The Financial Services Authority (FSA) has recently published its review of mortgage fraud against lenders, having carried out investigations into the ability of lenders to detect and prevent mortgage fraud.
The purpose of the report was to consider how lenders are managing the risk to their businesses of mortgage fraud. The report also estimates that the cost of mortgage fraud in the UK is £1bn.
The FSA conducted interviews and visits to a ‘representative sample’ of lenders that accounted for 56% of the mortgage market in 2010. They also conducted interviews with other stakeholders including the Council of Mortgage Lenders (CML) and the Law Society.
While the FSA found that steps to counter mortgage fraud had improved since the onset of the financial crisis in 2007, the report makes it clear that the FSA expects lenders to:
- do more to prevent mortgage fraud;
- take active steps to make recoveries where fraud has been identified;
- take steps to review portfolios to assess and understand the existing exposure to mortgage fraud.
The report is littered with the FSA’s underwhelmed view of the current position, which is reminiscent of an old school report with the resounding message of ‘OK, but could do better’.
Unfortunately, unlike a school report, the FSA’s review cannot be placed in the bottom of the schoolbag and ignored. Their message is clear, they expect the senior management of all lenders to consider the findings of the report and translate them into more effective policies and controls. Lenders must stay vigilant and apply the strongest possible systems and controls to aid prevention, learning lessons from the past. The FSA will continue to focus on lenders’ compliance in this area and have confirmed that they will not hesitate to take action against firms where necessary.
In-house lawyers are likely to have an increased role in assisting efforts to prevent, detect and deal with mortgage fraud.
By way of a synopsis, the report contains proposed guidance in the form of examples of good and poor practice in the following areas:
- Governance, culture and information sharing:
- The FSA found examples of robust governance at some lenders and considers that the sector as a whole now devotes greater attention to the risk of mortgage fraud than was previously the case.
- However, the report goes on to state that some lenders were unable to define what constitutes mortgage fraud and provided inadequate information to senior management. Firms, and their senior management, are positively encouraged toconsider how management information can be improved and used more effectively to mitigate the risk of mortgage fraud.
- Applications, processing and underwriting:
- The report highlights areas of good practice such as some lenders who contact applicants even if they were referred by brokers.
- The report did raise concerns that service demands at some lenders directly raised the risk of mortgage fraud and that ‘fast-track’ loans continue to allow an opportunity for anti-fraud checks to be bypassed.
- Concern was also expressed that while some lenders were able to apply rigorous underwriting scrutiny to mortgage applications, there were some questions as to whether this would be sustained if business volumes were to increase.
- Managing relationships with third parties:
- Many lenders identified third parties, such as solicitors, brokers and valuers, as the main source of mortgage fraud risk. Indeed, one lender considered that approximately 50% of mortgage fraud losses were attributable to the actions of the solicitors involved in the conveyancing aspect of the transaction.
- The FSA concluded that many lenders had significantly improved the control and oversight in relationships with some third parties and highlighted relationships with solicitors as an example of this.
- However, the report goes on to say that there is scope for improvement in the initial vetting and continual monitoring of the third parties with particular emphasis on brokers.
- Simply checking that a broker is authorised by the FSA is not sufficient due diligence in terms of vetting brokers. Recent FSA enforcement action has shown very clearly that even FSA approved brokers do not always act with integrity or take steps to mitigate mortgage fraud risk.
- Mortgage fraud prevention, investigations and recoveries:
- The FSA concluded that while most lenders were able to undertake fraud investigations, the teams who were tasked with such activities were often over-stretched and received inadequate training. It also found that the procedures at many lenders were unclear as to how and in what circumstances reports should be made.
- There was great disappointment expressed that a number of firms were not fully engaging with the Information For Lenders (IFL) scheme, undermining the efforts of the sector as a whole to reduce mortgage fraud.
- Importantly, the FSA also raised concerns that many lenders had not carried out any review of their mortgage books and so were not aware of the nature and scale of the losses that they face.
- Compliance and internal audit:
- The report raises concerns that very few of the sample firms regularly monitored the adequacy of borrower take-on arrangements, application processes or third-party relationships.
- Remuneration of staff:
- The report found that in general the remuneration structures were not leading to staff taking excessive risks.
- Only a few lenders actively rewarded staff for preventing mortgage fraud.
- Staff training and awareness:
- The report concludes that there were only a few lenders that specifically concentrated on mortgage fraud in training programmes.
