Posting for

Tuesday, August 11, 1998

by: Nancy Eisenschiml

neisenschiml@firstam.com

and: Bert Rush

brush@firstam.com

PAYMENTS OUTSIDE CLOSING/P.O.C. ITEMS/ESCROW AND CLOSING

In-house counsel Nancy Eisenschiml (St. Louis) writes:

Add Missouri to list of states with questionable flips. (In one flip, the appraisal was done by "Appraisal Enhancement Services"!)

Unfortunately, we are seeing new variations on apparently fraudulent schemes almost daily. Last week, a closer faxed to "Lender," the funding lender, a Settlement Statement which reflected a $4,000 credit to buyer per the contract for the buyer attending an "Educational Seminar". Lender called the closer and told her that we could not show the $4000 as a credit and directed us, instead, to charge the seller $4,000, pay the company putting on the seminar (probably an outfit affiliated with the mortgage broker) and have the seminar company bring in a check to us for the $4,000 showing the buyer as the remitter.

We refused to close the above transaction but would appreciate any input as to how far our oblgation goes before we have no customers left! I once thought that the funding lender would refuse to fund when notified of problems such as the above but that is obviously not true. Or, once all known parties to the transaction (buyer, seller, broker, funding lender) are advised of problems or inconsistencies, should we still be refusing to close just because we don't like the transaction?

Reply to Nancy: (I deleted the name of the lender--they are big, with a national presence.)

This looks to me like a discount of the buyer's purchase price--done in way calculated so as not to cause the lender to re-figure the amount it's willing to lend, based on whatever loan-to-value ratio the lender is using. In other words, I wouldn't be surprised to learn there was no "seminar."

Worse yet, it could be a prohibited rebate--requiring the borrower to pay someone an "unearned" fee.

For purposes of discussion, let's assume this was an attempt to give the buyer a discount--to be reflected as a credit to the borrower on the HUD-1. You're right in questioning the way the loan officer wanted to structure this deal, because the settlement statement (HUD-1) is prepared to show the parties (including purchasers of mortgages in the secondary market) precisely what consideration passed through closing. Anyone looking at a settlement statement after closing--to make sure the loan complies with lender/investor requirements--will review such items as sale price, cash (or other consideration) paid through closing by the buyer, and source and amounts of all purchase money loans. Loan-to-value ratios are still alive--and critical to some lender/investors. If any consideration to be paid by buyer is passed outside closing, it should be shown on the settlement statement (if at all) as a "P.O.C." item ("paid outside closing")--and the amount of such item is not to be included in the total consideration received from buyer as shown on the form.

The source of this rule is RESPA. The Real Estate Settlement and Procedures Act ("RESPA") was enacted by Congress in 1974 as 12 U.S.C. sections 2601, et seq. (The prohibition against kickbacks and unearned fees that we are all familiar with is in section 2607.)

HUD promulgates regulations to enforce RESPA, known as Regulation X (24 C.F.R. section 3500, et seq.). Regulation X includes the requirement that settlement statements be prepared in the form of the HUD-1. The regs include line-by-line instructions and rules as to how the HUD-1 is to be completed. The following is from the "General Instructions" (24 C.F.R section 3500, Appendix A):

The "P.O.C." requirement is also set forth in the upper part of the first page of the HUD-1 form.

But neither RESPA nor Regulation X provides a direct penalty for failure to comply with the regs in completing the HUD-1. And, the HUD-1 is really only required in connection with "federally-related mortgage loans" (the definition of which--at 24 C.F.R. section 3500.2[b]--includes almost all mortgage loans made on one-to-four family residential properties). So there has developed some laxity among escrow and closing officers in complying with the regs, and many escrow and closing software programs are not designed to handle the P.O.C. requirement. I've heard escrow and closing folk, including lots of attorneys, say that they can't comply because if they did the settlement statement would be out of balance--which, of course, it can never be!

What's the risk? Over the years we have seen a few (and I stress "few") cases where a rogue mortgage broker and/or closing officer will have handled a significant number of transactions in which amounts passing through closing were misrepresented, in aid of a scheme to misrepresent sales prices and/or the existence of "secret seconds." Where such misconduct is found, and where some lender/investor has suffered significant losses--or maybe an originating lender had to re-purchase suspect loans--the losing party may look to the escrow/closing officer--AND THE UNDERWRITER--for recovery.

These cases are few and far between--perhaps because we've tried to careful and avoid them--but when they arise they are serious trouble! When the contents of a closing file can't be reconciled with the HUD-1--we're sunk. In Claims Chronicles IV (the story from Fort Worth, TX) is told the tale of Conner Mortgage--a defunct mortgage broker that made numerous loans with misrepresentations about earnest money. The loans were insured by FHA. There ensued a nasty recession and many of the borrowers were foreclosed--leaving HUD with a lot of troubled properties to sell. HUD audited our escrow files and noticed some discrepancies--and made a claim against First American under the False Claims Act.

The False Claims Act is federal law which permits a federal agency to recover treble damages against one who provides false information to the government in connection with a government contract or program. It also permits the government to debar guilty parties from future business in connection with government-involved transactions. This is just as bad as it sounds--they can put you out of business. I haven't re-visited this subject for a while, but last I recall all of these sanctions can be imposed after a hearing before an administrative law judge.

In the Conner Mortgage case, we were blessed with good facts. There were only a few "stinker" files to be found involving First American. In the majority of cases HUD was complaining about, Conner had doctored settlement statements on its own--without the knowledge of our escrow officer--in some cases forging the escrow officer's signature to the HUD-1. So we settled with HUD for $225,000 on a handful of bad files.

These are important lessons--which shouldn't be forgotten in our training. In the situation described above--where the loan officer wants the seminar provider to show us the borrower's check for the seminar fee--the risk remains for us so long as the closing file shows this $4,000 not passing through closing, whereas the HUD-1 represents we (or our agent) handled the $4,000. Simple as that. The technically correct way to proceed is to advise the loan officer (by fax perhaps) that if the $4,000 is not handled through closing, then it will have to be set up on the HUD-1 as a "P.O.C." item--and depending on how the closing officer may look at things, the statement might not balance.

This may sound unrealistic or impractical. I expect we routinely handle loans where the lender pays itself fees or reimburses itself for expenses before sending funds for closing--and these are not shown as "P.O.C." items. This is probably the industry standard. But this practice is, at least, logical. It should never cause anyone a loss, and should never invite suspicion or scrutiny.

On the other hand, a $4,000 seminar--in connection with a home purchase--with the seminar fee paid through escrow--what is that???

We should also remind ourselves that any loan officer who routinely requests preparation of false and misleading documentation will set up their employer for legal trouble--and possible debarment--or will soon be gone. Either way, they are not good company to keep.

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