Finding Solutions to Protect Escrow Funds
April 10, 2012
Massive losses directly related to agent defalcations have brought increased scrutiny to the title insurance industry. Underwriters have absorbed staggering losses because of the actions of their agents and settlement agents have been rendered insolvent because of employee embezzlements. State regulators have enacted regulation while legislation has been passed to more closely regulate the industry. Meanwhile, underwriters are considering massive changes in escrow accounting standards.
The prolonged economic depression has put increased pressure on every part of mortgage finance. Not only have bank lending practices been scrutinized and appraisal standards tightened, escrow theft within the title industry is being questioned because it has resulted in the failure of several agencies and insurers.
The agency-principal relationship between a title underwriter and a policy-issuing agent or approved attorney has been limited to the issuance of a title insurance policy. While contracts between title insurers and their agents specifically exclude closing and escrow activities, more states are mandating closing protection letters or holding underwriters vicariously liable for the market conduct of agents.
“When theft of escrow funds occurs, consumers are harmed, business partners lose trust, and the credibility of the entire title industry is damaged,” said Michelle Korsmo, ALTA’s chief executive officer. “It is already difficult to explain to consumers the value of title insurance, and each report of escrow theft reinforces the perception that the industry provides little value to consumers. The industry must embrace a zero-tolerance standard and demonstrate to the public that escrow theft is unacceptable and treat any escrow theft as the most offensive of any professional misconduct.”
ALTA, Industry Respond
Korsmo said the industry must promote that it takes a number of steps to prevent defalcations, “and that in the rare event that escrow theft occurs, we have an orderly way of compensating victims and making them whole.” Over the past year, ALTA has led efforts to develop industry solutions. One option is creating a standardized agency agreement between title agents and insurers outlining minimum requirements for:
- balancing escrow accounts;
- making escrow accounts available for audit;
- promptly reporting risk to the appropriate insurer;
- complying with the law;
- complying with underwriting standards of the appropriate insurer;
- timely remittance of premiums; and
- timely remittance of policy data.
Other proposed solutions include additional and expanded insurance coverage for agent surety bonds and fidelity bonds; a new type of insurance policy to cover against fraud, dishonesty and negligence of escrow agents in handling funds and documents; an industry ombudsman to respond to consumer complaints and wrongdoing; a national agent database to identify whether an agent is authorized to issue policies on behalf of an insurer and whether they are in good standing, terminated or cancelled; centralized or standardized agent audits; real-time monitoring of agent escrow accounts by insurers; a national net-funding mechanism for bank-to-bank transactions; and establishing an industry-wide self-regulatory organization (similar to the National Association of Realtors) to set minimum standards, enforcement mechanisms and a structure to compensate consumers who are victims of escrow theft.
“If the industry fails to come up with its own solutions, there will be very little that anyone will be able to do to prevent regulators from forcing solutions upon us,” Pellegrini said. “These mandates may have undesired consequences for both agents and underwriters.”
Additionally, ALTA is working with MISMO on two technology pieces that would be utilized in combating escrow theft. One solution is eRemittance that will support an underwriter’s request for information about closed transactions and the agent’s response with transaction details including premium amount. The second solution is eAgentValidation, which will support a request for agent status from a lender or LOS and the response from an underwriter indicating whether or not the agent remains in good standing. “It’s the industry’s responsibility to take steps to curb escrow theft,” said Erika Meinhardt, president of National Agency Operations for Fidelity National Title Group. “By proposing industry solutions, we can minimize the unintended consequences on business practices that come from regulatory action and court decisions.”
Many in the industry believe pushing more liability for agent actions onto underwriters could ultimately result in the reduction of appointed agents, prohibiting agents from performing closings and withdrawal from markets or entire states, resulting in underserved markets. If more states adopt a strict liability concept, agents also may be forced to prepare for premium split adjustments because reserves will be impacted.
“If this trend continues, independent agents will find that no underwriter will agree to appoint them and they will disappear,” said Bob Philo, attorney at Title Experts and Management Services.
