Tackling deception

Professional Indemnity Insurance (PII) is currently one of the largest issues affecting law firms, the Law Society, and the conveyancing industry as a whole. PII premiums have been recently skyrocketing, in part due to the increase in fraudulent activity within the conveyancing sector and beyond.

According to an analysis of fraud trends by CIFAS, the UK’s Fraud Prevention Service, there has been a 14 percent jump in identity fraud during the first half of 2010 compared with the same period in 2009. There were also more than 50,000 victims of impersonation recorded by CIFAS’s 265 members during the first six months of the year, an increase of 22 percent from the same period in 2009. This means that the identities of 275 innocent victims are being misappropriated every day.

Providing false documents to banks and other lenders is another fast-growing area of mortgage fraud in the UK. In fact, four men where jailed earlier on this year for deceiving HBOS and Abbey for funds in the region of £8m after they bombarded lenders with false mortgage applications. More cases are likely to follow and the City of London Police has reportedly been working on around 15 separate investigations into organised mortgage fraud networks.

For once, the hype can actually be believed. A huge amount of fraud is occurring in the UK right now. Not only is the current scale of this problem alarming, but CIFAS have warned that the situation looks likely to get worse, despite a greater awareness of identity fraud among the general public.

The good news is that most fraud can be tackled with relative ease. By using appropriate anti-money laundering and anti-fraud controls to vet both UK and foreign nationals; law firms are now in a much stronger position to signpost the risks before disaster strikes, and therefore building credibility with lenders and the Solicitors Regulation Authority (SRA) in the process. This proactive approach is especially important for smaller firms and sole traders, since lenders are becoming increasingly wary of this group in particular.

Regardless of size, law firms need to make a serious and sustainable commitment to these steps. They need to be continually reviewed so that client profiles are regularly monitored for any potential warning signs. Without this approach, we can only expect to see PII rise even more frequently, leading to even greater consolidation in the industry.

The property market, in particular, is well known as a high-risk area for fraud. In fact, a Law Society Mortgage Fraud Practice Note issued in March 2008 specifically warned that criminals have been exploiting weaknesses in lending and conveyancing systems for sometime. While Money Laundering Reporting Officers may have a good grasp of the issues surrounding compliance and regulation in general, they do not always understand some of the risks that are unique to conveyancing. Therefore, many need to educate themselves on the specific workings of the conveyancing process in order to recognise the important warning signs.

In the modern world, even simple property transactions are now conducted on a global scale. When a tower block is sold in London, for example, there is a good chance that at least some inbound capital has been used to finance the purchase. Firms will need to clearly determine not only where these funds are coming from, but also whether there are any other parties who may be involved in financing the purchase “behind the scenes”.

With international transactions like this now commonplace, it’s easy to see why global identity checks are so important in the fight against mortgage fraud. All of this information – especially the source of the funding – needs to be verified accurately. In other words, just because this capital has come from a bank doesn’t mean that it’s safe. Firms need to verify bank accounts and statements carefully, especially since keeping a detailed evidence trail is very important in cases like these. The Council of Mortgage Lenders will not hesitate to pass on the responsibility for any fraudulent activity to the conveyancer, where possible.

Although the ‘Know Your Customer’ due diligence regulation has become a ubiquitous part of due diligence in many sectors now, it still has a special relevance in the conveyancing sector because of the prevalence of mortgage fraud. The sharp contraction in lending has led to many more customers making false claims to secure loans, which in turn has led to an increase in this kind of fraud in particular. As a result, lenders are making a lot of negligent claims against law firms – and PII continues to rise exponentially.

In order to protect themselves, firms need to ensure that they are following the guidance in the Law Society’s ‘green card’ warning on property fraud and ‘blue card’ warning on money laundering to ensure that they are taking reasonable steps to check the identity of their clients (including anyone who is required to sign the mortgage deed or other document connected with the mortgage). It’s worth remembering that lenders are usually calling the shots here, as they are giving most of the instructions at the moment – which ultimately means that firms need to take any steps necessary to avoid falling foul of lenders.

