Until August 2012, a segment of the financial industry known as non-bank residential mortgage lenders and originators (RMLOs) was exempt from the anti-money laundering (AML) requirements that the Bank Secrecy Act (BSA) and USA PATRIOT Act imposed upon commercial banks, broker-dealers, money services businesses and commodity futures brokerage firms.

The final rule that defined non-bank residential mortgage lenders and originators as loan and finance companies in order to require them to establish AML programs and report suspicious activities was effective April 16, 2012. The compliance date for meeting the Code of Federal Regulations 31 CFR 1029.210 was August 13, 2012.

Definitions

The following are definitions to keep in mind for this article:

• Residential mortgage lender: The person to whom the debt arising from a residential mortgage loan is initially payable or to whom the obligation is initially assigned at the settlement or immediately after the settlement.
• Residential mortgage originator: The person who accepts a residential mortgage loan application or offers/negotiates terms of a residential mortgage loan.

These companies are popularly known as mortgage companies and mortgage brokers. There is no exemption based on the number of transactions (i.e., loans made or originated), nor based on the dollar amount of the transactions nor a firm’s number of employees.

Commercial Banks vs. Non-Bank Mortgage Lenders

Prior to August 2012, non-bank RMLOs were not defined as loan or finance companies; therefore, they were exempt from most AML regulations. They were not obligated to file suspicious activity reports (SARs) nor were they required to follow certain BSA record-keeping and reporting requirements. The Financial Crimes Enforcement Network (FinCEN) analyses and law enforcement investigations identified this exemption as a regulatory gap that could be exploited by criminals, particularly in the conduct of mortgage fraud.¹

However, not all of the BSA’s AML provisions were imposed on RMLOs when the final rules were published in 2012. For example, RMLOs are currently exempt from Section 311 of the USA PATRIOT Act² currency transaction reports and certain special record-keeping requirements.

A Focus on Mortgage Fraud

AML programs are designed to be “risk-based,” taking into account the specific nature of, and services offered by, financial lenders. Therefore, FinCEN urged RMLOs to recognize that mortgage fraud is a more pervasive problem than the traditional money laundering or terrorist financing that banks and brokerage firms address. To illustrate the scope of mortgage fraud, the FBI reported that their investigations “resulted in 1,082 convictions of mortgage fraud, resulting in $1.38 billion in restitutions; $116.3 million in fines; seizures valued at $15.7 million; and $7.33 million in forfeitures in FY 2011.”³

Shortly after the August 13, 2012, compliance date, FinCEN’s director addressed the American Association of Residential Mortgage Regulators. In his prepared remarks, he expressed the following view:

“ …one of the predominant risks of criminal activity is mortgage fraud. Therefore, under a risk-based approach, we would expect this to be an area of concentration in a new AML program. RMLOs must also be aware of other risks, in particular, that criminals may attempt to launder proceeds of crime by investing them in real estate. The SAR regulation for RMLOs requires reporting of suspicious activity, including but not limited to fraudulent attempts to obtain a mortgage or attempts at laundering money through the purchase of residential real estate.”⁴

The various mortgage frauds for which RMLOs must be on the alert, and which could prompt the filing of a SAR, can be placed in the following three categories.

Fraud Perpetrated on the Mortgage Lender (Though Without a Criminal Intent)

• Occupancy fraud: The borrower is purchasing a vacation home or investment property but applies for a primary residence loan, which typically offers more favorable terms
• Liability fraud: Lying about the extent of one’s financial liabilities

Fraud Perpetrated on the Mortgage Lender With a Criminal Purpose in Mind

• Identity theft: Lying about one’s true identity or applying for a loan with the stolen identity of another individual, usually involving a stolen social security number, to obtain a mortgage fraudulently
• Income fraud (understating): Lying about one’s true income in order to qualify for hardship concessions or possible government assistance for low-income families applying for a mortgage
• Appraisal fraud: One variation of this type of fraud is obtaining an overly high property appraisal in order to profit from cash-out refinancing

Fraud Perpetrated on the Borrower (The Individual)

• Debt-elimination schemes: Might involve false promises to assist homeowners in reducing or eliminating their mortgage obligations and typically big upfront fees are charged
• Foreclosure rescue scams: Another form of consumer fraud whereby a homeowner transfers title to a (criminal) third party, in the belief that the purported rescuer can stop or delay an imminent foreclosure

The RMLO industry lacks a national self-regulatory organization like the Financial Industry Regulatory Authority or the National Futures Association. Therefore, AML professionals are concerned that too many RMLOs are either not aware of their compliance obligations under the law or are paying modest “lip service” to the four pillars of an effective AML program,⁵ choosing to forgo the undertaking of an independent AML performance test. Fortunately, there has been a growing trend among state banking regulators to require RMLOs to demonstrate that a recent independent AML audit has been concluded before granting either a new license or a license renewal in order to conduct business in that state. There is a shared opinion among AML professionals that the real driving force for BSA and USA PATRIOT Act compliance may come from commercial and warehouse banks—which may ultimately choose to suspend business relationships with mortgage lenders who have not had an independent AML performance test. There is still room for improvement; however, the industry has shown significant strides since 2012.

Larry Schneider, CAMS, vice president, EA Compliance Inc., Highland Park, IL, USA, lschneider@eacompliance.com. Schneider is the co-author of an online AML course designed for the RMLO industry. The course was recently provided to Habitat for Humanity Greater Orlando & Osceola County at no charge.

1. “31 CFR Parts 1010 and 1029,” Financial Crimes Enforcement Network, http:// www.fincen.gov/statutes_regs/frn/ pdf/1506-AB02_RMLO_Final_Rule.pdf
2. This section of the Code of Federal Regulations refers to identifying customers using correspondent accounts, including obtaining information comparable to information obtained on domestic customers and prohibiting or imposing conditions on the opening or maintaining in the U.S. of correspondent or payable-through accounts for a foreign banking institution.
3. “Financial Crimes Report 2010-2011,” Federal Bureau of Investigation,
   http:// www.fbi.gov/stats-services/publications/ financial-crimes-report-2010-2011/financialcrimes-report-2010-2011#Mortgage.
4. “Prepared Remarks of James H. Freis, Jr. Director, Financial Crimes Enforcement Network U.S. Department of the Treasury,” Financial Crimes Enforcement Network, August 16, 2012, https://www.fincen. gov/news/speeches/prepared-remarksjames-h-freis-jr-director-financial-crimesenforcement-network-us-12
5. The four pillars of an effective AML program are the development of internal policies, procedures, and controls; designation of a compliance officer; an ongoing employee training program; and an independent audit function to test programs.