Real estate mortgage schemes, foreclosure activities, equity stripping and fraud are booming. Individuals mastermind multi-tiered structures designed to hide participants or obfuscate relationships. They often have intentionally incomplete or poor financial records. These cases ordinarily involve desperate or opportunistic actions by very bright individuals, all connected by ambiguous documentation and well-hidden trails. As a result, the research, discovery, assessments, valuations and case preparation can become extremely complex.With the advancement of technology, new avenues for fraud, criminal behavior and outright negligence are surfacing. Now e-mail, cell phones and electronic monitoring systems provide volumes of information that can be used to discover the “smoking gun” in fraud cases. Using this electronic data and other hard-copy archives, the forensic investigation team, working closely with case attorneys and clients, sift through enormous volumes of documents to identify the possibility of fraud, financial reporting negligence, “cooked books” or other potential corruption.
Bankruptcy is an area that is ripe for fraud. There is often great incentive for unscrupulous individuals to fail to disclose their assets to the bankruptcy court. There are many schemes that the bankruptcy debtor may use to hide assets.
Some of the fraud schemes we have recently investigated include the following.
FICTITIOUS ENTITIES
A buyer at a foreclosure auction can purchase a property, create an entity name out of thin air and then claim to be the “agent” for the fictitious entity. Since no one is required to verify the existence of the entity purchasing the property at foreclosure, the buyer’s true identity is hidden. In cases where the buyer is in bankruptcy and has used undisclosed bankruptcy assets, this method serves to hide those assets. The entities are fictitious because they:
* Have no substance;
* Do not maintain books and records;
* Do not have bank accounts;
* Do not file tax returns; and,
* Do not have EIN numbers.
In essence, these entities are mere shells created to defraud the bankruptcy creditors.
‘OFF-BOOK’ TRANSACTIONS
Foreclosures require significant amounts of capital. Real property is comparatively expensive to purchase, generally requires extensive renovations to put into a condition to sell or lease, and may need to be held for significant periods of time. Those attempting to hide assets must retain access to the real estate market and banking systems, and often facilitate banking entries to minimize disclosure.
Individuals can effectively hide undisclosed bankruptcy assets and continue to operate in the foreclosure market in any of the following ways:
1. Bankruptcy assets laundered through a title/settlement company. One way for a foreclosure purchaser to disguise property ownership is to find an accommodating title/settlement company. If the same real estate title/settlement company is used to close successive transactions, the proceeds from the sale of one property can be “joined” to, and used for the purchase of the next property. This allows the bank accounts of the title/settlement company to be used for a multitude of transactions, thus obscuring the origin of a significant amount of undisclosed bankruptcy assets.
There have been instances where the same title/settlement company conducted settlements for hundreds of properties owned and controlled by a single family using a multitude of fictitious entity names. Properties worth millions were hidden from judgment creditors, the bankruptcy trustee and taxing authorities.
In these situations, the title/settlement company’s bank account could be used to direct disbursements from the sale of properties to further obscure the source of the funds. Payments such as the following could be made from the bank account of the title/settlement company:
* Payment of personal expenses such as credit card bills and medical bills;
* Transfers to friends or family members with no assignment by the seller;
* #Transfers to bank accounts created in the names of other fictitious entities or “straw buyers/sellers” that disguise the owner of the account; and,
* Payments converted to cashier’s checks made payable to cash, money orders, or cashier’s checks in other denominations.
2. Deeds of trust. Fictitious deeds of trust can be used to facilitate fraud in real estate transactions. For example, property could be conveyed to a straw purchaser while a simultaneous fictitious deed of trust is given to a third party. If a deed of trust is executed for the value of the property, the holder effectively owns the property despite the fact that their name is not on the deed. If left unrecorded, the holder’s name is not recorded in the public land records.
But an unrecorded deed of trust has no priority and can create problems. As a result, ownership is often further obscured through the use of a fictitious entity name on the deed of trust.
Another approach is to make the note and deed of trust payable to someone who is not in bankruptcy. This allows the property to be controlled despite the fact that the deed of trust does not reflect the true lender, or that there is no consideration for the alleged deed of trust.
3. Silent second mortgages. Undisclosed second mortgages extract additional profits at the expense of legitimate mortgage companies.
In the basic scheme, the property is purchased at foreclosure and sold to a third-party purchaser. Often the third-party purchaser is unable to obtain a mortgage sufficient to complete the transaction. The foreclosure purchaser may agree to finance the shortfall through an undisclosed second mortgage. The fraud is committed on the first mortgage company because the risk of default has increased. Often, the undisclosed mortgage is structured as a short-term loan at a high rate of interest. Servicing both loans will often push the homeowner into default and foreclosure. In addition, it is against the law not to identify all mortgages on the HUD-1.
4. Straw purchasers. In addition to using fictitious entities to hide the ownership of real property, friends, family and trusted associates could be used to hide the ownership. A simple way to make undisclosed bankruptcy assets difficult to recover is to deposit hidden bankruptcy assets into the account of third-party purchasers. The third-party purchasers present the funds at settlement as their own and take title to the property. This could constitute money laundering when the asset is subsequently transferred back to the fraudster.
To further complicate the fraud, the third-party purchasers could refinance the property and remove the equity.
5. Conspiracy. Often, real estate fraud involves collusion among a number of individuals and companies. For example:
* Appraisers can inflate the value of a property, thereby justifying a larger mortgage.
* Title/settlement companies can overlook the fact that the seller is in bankruptcy.
* Mortgage brokers can arrange loans for unqualified individuals. Often several loans can be arranged in the name of the same individual.
* Substitute trustees can overlook the fact that funds tendered to purchase properties may be undisclosed bankruptcy assets.
* Banks can overlook evidence of money laundering, suspicious cash transactions, numerous accounts in fictitious entity names, and other “red flags.” Cashier’s checks issued in the names of fictitious purchasers can be used to hide bankruptcy assets. The identified remitter of the cashier’s check is sometimes not the actual person with the funds.
We have uncovered instances in which the same straw purchasers also opened a bank account in their name using undisclosed bankruptcy assets. The straw purchasers are induced to pre-sign blank checks ostensibly for the purpose of repaying the mortgage. The bankruptcy debtor may continue to fund the bank account with undisclosed bankruptcy assets. Pre-signed checks are used to purchase cashier’s checks or make payments for the benefit of the debtor in bankruptcy, while creating the appearance that the funds belong to the straw purchasers.
6. Equity-sharing arrangements. A classic foreclosure scam occurs when the victim believes that the purchaser at foreclosure is attempting to help them. Often, the transactions are structured in the following manner: The foreclosure purchaser agrees to pay off the defaulted mortgage, and in return, the homeowner signs a note (often at an exorbitant rate) secured by a deed of trust on their property.
In return for this “service,” the homeowners convey through a deed a partial interest in their property, as high as 50 percent. (The homeowner may then also be charged “rent” to live in their home.) When the inevitable occurs and the homeowner defaults, the remainder of their property (and equity) is lost.
We have seen examples where future (unpaid) rent was calculated and secured by a deed of trust on the property.
While these are only a few examples, it is clear that fraud cases are on the rise. In order to manage this increase, knowledgeable forensic specialists must continue to work with qualified legal professionals to gather and interpret facts that will lead to successful recovery of assets, and other possible sanctions.
Marion Hecht Clay, CPA, CFE, is managing director of UHY Advisors’ Forensic Litigation & Valuation Service Group in Washington, D.C.
