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The Impact of Bankruptcy and Mortgage Fraud On Your Business

Filed under Detecting & Deterring Fraud. Fact checked on May 24, 2012.

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Bankruptcy fraud is a federal offense, but that won't help you if you're left holding uncollectible debt. Mortgage fraud is also a serious problem, particularly in light of the recent revelations of improprieties in their issuance.

Bankruptcy and mortgage fraud had grown quite rampant, so much so that laws in these two areas have been strengthened in recent years. While the crackdown on these types of fraud should help, it doesn't mean you should let your guard down because these frauds still exist.

Bankruptcy Fraud Is a Federal Crime

Bankruptcy is tried in federal civil court, but bankruptcy fraud comes under the federal criminal court system. Bankruptcy fraud is a very major federal crime. The consequences can be severe.

The Fraud: Concealing property is the major form of bankruptcy fraud. Seven out of ten bankruptcy frauds involve concealment in one form or another. Failing to list all assets when filing for protection in bankruptcy court and hiding those assets by transferring them to relatives or cohorts makes it impossible for creditors to liquidate them and secure what's owed them. (This is also a common divorce action strategy.)

Busting out is an infamous twist on bankruptcy fraud. A bustout occurs when a new business is formed, credit relationships are established with suppliers, and an inventory is built up. The inventory is either quickly sold off at a discount or trucked to some hidden location and the proprietor can't be found. Creditors are forced to file involuntary bankruptcy against the fraudster business, but can never collect their losses.

Yet another common bankruptcy fraud is filing in more than one state at a time.

The Flaw: In the past few years, the bankruptcy laws have been tightened up, but where there's a will, there's a way to con unwary vendors too anxious to record a sale.

The Fix: Creditors must be more selective as to who they sell to on an open account. Sales should be secured by collateral of some sort if at all possible. Secured creditors come out better than unsecured creditors, but not by much.

Mortgage Fraud Continues in Depressed Housing Market

The recent reliance of all kinds of lenders on third-party mortgage brokers has contributed mightily to the sub-prime meltdown we've experienced lately. Independent mortgage brokers are largely honest, but there is an element of organized fraudsters invading this field.

The Fraud: Fraudsters have committed or colluded in a long list of a variety of mortgage frauds, a few being:

  • broker-facilitated fraud
  • loan documentation fraud
  • short sales
  • foreclosure rescue scams
  • appraisal fraud

In addition, some homebuyers are also committing fraud by filing untruthful documents or lying about their ability to repay. Unscrupulous brokers and unworthy buyers make for a bad combination when it comes to mortgage fraud.

The Flaw: Lenders did not do due diligence. Unqualified applicants were automatically approved as the total of loans made was the goal, not the quality of the borrowers. This is another case of a compensation system encouraging fraud.

Moreover, government regulation encouraged the lending of mortgages to unqualified buyers, in the goal of expanding ownership among groups of people who historically haven't owned their homes.

The Fix: Vigorous due diligence to qualify applicants and adherence to the government's Suspicious Activity Reporting system methodology will be given close attention going forward. Compensation systems will also likely undergo significant changes.

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