In 2011, three underwriters were forced to cease issuing new policies because of solvency issues stemming from defalcations and an increase in claims. In February, New York-domiciled Washington Title Insurance Co. became insolvent after reporting higher than normal claims. In July, New Jersey Title Insurance Co. stopped issuing new commitments due to a dramatic increase in losses stemming from agent and/or closing attorney defalcations. One of its agents, TitleServ, abruptly closed in April 2011. Lawsuits against the company say more than $18 million is missing.
Meanwhile, in September, Southern Title Insurance Corp. suspended issuing new policies due to a significant defalcation by a former title agent coupled with a spike in claims. The underwriter has since been placed into receivership.
While escrow theft and regulating solvency of both title agents and underwriters were two main issues addressed by the National Association of Insurance Commissioners (NAIC) last year, it will remain a priority of the NAIC’s Title Insurance (C) Task Force in 2012.
According to its 2012 agenda, the Task Force is expected to coordinate with the Financial Condition (E) Committee to modernize the solvency regulation of title insurance. These efforts may include determining the attributes of recent title company financial failures and developing risk-based capital requirements, early warning tools and risk-focused financial examination guidelines for title insurers.
The Task Force will also examine ways to mitigate the impact of title insurer and agent insolvencies on policyholders. Such efforts may include promoting the use of blanket lender’s policies and individual owner’s policies to replace policies issued by insolvent insurers; examining the financial failures of title agents; and promoting the use of Closing Protection Letters to mitigate title agent defalcations.
Last year, the NAIC appointed three new working groups focused on different aspects of the title industry. The Title Insurance Market Conduct and Mortgage Fraud (C) Working Group will review and assist various regulatory bodies in combating fraudulent or unfair real estate settlement activities. Meanwhile, the Title Insurance Financial Reporting (C) Working Group will consider the effectiveness of recent changes in financial reporting by title insurance companies related to the Title Agent Statistical Data Plan Implementation Guideline and to identify further improvements and clarifications to Blanks, instructions, Statements of Statutory Accounting Principles (SSAPs) and other matters. A Title Insurance Guaranty Fund (C) Working Group has been appointed to consider whether a title insurance guaranty fund model law or guideline should be developed.
“Regulators are insisting more and more that underwriters stand behind their escrow agents,” Pellegrini said. “Over the years, experience has led to the perception that the industry has given the title agent free access to the underwriter’s checkbook. We don’t have to go too far to see the defalcations and agents making off with escrow funds. The underwriters have assumed a lot of the liability over the years and don’t have the appetite to take it on the front end.”
Jeff Trout, of the Law Office of Jeffery Troutt in Juneau, Alaska, believes that creating a culture of compliance is a needed solution. He said improved communication between underwriters and agents, and improved relationships with regulators, would also help.
“Improving the compliance area would help the industry substantially,” said Troutt, who served as deputy director for Alaska’s Division of Insurance from 2005 to 2009. “Regulators have lots of problem areas, and they consider title to be one of them. It would not take a lot of improvement in the compliance area to persuade regulators that there are better industries to target.”
Recently, several states including Nebraska, Illinois, Minnesota, Washington and Maryland have ventured into the territory of expanding agent liability to the underwriters. In 2004, Nebraska passed a strict liability statute for theft of escrow funds. The legislation requires a title insurer to issue closing or settlement protection covering a proposed insured if the title insurer issues a commitment or title insurance policy. According to the legislation, underwriters are liable for the loss if the title agent steals the settlement funds or fails to comply with written closing instructions.
Mired in several defalcations, including the abrupt closure of Guaranty Title Co., with more than $4.5 million missing from its escrow accounts, Missouri passed an insurance reform bill in 2007 aimed at protecting consumers and improving the title insurance industry. The legislation outlines conditions for maintaining escrow and security deposit accounts, prohibits misuse or commingling of real estate closing or settlement funds, with tight restrictions for deposits and disbursements; and requires title companies to actively oversee title agencies writing business on their behalf by conducting annual audits of escrow, underwriting and claims practices.
