3

The Causal Factors behind Fraud

Let’s begin this chapter with one fundamental frailty of human nature: People lie. Why do people lie? People lie to get what they want. Some of them want your client’s money, your employer’s money, or the government’s money.

The real estate industry does not attract saints. While it may attract sincere people, many of these people just sincerely want to become rich, and real estate is a proven way for people to become wealthy.

The eminent criminologist Donald Cressey defined the three causal factors leading to fraud as:

1. Motive
2. Rationalization
3. Opportunity

These three factors combine to form what he termed the “fraud triangle.”

In the case of real estate fraud, the motive is often greed. In one case study presented later in this book, we will see how the fraudster’s obsession over living a life of luxury drove him to commit fraud. In other cases of real estate fraud, the motive may be desperation, such as the desire to bail out of a losing investment and stick someone else (a buyer or lender) with the problem. This type of motive has become common in recent years.

Rationalization is the process by which the fraudster justifies to himself or herself a valid reason for perpetrating the fraud. Human beings generally do not like to think of themselves as bad people; rationalization is the thought process that allows them to believe that their fraud is justifiable. Common rationalizations for fraud in the real estate industry include:

1. Everyone is doing it.
2. I am trying to help people.
3. I am trying to help my family.
4. I am trying to help my community.
5. I can give more to charity with all the money I am making.
6. The property’s performance will improve, and no harm is done.
7. I need to pay off my debts.

There are also less noble causes, such as drug or gambling addiction, in which the rationalization is simply the need to feed the addiction. Once again, the fraudsters do not think of themselves as bad people but rather as unfortunate people.

Rationalization can cause some fraudsters to even become philanthropists. Some of the best known “robber barons” of the nineteenth century (and at least one from the twentieth century) became philanthropists. Bernard Madoff, creator of the world’s largest Ponzi scheme, was also a known philanthropist. Perhaps criminals turn to charitable giving to assuage the guilt they feel in receiving ill-gotten gains.

Opportunity consists of the circumstances that allow the fraud to occur, such as a lack of controls, oversight, supervision, regulation, or enforcement. For instance, most mortgage fraud occurs with lenders who do not visit the properties they lend on, relying instead on third parties such as brokers and appraisers.

Let’s suppose that the golf course loan default described in the Preface of this book was indeed the result of fraud, perhaps the use of a phony purchase contract. Here is a hypothetical example of how it could be explained by the fraud triangle:

• Motive
  To purchase the golf course without any cash down payment. Perhaps we lacked cash or just did not want to put our cash at risk.
• Rationalization
  The golf course’s performance will improve because we know how to improve golf course operations. The loan will be paid back, but it’s not our fault if the market value is appraised too high because of the phony purchase contract. We can also use the golf course for fundraising events to help charities serving crippled children.
• Opportunity
  The appraiser and the lender have no way of knowing that the purchase contract is fake and the real price is $4,700,000. The lender does not have instructions for escrow agents to notify the lender immediately if the closing of escrow occurs according to terms different than those stated in the purchase contract. Perhaps the lender is even allowing us to choose our own escrow agent, our sister-in-law.

In conclusion, it is important to keep in mind that appraisers should expect to be lied to, considering the self-serving motives of property owners or brokers. A proper understanding of motive, rationalization, and opportunity can go a long way toward understanding how commercial real estate fraud can happen, and such an understanding can help appraisers prevent such fraud from occurring.