Problems associated with fraud go beyond just conveyancing, however, and now extend to any kind of commercial transaction, including areas like probate. Staff vetting during the recruitment process is also vital. All companies, regardless of their specific industry, will want to ensure that they don’t have a “spy in the camp” as a result of inadequate employee vetting during the recruitment process, since this could have a disastrous effect on the business, both financially and in terms of reputation to customers.

This is especially true in the legal sector, in which reputation counts for so much. What would happen, for example, if a rogue employee used the firm’s letterhead to commit fraud? Not only would the legal and financial repercussions be hugely severe in the short term, but the long term damage to the firm’s reputation and brand value would be disastrous. For all of these reasons, the ability to guard against fraud-related activity and to positively ID a wide range of individuals – including both clients and employees – has never been more important.

In one high profile case reported at the end of last year, the Solicitors Disciplinary Tribunal (SDT) ordered that a solicitor based in Sheffield should be suspended from practice as a solicitor for an indefinite period, as he had recklessly acted in breach of the first rule of the Solicitor’s Code – “You must act with integrity” – in relation to conveyancing matters where there had been signs of mortgage fraud.

The allegations that the SDT had found against the above solicitor were very serious. According to the SDT’s notes, the individual concerned had been extremely reckless in his practice of conveyancing, had failed to appreciate his duties to lender clients and had acted in flagrant disregard of the Green Card Warnings. As such, and in order to protect the public and to maintain confidence in the profession, the SDT determined that it was necessary to suspend him from practice as a solicitor for an indefinite period of time.

Another recent case involving a law firm based in Newcastle was equally serious. The SDT ordered that one of the firm’s solicitors should be struck off the roll for misleading the Solicitors Regulation Authority during its investigations. The solicitor had ignored the Law Society’s warnings relating to property fraud, acted in circumstances where the purpose had been designed to disguise the ownership of property to avoid his client’s liabilities, making misrepresentations to HMRC – the list goes on and on.

The allegations, as proved against him, involved huge losses to clients and considerable damage to the reputation of the profession. As such, and to reflect his key role in all these matters, he was ordered to pay costs in excess of £100,000.

Along with the SDT, the SRA has also stepped up its fight against solicitor involvement in fraud through new appointments to its investigative team, and by a concerted programme of investigation. An estimated 106 firms were investigated by the SRA last year as part of this clamp down, resulting in the closure of 22 firms and the referral of 26 firms to the police.

Whether these claims were a result of dishonesty or pure negligence, law firms need to take the steps necessary to protect themselves against this kind of activity, as well as making sure that they are complying with all current anti-fraud regulations. A new online Foreign National search system now available to law firms is making this much easier, as it is now possible to scan a wide range of databases, covering more than 240 countries.

Systems like these should form a key part of an effective risk-management strategy, since they are essential for protecting the firm against any potential claims made by a lender. For example, a bank could claim that it was misled by information passed on by a law firm and assert that the firm should have provided it with more details of the client and/or transaction to help support its decision as to whether or not to provide funding.

Not only are claims like these on the rise, but insurers regularly complain that solicitors faced with these situations have the worst claims experience of any profession, with a loss ratio of over 90 percent in many cases, according to recent reports. This means that, for every pound in premiums they collect, they pay out 90p in claims, and that is before expenses and profit are factored in.

PII premiums have therefore jumped considerably as insurers seek to cushion themselves from potential mortgage fraud. Insurers are becoming increasingly interested in examining how well risk is managed before agreeing to engage with a law firm, and many firms are now leaving the market all together. An effective and comprehensive risk management strategy – including regular ID checks on a global scale – needs to be introduced as a matter of urgency for all firms. Not only that, but senior partners need to buy into this commitment, and understand that this needs to be more than just a tick-box exercise.