaluating their credentials. As a result, lenders have had no real comfort in the existence of these letters as a method of evaluating the experience, trustworthiness, and reliability of the agents who will handle their funds and documents at a closing. Similarly, most lenders have had no standard policy for reviewing and verifying CPLs, not just for their validity (i.e. were they properly issued), but also to verify the credentials of those to whom the letters were issued.
Fannie Mae's Recommendations Have Largely Been Ignored
Fannie Mae's December 2005 Newsletter on "Preventing, Detecting & Reporting Mortgage Fraud" states in part that "mortgage lenders must know [their] business partners and consider using outside sources to and selectively choose closing attorneys and settlement agents." The guidelines were issued over three years ago, yet even today there are few lenders who are following this sound advice. Lenders for the most part have no comprehensive program to verify settlement agent credentials, and no one from the national or state bar associations, notary association, or title agents association have stepped forward with any guidelines or requirements for certifying the qualifications of the people who control the loan documents and mortgage funds at closings nationwide.
Without a new method of certifying the credentials of settlement agents and insuring them for both fraud and negligence at closing, there is no reason for lenders to continuing relying on the current closing protection letter as security for the proper coordination and execution of the mortgage loan closing process.
A Solution: Certification & Uniform Standards
One solution would be to take the vetting process away from lenders and the insurance responsibility away from title underwriters and their agents. Instead allow third parties to perform independent scrutiny and certification of settlement agents and on the basis of their risk evaluation, offer a new form of closing protection that involves fidelity and negligence coverage for the agent for the benefit of the lender, the borrower(s) and the title underwriter.
Lenders control closing funds so they have every right to demand the criteria for making those funds available at closing by requiring settlement agents meet certain minimum levels of experience, insurance and overall reliability. Shining a light on the closing process, and those who work it, can go a long way toward weeding out the bad operators. It will also help define a better process for the honest and orderly execution and recording of loan documents, as well as the proper and ethical management of mortgage loan funds.
Title underwriters, who are under siege from lawsuits attempting to validate claims for losses under the closing protection letter, need someone without their claims legacy to replace the current self-insured environment with a sensible product that combines fidelity and negligence coverage in one package. Title underwriters and their agents need to get out of the business of insuring the acts and omissions of settlement agents as they have allowed the closing process to be subject to unacceptable risk for far too long. Lenders who never read their closing protection letters until the past two years, would welcome real protection from closing fraud backed by standards that give some comfort whenever the lender wires funds to a closing table.
Settlement agents, including real estate closing attorneys, must wake up and realize that the closing process is not one left to last minute preparation, or to be entrusted to paralegals and legal secretaries. The Bar has already seen disciplinary decisions holding lawyers responsible for everything that transpires at a closing, and to be diligent to uncover and report fraud. See for example, NJ Ethics Commission Matter, In re Sonia Harris, 2001. Real estate closings, once deemed a "meat and potatoes" area of practice, has suddenly become a minefield for fraud and enormous potential losses for lenders. As a consequence real estate lawyers, and all settlement agents whether or not they are members of the bar, must expect heightened scrutiny and new criteria for evaluating their ability to perform the important function of acting as a gatekeeper on behalf of lenders in their ongoing battle against mortgage fraud.
Public Expects It, CFPB May Soon Demand It!
An overwhelming majority of respondents believe that only attorneys should be permitted to act as settlement agents, that the attorneys should be more carefully regulated, and that providing for their independent certification based on criteria including experience, is essential to establishing public faith in the process. Furthermore, 87% of those polled are in favor of a new type of insurance covering negligence and bad acts at the closing, with 84% are willing to pay for it as a closing cost. Perhaps most important to the mortgage industry, 70% of those polled believe that with improvements such as additional protections from fraud at closings, lenders can re- build the public's trust in financial industry without government intervention. Faced with highly publicized plans for nationalization and heightened regulation by politicians in Washington, banks might want to take the hint and start initiating new safeguards and self-regulation programs on their own, such as those proposed in this article to address closing fraud. After decades of allowing the title industry to regulate risks at closing it's time for lenders to seek a more independent and reliable source of protection from closing fraud.
The new Consumer Financial Protection Bureau, ever vigilant to protect consumers from the negligence, malfeasance and overall inadequacies of the mortgage process, will likely be looking closely at this issue. It is much better for the industry to self-police and adjust now, for the best interests of all parties, rather than face mandates and additional regulation and oversight for failing to act.