Case Illustrates Hurdles In Bank Reform: Swamped Regulators Have To Rely On Applicants’ Honesty [The Hartford Courant, Conn.]

July 18--In mid-2007, just months after the catastrophic meltdown of Mortgage Lenders Network in Middletown, regulators were clamping down on the rules for state-licensed subprime home mortgage companies.

At the same time, the founders of Maverick Funding Corp. in New Jersey were busy launching their new mortgage lending company and seeking licenses from at least a dozen states, including Connecticut.

But as Maverick applied for its Connecticut license, it failed to mention one thing: Its founders were embroiled in a civil lawsuit that accused them of acts of fraud, negligence and conspiracy at a previous mortgage company.

Connecticut state law requires mortgage brokers and bankers to disclose any pending civil litigation when they apply for a license, or at any time after it is granted. But Connecticut banking regulators didn't learn about the litigation until this spring, more than two years after the original license was issued, and then, only after a complaint from the public, according to an internal banking department document obtained by The Courant.

While reforms crafted in marbled legislative halls make for good political rhetoric, the Maverick case illustrates the difficulty faced by state regulators in carrying out those reforms. Regulators still depend on applicants to be truthful because they are stretched too thin to keep ensuring that mortgage companies comply with all laws.

State Banking Commissioner Howard Pitkin confirmed last week that his department is investigating the Maverick case, but he declined further comment. But the internal memo, dated May 6, indicates that the investigation is well underway, touched off by a complaint last November.

The near-meltdown of the nation's financial system and its mortgage industry -- at the heart of reasons the country plunged into a deep, devastating recession -- sparked a massive push for reform that has been played out for three years in Connecticut and across the country, as well as in Washington.

Congress has now put the finishing touches on the largest overhaul of the nation's financial system in more than a generation. The reform fast-tracked a nationwide registry in which consumers can check to see if mortgage brokers or mortgage companies like Maverick are licensed.

But the power of reforms rests in large part on the honesty of the very people the rules are meant to oversee.

"Given the number of applications, the banking department doesn't have the staff to check every piece of information, so it's important that they tell the truth," said Patricia McCoy, a professor of banking and securities law at the University of Connecticut's School of Law. "So it's important if there is a serious concern about a falsehood that they open an inquiry. That helps restore faith in the system."

That faith has been tested in the recent mortgage crisis, in which allegations of fraud have surfaced at both well-known and obscure firms.

"Honestly, mortgage bankers have to earn that confidence back," McCoy said.

Maverick officials say there was no intention to mislead regulators. When the company was applying for licenses in 2007 it was dealing with multiple states, each having slightly different requirements, they said, adding that it is possible the question could have been misunderstood.

John Edwards, a lawyer representing Maverick, downplayed the significance of failing to disclose litigation. When the company was asked for more information this spring by regulators in Connecticut, it provided a detailed response, he said.

Edwards said the company wasn't aware of the lapse in reporting until informed by regulators, and when it was, it responded quickly.

"Maverick has an excellent record of compliance," Edwards said.

In April, Maverick provided Connecticut regulators with an outline of litigation in which the company is involved, according to the May 6 memorandum.

"This information was provided only on response to a compliance letter sent from this department requesting such information," according to the memorandum. "Prior to this response, Maverick and its officers have not provided any information to indicate any civil suits had been brought against them in any capacity."

Fraud Alleged

Maverick, based in Parsippany, N.J., was founded by longtime business associates Michael Petruccelli and Ralph Vitiello, who previously controlled the operations of another New Jersey company, Rose Mortgage. Rose made subprime home loans, and it closed in early 2007.

The civil litigation not reported to regulators in Connecticut and other states involved a transaction at Rose in 2002. The 2007 lawsuit alleged that both Petruccelli and Vitiello committed fraud, negligence and conspiracy by selling a fraudulent, $2.9 million mortgage to an investor, MorEquity Inc.

According to court documents, the loan sale became entwined with names that figure big in the country's financial services industry crisis, including American International Group Inc., which got a major government bailout and investment bank Lehman Brothers, the venerable New York firm that failed under the weight of soured subprime loans.

The lawsuit was settled earlier this year before going to trial and the details were not made public. It did, however, spawn separate litigation from former colleagues at Rose that is still pending. That lawsuit seeks more than $1 million in damages and charges a pattern of fraudulent subprime lending practices,

Homeowners in Rhode Island and Massachusetts also filed a lawsuit earlier this year seeking class-action status against Maverick. The suit charges that Maverick failed to disclose fees that resulted from borrowers refinancing into mortgages at higher interest rates that they actually qualified for.

While Maverick Funding may not be a household name in Connecticut, it does business with more than a dozen brokers throughout the state, including more than half of the brokers in the Hartford area, according to the U.S. Department of Housing and Urban Development.

One Hartford area broker, who asked not to be named, said only one of his employees used Maverick regularly and eventually that employee went to work for Maverick. The broker said Maverick appeared to have an appetite for more risky loans and seemed to be more flexible in its underwriting.

UConn's McCoy said she couldn't comment specifically on the Maverick case because she is not familiar with the company. But she said she generally considers it a "serious omission" not to disclose pending litigation.

"It's doubtful that you can forget that you are the subject of a lawsuit," McCoy said. "This omission casts the veracity of the mortgage banker in doubt. It raises the question: If the bankers are lying, what else would they lie about?"

The disclosure of civil litigation doesn't necessarily mean a license application would be rejected by regulators. But the failure to do so could result in an enforcement action or a fine, depending on the timing or the circumstances.

The new national mortgage registry system, which helps regulators more easily share information, also began providing information to consumers earlier this year.

The registry was hailed as a big step forward in keeping tabs on mortgage companies, which have come to dominate U.S. mortgage lending. But their licensing varied from state to state. The registry was an attempt to standardize that process.

Consumers also can check whether a company is licensed and work histories of individual loan officers.

Next year, the registry will add enforcement actions against brokers and mortgage companies as well as noting whether there is litigation pending against that company, according to registry officials in Washington.

Pitkin, the banking commissioner, said he believes the department handled the 2007 license application from Maverick to the best of its ability, given there were 18,000 mortgage lending originators in the state at the time and nearly 6,000 companies.

"To sit and individually check 50 states would have created a backlog," Pitkin said.

The mortgage industry in Connecticut and elsewhere has contracted significantly in the wake of the mortgage meltdown. The state now has about 5,000 orginators and 850 companies that are licensed, the majority operating in more than one state. Currently, the department's consumer credit division has 29 employees, 10 full-time and one part-time that deal with licensing.

While technology now has made it possible to share more information easily with other states, regulators still rely on mortgage license applicants to be accurate -- and on complaints from the public.

"If the other steps in the licensing process turned up no reason to question that response, based on our other steps in the process, we would not question it," Pitkin said.

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