To implement the law, the insurance director appointed a Title Insurance Advisory Committee to work with the department to come up with the best ways to administer the provisions and create regulations.
Following a $91 million fraud case and the 2005 convictions of the owners of Chicago-based Intercounty Title, Illinois enacted legislation requiring title insurance companies to maintain reserves for losses independent of any other form of insurance and also provides that title insurance agents acting as escrow agents must deposit funds in separate fiduciary accounts. Problems persisted in Illinois, which ultimately led to CPL legislation being enacted in January 2011 after it was discovered a title agent continued to issue policies and close deals after it was cancelled by its underwriter. The underwriter took the position that it wasn’t responsible for the agent’s acts because it had terminated its relationship with the agent.
This created a firestorm resulting in the regulator saying that unless underwriters were prepared to stand by their agents, it wouldn’t register any new agents or allow the continued re-registration of current agents. The entire agency framework faced dismantling. The Illinois Land Title Association worked with the regulators to develop legislation that would protect consumers. Effective Jan. 1, 2011, Illinois title agents are now required to issue Closing Protection Letters to all buyers, borrowers and lenders involved in all real estate closings. The law applies to a title agent who closes the transaction and disburses the funds. It does not apply to an agent that is only doing title work and is not acting as an escrow agent. The law applies to all residential real estate transactions and all non-residential real estate transactions under $2 million.
In 2009, New York formed a Mortgage and Title Unit to fight thefts committed by members of the title industry. The unit focuses on investigating complaints of alleged fraud involving title insurance transactions.
The state’s insurance department cited arrests of two men accused of stealing more than $7 million in title insurance premiums and settlement funds.
In May 2009, Brian H. Madden, the president of N.Y.-based Liberty Title Agency LLC, was arrested for allegedly misappropriating more than $5 million in real estate transaction fees collected from property sellers and buyers and supposed to be paid to municipalities. In September, a federal court sentenced him to 20 months in prison.
In July 2009, Jonathan Boxman, owner of Titledge Insurance Company of New York, was arrested for allegedly defrauding title insurance clients of more than $1.7 million. In September, a federal court sentenced Boxman to six months in prison.
Defalcations have spurred other states to pass legislation over the past few years.
Last year, Minnesota attempted to pass a strict liability statute similar to Nebraska. The bill would have made title insurers liable for defalcations made by appointed title agents. If no title insurance commitment or title insurance policy was issued in a transaction, each title insurer that appointed or maintained a written contract with the title agent at the time of the discovery of the defalcation, would have shared in the liability.
The proposed legislation would have required closing agents to have a net worth of at least $250,000, a surety bond in the amount of at least $100,000 and an errors and omissions insurance policy of at least $500,000. Meanwhile, Maryland regulators in 2011 pressed for new CPL and solvency legislation, but nothing has been passed so far.
While many states have varying CPL requirements, ALTA also provides customers protection in connection to escrow closing activities. ALTA developed a CPL in 1987 that reimbursed the customer named in the letter for losses incurred under certain conditions and as the result of certain actions or inactions by the issuing agent or approved attorney. The title insurer is liable for such reimbursement only when the customer is purchasing the title company’s policy. ALTA has revised the CPLs over the years. In December 2011, revised CPLs went into effect for single and multiple transactions to clarify the coverage and amount of liability under the CPL. Each CPL now contains a limitation on the size of the covered transaction that may be established in the letter. The blanket CPL without a limit on the size of a covered transaction that was approved by ALTA in 2008 was decertified.
The following provision in the single and multiple transaction CPLs clarifies the amount of coverage: The Company’s liability for loss under this letter shall not exceed the least of:
- the amount of your settlement funds;
- the Company’s liability under its title insurance policy at the time written notice of a claim is made under this letter; or
- the value of the lien of the insured mortgage or the interest in the land insured or to be insured under the Company’s title insurance policy at the time written notice of a claim is made under this letter.
