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Almost a decade ago, before mortgage fraud was tied to a greater economic calamity, a small group of real estate professionals set out on a scheme to illegally sell and buy houses in Mecklenburg and surrounding counties.
The acts themselves were unspectacular, according to federal documents. In fact, they were a sampling of basic mortgage fraud schemes, including flipping houses and lying about who would live in them. But the cumulative damage has amounted to one of the largest mortgage fraud cases in Mecklenburg history – more than 200 houses and about $15 million in fraudulent loans.
At least five men in the group have pleaded guilty. A woman, Victoria Sprouse, goes to trial Monday in federal court.
Sprouse, a Charlotte real estate attorney, was at the center of the crimes, court documents say. She is accused of lying to lenders, falsifying settlement statements and stealing from her clients while reaping millions of dollars for her and co-conspirators – including two mortgage brokers, two real estate agents and an appraiser.
Sprouse, 38, is charged with bank fraud, mail fraud, money laundering and perjury. If convicted on all charges, she could spend more than 25 years – possibly the rest of her life – in prison.
Sprouse refused last week to talk to an Observer reporter about the charges against her. Defense lawyer Pete Anderson, who represented her during the government's investigation and in the months following her indictment, said Sprouse had always maintained her innocence.
“My client is a real estate lawyer who was victimized by mortgage fraudsters who hired her for certain property closings, but kept her in the dark about their improper practices,” Anderson said.
The mortgage schemes began in 2000, prosecutors say, and ended in 2004, the same year Chris Swecker, then an FBI assistant director and former head of the agency in North Carolina, warned Congress that mortgage fraud could “place financial institutions at risk and have adverse effects on the stock market.” One casualty: nBank, a 103-year-old Georgia institution that closed in 2007 in part because of mortgage fraud losses, including from the Sprouse case.
While house flipping schemes may not be as prevalent as the subprime loans – legal and illegal – that led in part to the current U.S. and global financial crisis, experts say they are part of the mosaic of mortgage deceit that contributed to the credit collapse.
“Everybody has been playing fast and loose,” said FBI agent John Wydra, who's in charge of white collar crime investigations in North Carolina. “It's greed. It's not just corporations. It's not just Wall Street. It's Main Street.”
The Sprouse case
Sprouse, a Virginia native, began practicing law in North Carolina in 1997. Friends say she is honest, dependable, a Red Cross donor.
She is accused, however, of participating in three mortgage fraud schemes that involved mortgage brokers, real estate agents, appraisers and investors. In a brief outlining their case against Sprouse, Assistant U.S. Attorneys Matthew Martens and Kurt Meyers say the crimes generated more than $5 million in proceeds for the conspirators.
“The conspirators lied about nearly everything as part of their scheme to flip-sell homes …,” the prosecutors wrote. “The flip scheme was strikingly simplistic – the conspirators would buy and then flip-sell properties, often on or about the same day, stealing tens of thousands of dollars with each flip.” In a flip scheme, a buyer purchases and sells a property in simultaneous closings, selling the property for a higher and sometimes artificial value set by an appraiser. Exaggerated appraisals can deceive lenders into giving loans for far more than a house is worth.
Michael Gee, who has pleaded guilty to his role, wrote appraisals for the inflated value for the second half of the flip, and lied about the owners of the properties to hide the flip, according to prosecutors.
It was impossible, prosecutors allege, for Gee to insert the wrong name into the owner section of the appraisal by mistake.
“It would be just as likely for defendant Gee to write next month's winning Powerball lottery number by mistake,” prosecutors wrote.
Michael Pahutski, who has also pleaded guilty, prepared the mortgage loan applications. Prosecutors say he prepared and submitted false bank statements, false tax returns and false loan applications for borrowers.
“Sprouse was the closing attorney who conducted the closings for both sides of the flip, handled the money and lied to the lenders about where the money came from and how it was handled,” prosecutors allege.
Sprouse also is accused of participating in what prosecutors described as the “Decorator Disbursement Scheme” and the “Primary Residence Scheme.”
In the decorator disbursement scheme, a builder would give part of the purchase price back to an investor under the guise of a “decorator allowance.” Such kickbacks gave cash to buyers while allowing the sellers to artificially inflate the value of the homes.
In the primary residence scheme, the buyer's intent to live in the property is falsely represented on mortgage loan applications. Claiming that borrowers will occupy the homes often results in better loan terms, including better interest rates and lower down payments.
Prosecutors cited the example of a buyer identified as “Ms. BB.”
“Ms. BB closed three primary residence purchases with three different lenders with defendant Sprouse – on Dec. 31, 2002, four weeks later on Jan. 24, 2003 and then again two months later on March 28, 2003,” prosecutors wrote.
