Businesses and individuals need capital to run or expand a business or to purchase assets. Financial institutions, usually banks, provide that capital through financing. To protect banks from fraudulent borrowers, Congress has enacted a series of laws aimed at criminalizing fraud. Therefore, anyone involved with obtaining financing from a bank should be cognizant that bank fraud has far reaching consequences.
In relevant part, the US Code provides how Bank Fraud occurs: “Whoever knowingly executes, or attempts to execute, a scheme or artifice—
(1) to defraud a financial institution; or
(2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises.”
In other words, obtaining or attempting to obtain bank financing by “knowingly” providing false statements is a serious crime. “Knowingly” means that the person who committed the crime knows or should have known that the crime was being committed. Note that “mistake of law”, or being unaware that a law exists, is never a defense.
A common bank fraud scenario is when a parent company moves assets from affiliate companies to obtain a bigger loan. For example, company A wants to get a line of credit for itself and for its affiliate companies X, Y and Z. A submits a statement to a potential lender providing its net worth. A then moves assets to X and provides a statement that inflates X’s worth via the asset transfer. A then does the same for Y and Z. After submitting the statements, A then transfers the assets back from Z to A. A committed three counts of bank fraud, even if the lender eventually denies the loan. What’s more, A’s intention may have been to simply get a larger line of credit if affiliate business improves but would never utilize the line of credit until then. Regardless, this is bank fraud that carries stiff penalties, even if no one was harmed.
Suppose someone is a potential buyer of a commercial property. The potential buyer has plans to develop the land by creating a mixed-use residential/commercial project. To implement the plan, the buyer approaches a bank via a mortgage broker and submits its plans for the property. While the bank shows interest, it insists on a partial personal guaranty from the potential buyer. Part of the personal guaranty process requires that the potential buyer submit a statement of net worth. The potential buyer, a seasoned real estate investor, provides a statement of net worth that depicts partial ownership and value in several multi-family properties.
As we know, submitting a statement of net worth that is “knowingly” false is bank fraud. Our potential buyer believes that he has ownership in these properties because he invested in several syndicated deals with a money manager and the money manager provides quarterly statements describing ownership and value. As we have seen recently, money manager statements describing ownership value in multi-family projects are suspect and may not be reliable.
Suppose our potential buyer is a victim of a ponzi scheme in the multi-family space and, in reality, does not have ownership interests in these properties. Has the potential buyer committed bank fraud by submitting a statement of net worth to a bank for financing when that statement describes ownership in those properties? The potential buyer believed that he had ownership interests in these properties; he based his personal statement on the money manager’s statements. Those money manager statements are not audited by an independent third party; it is industry standard for investors to obtain audited statements from their money managers. Perhaps the potential buyer did insufficient due diligence in determining whether he held those ownership interests.
In further analysis, with the “knowingly” standard as should have known, does potential buyer fall into the “should have known” category? Or does the money manager’s high level of success and strong track record make the unaudited statements sufficient that the potential buyer is not in the “should have known” category and therefore has not “knowingly” attempted to fraudulently obtain bank financing?
In sum, bank fraud is a serious crime, even without corrupt intentions. It is applicable if the person committing fraud should have known that it was fraud and even if the financing is ultimately denied. To that end, where someone is seeking bank financing, it may be advisable to make sure your house is in order before submitting anything to the bank. This includes an analysis of how you are determining your net worth.