Should the fox be guarding the henhouse?Charlie Elliott Jr., MAI, SRAfraud, mortgage fraud, H.R. 1295, Responsible Lending Act In this era of pressure to meet goals and financial objectives, it behooves each of us to step back and focus on any role that we may have in the increasing mortgage fraud trend. It tears at the very fabric of our profession and, to the extent that it exists, our livelihood and perhaps our freedom is at risk. In some cases, fraud has become so commonplace that its participants consider it the standard rather than the exception. The bounds of ethics are often being stretched to the point where variances that were once considered blatant violations of the law, are now considered immaterial. What is mortgage fraud? When we were taking business law in college, our textbook defined fraud simply as "the misrepresentation of a material fact." Black's Law Dictionary defines fraud as "an intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right." While these two definitions differ somewhat and while neither speaks directly to loan fraud, most of us with reasonable intelligence will agree that fraud occurs in our business. Is it a big problem? Yes. The FBI reports that mortgage fraud complaints more than doubled in 2004, reaching 17,127 as compared to 6,936 the previous year. The mortgage fraud problem is so prevalent that the Mortgage Bankers Association saw fit to devote a new Web site, www.stopmortgagefraud.com, exclusively to this industry-wide problem. The FBI reports that suspicious mortgage activities during 2004 involved $400 million in related losses. How does mortgage fraud manifest itself? Is fraud primarily blatant, as in the case where several people conspire to take the entire proceeds of a loan without paying off the previous loan? This type of fraud usually requires the cooperation of participants, such as loan officers, attorneys, real estate agents and appraisers. Or, is fraud primarily subtle and untraceable, with very little concrete collaboration? For example, an appraiser values a property for more than it is worth, so the person ordering the appraisal can make a loan that would otherwise be rejected, and collect a commission on the property. This may happen with little or no direct discussion between the lender and appraiser. It is likely based upon understandings from previous transactions that could best be defined as "code." There are no smoking guns here, only phrases like, "We need $200,000 on this one to make it fly," and "Our previous appraiser just didn't understand this market." While most appraisers would not cooperate with a scheme like this, some will. So, the answer to both questions is yes: Mortgage fraud is both subtle and blatant, and it's occurring right before our eyes. Fraud is becoming a bigger problem and, yes, we all have a responsibility to do our part as professionals to prevent such activities when we can. In the past, some of us may have found ourselves as unwitting participants in fraud. This could have occurred when we had no idea that it was going on. Or, we may have had questions, but figured it best to let sleeping dogs lie. Others are willing participants in fraudulent activity. Whatever the case, mortgage fraud is an insidious cancer that affects our entire industry. This cancer is not always easy to detect and its effects are not always obvious. What is being done to prevent loan fraud? On Oct. 27, 2003, the Office of Comptroller of the Currency along with four other federal regulators sent a statement to all of the 12,000-plus regulated financial institutions, clarifying existing regulations. The statement, titled "Independent Appraisal and Evaluation Functions," provided that appraisers must be selected by parties that do not have an interest in the loan transaction, including borrowers. It made exceptions for small institutions and did not cover mortgage brokers. On March 15 of this year, H.R. 1295The Responsible Lending Actwas introduced to the U .S. House of Representatives. This bill requires (among other things) that the physical inspection by appraisers of certain properties that lend themselves to flipping; improves appraiser licensing standards; creates new standards to abate appraiser intimidation; establishes minimum state licensing standards for mortgage brokers; and provides for the establishment of a national mortgage lender database. What else must be done? While some positive steps have been taken to address the problem of mortgage fraud, more must be done. Many people feel that fraud is a necessary evil in the mortgage industrysomething we all must accept and that none of us can prevent. I beg to differ. Mortgage fraud, for the most part, cannot exist without the knowledge and permission of those mortgage loan professionals among us, including appraisers, lenders, real estate agents and government regulators. As a whole, we have an outstanding group of mortgage professionals in all disciplines. There are a few rotten apples, and they cause the entire basket to reek with a very foul smell. Fraud is an insidious threat to our society, akin to violent gangs and illegal drugs. Two things must happen in order to curb mortgage fraud. Mortgage professionals must hold each other accountable in a supportive and constructive way. While there may be some of us who go to prison as punishment for their actions, the prisons are not large enough to hold all of those who break the law when left unsupervised. We have a responsibility to police our own industry in an effort to prevent fraud. Our government regulators have a responsibility to develop a better playing fieldone that does not lend itself to the temptation to commit fraud. Our lawmakers and government agencies must develop stronger policies that further separate the functions of appraiser selection and communication, from those individuals obtaining sales commissions from the successful closing of a mortgage transaction. Foxes do not make good guards for the henhouse. Charlie W. Elliott Jr., MAI, SRA is president of ELLIOTT & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889, [email protected] or through the company's Web site at www.appraisalsanywhere.com.