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   ARTICLE   |   From Scotsman Guide Residential Edition   |   December 2017

Ease the Pain of Money Laundering

Diagnosing financial crimes early can help mitigate lending risks

Ease the Pain of Money Laundering

Key Points

Red flags for lenders and loan servicers to watch for

  • Very early loan payoff, especially with cash or from suspicious or unknown sources
  • First payment default
  • Cash payments
  • Sudden payoff of a frequent problem loan
  • Large wire payment or payoff from an unrelated source
  • Lack of an arms-length transaction
  • Inconsistent or inappropriate use of loan proceeds

When the Bank Secrecy Act (BSA) was expanded by the Financial Crimes Enforcement Network (FinCEN) in 2012, its goal was obvious: To ensure nonbank mortgage companies do not fall prey to money laundering schemes by having them implement and operate an effective anti-money laundering (AML) program.

Despite facing civil and criminal penalties and enforcement actions that could lead to significant remediation time and costs, many lenders and mortgage companies still struggle to maintain an effective AML program five years later.

FinCEN’s Final Rule reflects a decision that residential mortgage lenders and origination companies are the focus in what appears to be a multi-phase approach to include a broader loan or finance company category. According to a Geraci Law Firm report — Anti-Money  Laundering Compliance: A Growing Concern — the expanded BSA (Bank Secrecy Act) applies to “any lender who makes or acquires loans secured by deeds of trust or mortgages on residential properties. This includes mortgage lenders, bridge lenders and other investment-purpose loans secured by residential property.”

Thus, all nonbank residential mortgage lending and originating businesses must comply with the expanded set of FinCEN requirements. According to Stephen Hudak, chief of public affairs at FinCEN, “The rules apply to any business that meets either the definition of ‘residential mortgage lender’ or ‘residential mortgage originator.’”

The key word here is “business.” The law does not apply to individual loan originators except as part of the company’s requirements. An individual originator operating in the capacity of a sole proprietor would have to comply, however. Any company unsure if the requirements apply to them can write to FinCEN for clarification.

These lenders are expected under the expanded BSA to have in place an effective AML program commensurate with their organization’s risk profile. Individual originators need to know this information to help the companies they work for and the lenders they work with implement their AML programs.

Compliance matters

Without a comprehensive risk-based program built around the five pillars of an effective BSA/AML program, a lender or mortgage company is at a disadvantage in its ability to combat money laundering, terrorist financing and even mortgage fraud. Mortgage lenders are in a unique position to identify criminal activities and provide law enforcement with vital information to stop perpetrators.

A successful BSA/AML program is supported by these five pillars:

  • Designating a compliance officer;
  • Implementing internal controls;
  • Hiring a third party to conduct independent testing;
  • Providing regular training tailored specifically to compliance staff, plus additional training for the entire organization; and
  • Instituting customer due diligence procedures.

Criminal intent

By now, most lenders and mortgage companies should be familiar with their responsibilities as an institution and those of the individual originators and support staff working under their umbrella.

Individual originators should become familiar with, and learn to recognize, common red flags that point to money laundering, terrorist financing or fraud. A willingness to comply with the internal procedures in response to such activity also is a key factor in the success of their company’s AML program.

In most cases, the actions of criminals are fairly straightforward. The launderer will apply for a loan and use the downpayment, monthly payments and eventually pay-off transactions to launder money. They use illicit funds for these payments to clean the money, which is referred to as the layering and integration stages of money laundering. Some criminal borrowers will attempt to make cash payments in effort to evade paying tax on the funds used.

Mortgage lenders are in a unique position to identify criminal activities and provide law enforcement with vital information. 

What are some of the more common forms of suspicious activities that lenders may encounter? Some criminals use a straw buyer to take out a mortgage loan using their legitimate information and then make the payments using illicit funds. At some point after the loan closing, the straw buyer will rent the property, often to another cutout or shell company, allowing the criminals to retrieve their now clean money. This straw buyer also may sell the property after a short time to another party in the conspiracy and pay off the loan to clean the illicit funds, or this person may refinance after a short period to draw out equity.

