FBI: Mortgage fraud still prevalent, hard to catch - USATODAY.com

FBI: Mortgage fraud still prevalent, hard to catch - USATODAY.com

With all of the public attention paid to the complex web of failures that led to the mortgage crisis and resulting economic meltdown, you would think that the mortgage biz would now be squeeky clean. If you've tried to get a home loan or refinanced your house lately, you've probably seen a tightening in the eligibility rules; stricter documentation requirements; and a significant "raising of the bar" in underwriting standards. Gone are the days of "no-doc" loans, 125% financing, and mortgages handed out like candy without regard to ability to pay them back, right?

According to the news article above from USA Today, fraud is still running rampant in the mortgage industry. How can this be? The FBI's annual report on mortgage fraud said such schemes are particularly resilient and hard to discover, and their total cost is unknown. Real estate firm CoreLogic says more than $10 billion in loans were made with fraudulent application data in 2010, the report noted. In spite of all of the additional public attention and oversight, fraud last year stayed at levels seen in 2009 as the housing market remained in distress, providing ample opportunity for schemes, the FBI report said. It predicted that perpetrators would "continue to seek new methods to circumvent loopholes and gaps in the mortgage lending market."

The most prevalent schemes involve falsifying financial information to qualify buyers who otherwise would be ineligible for a loan. Other crimes involve inflated appraisals, including schemes that use dishonest appraisals to sell homes at elevated prices. Some get-rich-quick schemes persuade investors to buy rental property or land believing the price will appreciate quickly. The FBI report indicates that the crimes are committed by licensed and unlicensed brokers, loan officers, real estate agents, appraisers and other industry insiders who use their expertise to exploit vulnerabilities in the system. Organized crime groups are also behind some of the fraud, the report said.

Perhaps the most disturbing conclusion from the FBI is that "mortgage fraud enables perpetrators to earn high profits through illicit activity that poses a relative low risk for discovery." A low risk of discovery? Haven't we learned anything from the bedlem over the last few years?

The perpetual problem with virtually every area of government regulation is that there are, and never will be, enough examiners, inspectors, auditors, and investigators to enforce all of the regulations. Regulated industries such as the mortgage industry know this, which drives the game of "playing the odds", calculating the enormous gains of skirting the rules with the low probability of getting caught. As government budgets at the federal, state, and municipal level continue to decline during this period of austerity (which will likely last for decades to come), traditional methods of government oversight and enforcement need to be augmented by new and more creative approaches.

First and foremost, government regulators need to focus their attention on the credibility and effectiveness of the regulated industries' own Ethics and Business Conduct programs. Such programs need to be a comprehensive, real, and recognized method for companies to conduct their own self-policing. They must have a values-based emphasis on promoting ethical culture and behavior, as well as contain mechanisms to ensure compliance with the myriad of government regulations and requirements. Key elements include a user-friendly code of thics and business conduct; ethics training that includes a combination of both live and computer-based methods; constant corporate communication on ethics and integrity matters and an unequivocal "tone at the top" of the organization (which includes board of directors involvement); a credible, anonymous employee reporting hotline; and a professional, internal investigative capability. There are many more elements involved, but the basic message is that industry needs to develop its own internal self-policing capability, and government agencies need to focus on evaluating these programs.

Another way to expand the breadth and depth of government oversight is through independent compliance monitoring. The independent compliance monitoring model has been typically used as a reactive alternative to punitive government actions, such as suspension, debarment, or prosecution. In this model, a company, contractor, or regulated entity is found to have violated rules, but the government entity agrees to forgo more punitive action in favor of something akin to "corporate probation". The wayward company or regulated entity pays the monitoring bill, but the private monitor takes direction from, and reports to, the government regulator on whether the company is meeting its responsibilities by fixing the problems that have been identified. This model can be highly remedial and productive by helping regulated entities improve their internal processes and capabilities, thereby preventing future infractions.

Recently, some federal, state, and municipal government regulators have found that independent corporate compliance monitoring can offer more proactive benefits by engaging monitors, as a matter of course, in all high risk contracts in a particular initiative or industry. Monitors, for example, are used frequently in government construction programs (the Port Authority of New York/New Jersey is a great example). Given the high risk of fraud in the mortgage industry, coupled with massive decentralization and a tangled web of requirements and regulations at every level, the placement of independent monitors (at industry expense) could provide the government with just the kind of insight, and oversight, that is badly needed in order to prevent yet another mortgage crisis.