Prosecutors allege that Sprouse received more than $800,000 from First Charter Bank for fraudulent loans, and used that money to pay off loan balances at nBank to cover up her own fraud.
Time and time again, prosecutors allege, Sprouse accepted purported down-payment checks from an investor while falsely certifying on settlement statements that the checks had been provided by the buyer.
Prosecutors say Sprouse falsely certified that buyers had signed documents in her presence.
“The buyers and sellers often had their names simply forged,” the prosecutors wrote. “In other instances … the buyer or seller did appear to sign the notarized document, but defendant Sprouse falsified when they appeared.”
Sprouse also is accused of falsifying the owner on the preliminary title opinions.
Prosecutors, citing one example, say Sprouse falsely certified that K.C. was the owner of property from May 30, 1998, to January 18, 2002. In truth, prosecutors said, K.C. did not own the property and never had owned the property.“Defendant Sprouse knew this because two weeks later…she herself conducted the closing in which K.C. for the first time purchased the property from ‘A' for $42,500,” prosecutors alleged in the brief.
“The same day, defendant Sprouse conducted the closing in which K.C. sold the property … for $78,000, a one day price increase of 54 percent.”
Anderson, Sprouse's former lawyer, said Sprouse intends to prove her innocence. He said Sprouse fully cooperated during the government's investigation and turned over thousands of pages of documents and real estate records.
“She made some mistakes,” Anderson told the Observer. “She didn't keep track of deposits coming in and checks going out. She didn't run her office in a responsible manner. It was sloppy. But mistakes and sloppiness are not crimes.”
Loan crisis
Economists and analysts caution that house-flipping schemes are one of many contributors to the country's economic crisis.
“This kind of fraud has been going on for years,” says Randall LaSalle, an economics professor at John Jay College. “It's added to the crisis, but it's not the primary cause.”
The root of the problem: an explosion of loans – both legal and illegal – given to ill-equipped homebuyers by lenders willing to exploit a reckless mortgage environment.
That climate flourished in the past two decades as the Clinton and Bush administrations made increased homeownership a policy goal, prompting the Department of Housing and Urban Development to loosen eligibility requirements for FHA loans. Homeowners were allowed to borrow more money relative to their incomes, and many were permitted to effectively forgo making a down payment.
The FHA also guaranteed repayment of their mortgage loans, allowing lenders to take more chances, because the government took on the risk of default. Loosened regulations also resulted in the spawning of high-interest lenders willing to take on riskier borrowers with subprime loans.
Loans also were sold in initially profitable packages by Wall Street investors, who clamored for more.
“Wall Street encouraged lenders to loosen underwriting so they could do more loans and get them out faster (on the market),” said Mark Pearce, deputy commissioner for the N.C. Banking Commission.
The softer loan requirements were fertile ground not only for application fraud, such as misstating income in order to qualify for a loan, but also more elaborate schemes such as house flipping. “It created an environment where you get these folks who want to make big money,” said Pearce. “And they find each other.”
The result: As much as $15billion in losses from mortgage fraud, experts say, largely from defaulted loans.
But, says Pearce and other experts, the fraud alone was not enough to ravage the economy, which now is facing losses in the trillions. That came from lenders and investors packaging and selling risky loans – and “insuring” those loans in the form of credit default swaps. While doing so, the lenders, buyers and rating agencies failed to properly assess the mortgages they were buying and selling – or ignored the risk in the face of fast profit.
“Rating agencies were willing to give AAA ratings (little to zero risk of default) to stuff that was literally known in the market as toxic waste,” said William Black, a former federal regulator and now professor at the University of Missouri-Kansas City.
When many of the mortgages began defaulting, the losses exponentially increased.
Said Pearce: “Fifteen billion (in mortgage fraud losses) can turn into 30, 40, 50 billion.”
Pearce said his office is seeing a greater percentage of mortgage fraud schemes, such as house flipping, as lenders have tightened loan criteria, leaving fewer ways to exploit the system. About half of North Carolina's mortgage brokers have gone out of business in the past year, he said, and some who remain are getting desperate about surviving.
The FBI is reporting a nationwide increase in all types of fraud. Pending cases and reported suspicious activity have risen in each of the last five years.
Its impact continues to strain not only the economy, but the streets and neighborhoods in counties like Mecklenburg. Foreclosures from mortgage fraud have added to the devastation, decreasing the value of surrounding properties and leading to more defaults when neighbors have tried to sell their homes.
In the 19 homes cited on the federal indictment of Victoria Sprouse, at least 10 have gone into foreclosure, the Observer found.
“When these fraud transactions unravel and those loans go bad, innocent people are hurt,” Pearce said. “It's all part of a chain. Everyone, all the way down the line, is to blame.”