WHAT CAN IN-HOUSE LAWYERS DO TO ASSIST?
The report gives numerous examples of ways in which lenders can change and mould current processes and procedures to deal with mortgage fraud past, present and future and it is clear that the FSA requires the report to be reviewed and digested by lenders.
There are a number of interesting themes and areas in which in-house legal teams and external legal services providers can work with lenders to assist in complying with the guidance, avoiding FSA sanctions and increase mortgage fraud recoveries.
Getting added value from existing legal service providers and back-book reviews
Many lenders now have enhanced due diligence checks when deciding on prospective and existing panel conveyancing solicitors, valuers and brokers. Indeed, a large number of lenders, as a minimum, do not provide instructions to conveyancing firms with less than two partners for insurance coverage reasons. The last thing a lender wants is to open itself up to the potential of a professional indemnity insurer refusing to pay damages for the fraudulent acts of the solicitor.
Continued monitoring of third parties is essential and having systems in place to review the quality of lending involving third parties, including solicitors, valuers and brokers where levels of arrears are apparent will almost certainly assist in the early detection of mortgage fraud particularly where the third party may have been complicit with the fraud. Specialist legal service providers (such as Eversheds) already engaged in taking actions against conveyancing solicitors, valuers and brokers for both mortgage fraud and negligence claims are a very good source of information for lenders and in-house legal teams. Engaging with these specialist legal service providers, obtaining this information and feeding it back into the front end of the service (ie when considering panel positions) and at the back end, when considering the extent of mortgage fraud in the existing portfolio of accounts, is highly likely to provide evidence of steps taken to comply with the report. In addition and just as importantly, this process could help save money being paid away to otherwise undetected mortgage frauds and help identify and deal with existing frauds proactively.
Specialist legal service providers have significant recent experience of the ways in which mortgage fraud have been conducted and are well placed to feed this information back to lenders and in-house legal teams. Bespoke training courses provided by the specialist legal service providers can be a useful and cost-effective way of raising awareness of mortgage fraud issues for employees at all levels and can be tailored for lender specific needs.
Embracing industry-specific merit awards and initiatives
The FSA sees engagement with the IFL scheme as ‘one yardstick by which to judge a lender’s “state of readiness” to confront mortgage fraud’. Several lenders and the CML have all stated that the IFL scheme should be made compulsory. Clearly buying-in to cross industry and industry-wide information sharing is to be actively encouraged.
Going further, embracing industry-specific merit awards and initiatives and incorporating these into panel requirements as a proactive measure is likely to be considered a positive step by a lender whose attitude to fraud is being assessed. As examples:
- The Law Society has introduced a new Conveyancing Quality Scheme (CQS) award, the first of which was awarded in February 2011. The hope is that this new standard will provide lenders with an extra level of comfort and deter fraud. This scheme is in its infancy but as more firms join the scheme, this should provide a helpful tool to lenders in limiting exposure to risk of mortgage fraud in this key third-party area.
- Royal Institute of Chartered Surveyors (RICS) have introduced their Valuer Registration Scheme which is a monitoring scheme for all RICS members undertaking valuations in accordance with RICS Valuation Standards (The Red Book). This is a voluntary scheme, but already RICS have already indicated that those firms joining the scheme are likely to obtain a market advantage if the monitoring undertaken shows them to be transparent and performing consistently well.
Specific lender innovations
Monitoring the registration of charges and chasing solicitors for reasons behind delays is considered good practice by the FSA as delay in registration is a key indicator of potential mortgage fraud involving typically either a fraudulent transaction taking place without the true owner’s knowledge of indicative of an unreported back-to-back transaction. Creating such a policy and allocating resources to it is not only good practice as far as the report is concerned, but will ultimately serve to reduce the risk to lenders of not obtaining any security for its money. Additionally, establishing a system by which this issue is detected as soon as it happens provides a greater opportunity of tracing the funds to the fraudster, increasing the chances of making a quicker, and larger recovery.
Lenders have made progress in tackling the risk of mortgage fraud in recent years, but the FSA has made it clear that it expects significant improvement within the sector.
There is a plethora of easily obtainable and highly valuable information available from specialist legal service providers who deal with and have dealt with mortgage fraud and negligence claims for lenders. This information can be utilised by lenders to ensure compliance with the FSA requirements, to guard against mortgage fraud going forward and identify and deal with mortgage fraud that is already contained within existing portfolios. Early discussions with external specialist legal providers are to be encouraged.