A Year After Dodd-Frank, Too Big To Fail Remains Bigger Problem Than Ever

A Year After Dodd-Frank, Too Big To Fail Remains Bigger Problem Than Ever

Terrific article by Shahien Nasiripour, senior business reporter from the Huffington Post. He writes frequently about Wall Street/corporate fraud issues and attempts at government regulation. In this piece, Shahien takes a critical look at the Dodd-Frank Wall Street Reform Act a year after its passage. He writes that, in spite of all of the hoopla surrounding the enactment of the legislation, little has really changed. The nation's largest banks and brokerage firms are getting bigger; the structural deficiencies and incredible financial incentives that motivated unethical decisions still remain; and the ability of regulators to "mind the store" continues to erode to the point of absurdity. He concludes that, in spite of the new regulations, the economy simply cannot afford to let these banks fail, and they know it. The knowledge that any behavior will ultimately be tolerated creates a kind of institutional arrogance that perverts even the most conservative of free market economy theory, which hold that in a true capitalist system, those institutions which violate the rules of order will pay the ultimate price and will not survive.

One of the problems with the way we have approached banking and finance regulation is that it is almost predominantly reactive in its focus. Legislation creates a set of rules; a whistle blower reveals a violation of the rules; and the regulators must take some kind of punitive action. Unfortunately, those actions often fail to have any deterrent effect, because economic interests are seen to outweigh ethical and legal considerations. In my view, regulators need to focus on proactive, preventive measures by (1) requiring companies to establish genuine business ethics and compliance programs, and have them regularly assessed by an independent third party, (2) leveraging the use of independent corporate compliance monitors, at company expense, to regularly evaluate corporate internal controls and compliance with the most critical regulations that can negatively impact consumers and the economy, and (3) integrating integrity agreements into every administrative, deferred prosecution, and non-prosecution agreement that call for even more intrusive monitoring of company practices on a regular basis, before violations occur.

UK anti-corruption drive has US companies sweating | Reuters

UK anti-corruption drive has US companies sweating | Reuters

Now is definitely the time for companies to do an "Ethics check-up". An external, independent assessment of corporate ethics and compliance activities can help improve a company's ethics and integrity posture, and proactively demonstrate to government agencies, regulators, oversight bodies, and customers that they are committed to ethical behavior BEFORE a crisis occurs.

In Shift, Prosecutors Are Lenient as Companies Break the Law - NYTimes.com

In Shift, Prosecutors Are Lenient as Companies Break the Law - NYTimes.com


Fascinating NY Times piece on DOJ's increasing use of deferred or non-prosecution agreements as an alternative to more aggressive prosecutions of corporations. Although the article is cynical in places, I don't believe that long, expensive prosecutions of companies are always in the public's best interests. In fact, many large corporations conduct a risk/benefit analysis to determine whether a particular business decision, if close to or over the ethical line, would ultimately be in the company's best financial interest if discovered by the government. Aggressive prosecutions, which almost always end in a fine and settlement, are merely part of this calculus.

The effectiveness of deferred prosecution agreements (which save the taxpayer an enormous amount of money) would be greatly enhanced if they routinely included independent corporate compliance monitoring as a condition of the agreement.In this model, the company agrees to an independent monitor looking at books and records, talking to employees, inspecting factory floors - - anything that is germane to the offense being investigated. The government identifies the items to be monitored (such as the accuracy of billings, for example), and the frequency and duration of the monitoring. The Independent Monitoring firm provides technical experts, ensures there are no conflicts-of-interest, and prepares reports on the company's compliance to the government. Typically, the monitor will also assess the company's Corporate Ethics and Compliance Program to ensure it is robust, effective, and actually ensuring an ethical corporate culture. The monitor would also assess a company's internal controls and identify process deficiencies that may have led to the initial offenes, making recommendations to the company along the way.

Independent monitoring helps protect the taxpayer; extends the oversight capability of government agencies and regulators; and (if done properly) helps the contractor remedy many of the bad processes that led to their problems in the first place.The government receives regular monitoring reports, but the total cost is borne by the company, not the taxpayer. At a time of severe budget austerity and increasing demands for accountability of government funds, the expanded use of deferred prosecution agreements that contain requirements for independent monitoring is simply a "no-brainer."