Red flags

Individual originators should watch for red flags that could indicate money laundering, fraud or other suspicious activities. These red flags include recent large deposits on bank statements before a loan application, large cash downpayments, discrepancies or irregularities with income or employment verification, applicant- or borrower-identification discrepancies, excessive real estate commissions and anything that creates uncertainty or suspicion about the legitimacy of a transaction or document.

In addition, while the loan application is being processed and underwritten, originators and staff should watch for anything that creates uncertainty or suspicion about the legitimacy of a transaction or document; any indication that a party is not acting on his or her own behalf; or that a party is attempting to hide his, her or the borrower’s identity, as well as any indication of identity theft. When identified, red flags should be reported internally per an institution’s AML program.

Many times, red flags simply require additional diligence to satisfactorily address concerns. There should be a process for addressing red flags, however, as well as determining when to escalate them and how to document results. It is critical to document anything identified as suspicious and the rationale used in determining the decision on whether or not a suspicious activity report (SAR) is filed.

Awareness of red flags is critical to an institution’s effectiveness in reporting valuable suspicious activity to assist law enforcement investigations and identification of fraud and laundering risks affecting the institution.

Common schemes

In 2016, a California residential mortgage fraud and money laundering scheme cost financial institutions more than $16 million. Multiple parties involved in the scheme purchased more than 30 homes through straw buyers using fraudulent loan applications. The straw buyers secured more than $30 million worth of residential mortgages before the scheme was uncovered.

According to a Department of Justice press release, “The loan applications contained materially false information as to the straw buyers’ income, employment, assets and intent to occupy the residences. The loan paperwork also hid from lenders millions of dollars of payments that went to the defendants.”

Another mortgage scheme from 2015 involved a former real estate developer purchasing a multifamily residence and then selling the individual units as condominium units. According to the U.S. Department of Justice, the developer and two co-conspirators fraudulently recruited straw buyers, promising them that they would not have to pay anything upfront or make any mortgage payments along the way, while also agreeing to cut them in on a share of the profits once the real estate was sold.

To gain approval for these individuals’ mortgage loans, the perpetrators provided applications falsely representing key information, including income, personal assets, downpayments and occupancy intention. Nine national mortgage companies and one local bank were led to believe the straw buyers had made significant downpayments.

A well-oiled AML program should have been able to uncover these schemes in a timelier manner and should have prevented the levels of loss experienced by the financial institutions. Often, one individual piece of the puzzle may not uncover a crime, but several pieces viewed together can create a clearer image, which is often what is required to further pursue and uncover these criminal activities.

Thus, the ability for law enforcement to receive information from all institutions and aggregate the data is crucial to identifying schemes that take advantage of multiple institutions. Successful efforts to combat money laundering, fraud and terrorist financing depend heavily on private industry sharing information with law enforcement through legal channels.

Eyes on the prize

All covered institutions are required by law to have an effective BSA/AML program in place. Beyond the requirement, it makes sense for financial institutions to implement a strong program to combat the threats from criminals. Once an AML program is established, training is regularly being administered and procedures are functioning, it is critical to remain vigilant.

The following steps will ensure continued adherence to the program:

  • Conduct regular evaluations to identify changes of inherent risk.
  • Monitor the program periodically to determine if it and internal controls are adequate.
  • Observe staff to ensure they are abiding by the program and controls.

Environmental risks undoubtedly will evolve over time. These changes likely will require updates to the organization’s risk assessment and AML program to ensure risks are mitigated to an acceptable level. A BSA/AML program should not be static. As risks evolve over time because of various factors, it is critical for lenders and mortgage companies to regularly monitor their businesses for unique risks and have a process in place to identify when a program change is necessary. As the frontline defense against fraudulent schemes, mortgage originators must remain vigilant.

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