In the courts, liability for the fraud is still being allocated and decisions have been mixed. In one important decision in 2010, the Virginia Bankruptcy Court in Gold v. Old Republic National Title Insurance Co. ruled that a closing agent was the agent for the underwriter only for the limited purpose of issuing title insurance, not for purposes of recording the mortgages to be insured.
Meanwhile, the New Jersey Supreme Court ruled in 2010 that underwriters are not liable for defalcations. The Court decided Stewart Title Guaranty was not liable for money a disbarred attorney stole from his clients because the misappropriation of funds took place before the attorney acted as the underwriter’s agent.
In overturning an appellate court’s ruling in New Jersey Lawyers’ Funds for Client Protection v. Stewart Title Guaranty Co., Justice John Wallace Jr. wrote that “no agency relationship existed between (the attorney) and the Title Company at the time the funds were misappropriated.”
Meanwhile in Washington, a judge in 2009 affirmed that the state insurance commissioner may hold an underwriter liable for the actions of the company’s appointed agent.
There are also several options available in the marketplace aimed at mitigating fraudulent activity and defalcations. Wells Fargo Home Mortgage has a system that will send a message to the agent’s underwriters to get confirmation that the agent is in good standing. While the current accepted industry standard for account reconciliation of settlement funds is 30 days, RynohLive offers software to companies wanting to mitigate escrow losses by providing automated daily account reconciliation and positive pay functions.
“Every day it seems that there is another announcement of an agency owner being indicted or convicted,” said Dick Reass, president of RynohLive. “This has outraged regulators and consumers, and has altered the underwriter/agent relationship. Our industry is under increasing scrutiny, and it will no longer be business as usual.”
PCN Closings offers an online centralized disbursement service aimed at eliminating the risk of agent misappropriation of escrow funds. Through the service, escrow accounts are managed independently by PCN and segregated by agent. The company says it maintains high levels of fraud and liability insurance and is committed to bonding its employees for disbursement services. The company said underwriters will be able to assist their agent base in reducing the escrow account risk, which may save on employee and insurance costs.
“The agent will maintain the present level of control, with the exception of managing the escrow account and funding the transactions,” said Pritam Advani, president and chief executive officer of PCN Closings. “This is a key issue because PCN wants the agent to maintain the file control, preserving the business relationship while not having to deal with writing checks, reconciling accounts and going through audits. This will make for a smooth transition and an excellent working environment for all parties.”
He said underwriter risk is reduced or eliminated because an independent third party adds a level of checks and balances, has a professionally managed and controlled disbursement operation and ensures that all accounts are reconciled and balanced to the file level each day.
“A lot of large underwriters are cutting back on smaller agents saying it’s too expensive because there is not enough volume. An option might be to use a smaller agent, if they agree to this platform, because the underwriter doesn’t have to send an audit team out to the agent,” Advani said.
By not offering escrow services, title agents may also be able to reduce expenses by not staffing for disbursements or managing escrow accounts, or eliminating extra insurance coverage for escrow responsibilities.
“The solution doesn’t have to be across the board,” said Tom Frunzi, president of the Phenix Group Inc, who has been retained to help market PCN’s escrow disbursement solution. “Look at your book of agents and segregate it based on risk category. If you have 1,000 agents and you know 150 of them had some type of reconciliation problem in the past, then those are the prime candidates. Or you could take any loan over a given amount and disburse those through an independent third party.”
Another option keeps agents in control of disbursements. Last year, ATS Secured unveiled a platform that allows title agents to electronically disburse and reconcile files. It provides full audit trails for authorized participants and establishes dual controls for funds disbursement.
“There are many potential solutions available and individual companies must decide how they want to respond to this problem,” Korsmo said. “Additionally, there are a number of steps that title industry professionals should identify to reduce the occurrence of escrow theft. These steps should be communicated to regulators and the public to create awareness that the title industry is serious about combating this criminal behavior.”
This article appeared in the February edition of TitleNews. You can download the edition here.
For more info:
- ALTA submits suggested outline for NAIC escrow theft white paper.
- The Nebraska Department of Insurance also has provided a draft outline.