A Wake Up Call for Boards and CECOs

In the July 2011 edition of Fraud Magazine (published by the Association of Certified Fraud Examiners)., Sheila Keefe, CFE, CPA writes a wonderful article about how Audit Committees should be worried: it seems that the SEC is finally holding Boards of Directors, particularly those serving on Audit Committees, responsible for the shenanigans that go on right under there noses at the companies they "direct". 

Sheila sites a February 28 SEC decision to charge three ex-directors and audit committee members of DHB Industries for failure to address a growing fraud in their organization.  This follows the conviction last last September of the DHB CEO and COO on multiple counts of securities fraud, insider trading, and obstruction of justice.  The SEC is now prosecuting the ex-directors because their lack of oversight allowed senior management to manipulate results and to funnel millions of dollars to DHB's founder to pay for luxury cars, vacations, art and even prostitutes.  The SEC noted that , "as the fraud swirled around them," the directors "ignored the obvious".

The SEC's action is a clear wake-up call for Boards of Directors.  Equally as important, it is a wake-up call for CEOs and Chief Ethics and Compliance Officers (CECOs), whose duty it is to create an ethical culture that promotes integrity from the Board room to the mail room.  While CECOs can't control a Board's actions or inactions, they can take a number of simple steps to get the Board actively involved in the company's Ethics and Compliance activities: 

1. Develop a Board training curriculum (not a one-time Powerpoint presentation) to promote their awareness of, and engagement in, ethics and compliance in the company..

2. Use a combination of relevant, targeted statistics and real world examples from the frontlines to underscore the risks and the efforts of the program to mitigate those risks.

3.  Ensure that all reports to the Board are directly in support of the Board's oversight role, and articulate this clearly and often.

4.  Collaborate with other functions in the company to reduce redundancy, clarify inconsistencies, and maximize relevancy of the CECO report

5.  Cultivate a balanced judgment on what Boards really need to hear to support their oversight role.  Avoid both "the sky is falling" and "everything is coming up roses" scenarios and provide credible, objective reporting in proper context, supported by compelling facts

"Tone at the Top" is a commonly used phrase to describe what the CEO and executives need to do to promote an ethical culture.  Clearly, if we are to succeed in creating real ethical change, accountability of the Board, as recently implemented by the SEC, will help redefine exactly where the "top"  might be.

Toyota and Ethical Culture

 Check out this article from the LA Times on 24 May:
http://articles.latimes.com/2011/may/24/business/la-fi-toyota-safety-20110523

The article describes a 60 page report from Toyota's North American Quality Advisory Panel, which found that the company responded slowly and inefficiently to the sudden acceleration "crisis" involving its automobiles because it was hampered by a top-down management style that gave "short shrift" to customer complaints.  The report also found that the company had come to regard federal safety regulators as "adversaries", and had developed an institutional arrogance as an unintended consequence of of its drive to become the world's largest automaker.

While neither the report nor the newspaper article mention "ethics" even once, both conclude that Toyota's culture was "at the root of its woes".  In my view, Toyota's woes were all about corrosion of its corporate ethical culture.  One can tell a lot about a company by how it responds to a crisis.  The lack of transparency; the arrogance for regulators; and the company's refusal to own up to the safety problems that had killed and injured many of its customers reveal that Toyota had strayed from its core values as a company, focusing on the short-term cost of recalls (and impact on stock prices) rather than its longer-term commitment to quality and safety. 

It's amazing how much time and effort it takes for a company to develop "reputational capital", and how quickly it can be lost by straying from the corporate "ethical compass" in the heat of a crisis.  What do you think of when you hear the name Toyota?  How about BP? Goldman Sachs? Lehman Brothers? The answer would have been different just a few years ago.  This is why Ethics and Compliance programs, (emphasis on the ETHICS part) are so important.  Bad behavior of employees is uncontrollable; disasters are unforseeable; but how prepared a company is to respond appropriately is a product of leadership and employee commitment; an incentive structure  that rewards integrity; a meaningful code of conduct; substantive training; appropriate rewards and sanctions ; and an  involved Board of Directors - - all of the ingredients for a sound, sustainable ethical culture.