There are plenty of factors that have contributed to the title agent defalcation problems in the title industry, as has been discussed in the pages of The Title Report and elsewhere, but at the center of it all is the title agent — the visible faces that have misused escrow accounts and committed fraud. Because of that — because of the bad apple title agents — people inside and outside the industry are looking for solutions at the title agent level to fix the industry’s most glaring problem.
Title agent defalcations are a big deal because millions of dollars are at stake, along with the financial lives of consumers and the businesses of lenders and underwriters. The size of the title agent defalcation problem has caused people to look for a solution of equal size, aimed at either radically improving the escrow processes of title agents across the country or surgically removing that duty from an agent’s workflow.
Nelson Lipshutz, president of the Regulatory Research Corp., is one of those people. In his view, the escrow and disbursement responsibilities of an agent should be centralized in order to reduce the risks across the industry for everybody involved. The concepts he proposes involve a consortium of underwriters or another third party taking control of the disbursement activity.
“An underwriter consortium is the most natural type of solution,” Lipshutz said. “Elements critical to a large number of jurisdictions, like title plants, have been done as consortium rather than individual entities and worked out pretty well. The only difficulty is the amount of information the other individual underwriters would have in the consortium, but protecting confidentiality inside a system like that is a pretty straightforward task. It’s not terribly different than what goes on with medical records. I just think keeping control of the money is an increasingly important issue.”
Lipshutz believes that title agents are not fans of dealing with the escrow accounting side of their business anyway, making this sort of solution safer for the industry and friendlier for the agents.
“I don’t see any competitive disadvantage for a regional underwriter being a part of such a system, and there’s a real risk reduction,” he said. “You could build a system with much better controls. There are certainly fewer people to watch, and that’s the huge issue.”
Lipshutz’s concept isn’t an indictment of the title agent, it’s an indictment of the decentralization of such an essential and big-money duty. He feels it is the same for escrow states as non-escrow states because that process is just as decentralized — the more hands in the cookie jar, the riskier the system is.
“The only real solution is central control, controlled by the underwriters because they’re ultimately on the hook,” he said. “Behavior in the industry has changed. The size of escrow accounts and the amount of money in there is enormous compared to what it was 20 years ago, and I don’t think the system overall has adapted to the increased risk that this scale of exposure indicates.”
Third-party escrow solution
Lipshutz has some thought-provoking points on preventing title agent defalcation, but an underwriter consortium would be a huge departure from the current setup. Even if underwriters are ultimately on the hook, they don’t necessarily want the escrow accounting responsibility any more than an agent might. That line of thinking is behind a new solution from PCN Network.
“We understand everyone is frightened by their escrow accounts and we understand that when we have a boom, there’s enough to flow through the accounts to cover a lot of bad things that might be in there,” said Pritam Advani, president and chief executive officer of PCN Network. “When the industry goes through a down cycle, all of those get exposed. That’s typically when you find the defalcations.”
In Delaware, the law requires attorneys to handle the responsibility out of their own escrow accounts, and that is what led PCN to create a disbursement solution to more efficiently manage that duty. Since implementing the idea four years ago, the system has become more technologically advanced, and has been used in other states. Currently, the company handles about 1,000 transactions a month, and with the spotlight of the industry on the recent high-profile defalcations, Advani believes now is the time to take a solution like this into the mainstream.
Advani pointed out the audit processes underwriters use to find these accounting problems are fairly inadequate. There are too many agents, few auditors, predictable schedules and low audit coverage — about 2 to 3 percent of all transactions. Most fraud is found through customer complaints. The idea behind PCN’s service is that underwriters of all sizes would use it to manage all of the disbursement functions of their agents. Title agents would maintain every single aspect of their workflow the exact same way, but when it came time to handle the money, that duty would go directly to PCN.
“The agent never touches the money. They don’t have control of the money; but they have control of the transaction,” Advani said. “They submit the HUD-1 and all the supporting documents to us and we would be doing the funding.”
When the lender approves the HUD-1, the process would be for the bank to send the approved HUD-1 to PCN and a copy back to the agent. The agent then sends the disbursement instructions to PCN and the bank would send the funds to PCN’s escrow account. The main change in the workflow is that the agent never receives the funds and would not be responsible for the disbursement process.
PCN then runs all transactions through a centralized account. That centralized account then becomes a single audit point for underwriters, which could improve their auditing processes. The PCN disbursement system then uses a combination of manual and automated controls in order to provide the most protection. The technology accomplishes tasks like: detecting defined automated risk points in a transaction, sending out risk alerts, reconciling accounts daily, using positive pay that automatically rejects any check that doesn’t match the approved disbursement file. The 14-point manual process is needed for quality control. Two people are involved in every part of the transaction.
“The independent third party provides a checkpoint and eliminates any chance an agent could misappropriate the funds. Also, the agent is being paid from the central disbursement process and is interested in making sure it is functioning properly, making the agent an auditor,” Advani said. “They don’t have the money but they have responsibility for the transaction, no incentive to steal, and every incentive to make sure we don’t steal.”
Agents and underwriters could look at the data in the system, see the federal wire numbers, check numbers, mailing labels and so on through a web portal. The web portal will also integrate with the top title production systems so the data can be retransferred back into the system. PCN would implement various audit and cross check protocols in collaboration with lenders and underwriters to ensure that key data on the HUD-1 was verified and that funds were always transferred to the correct account.
As simple as Advani can make the solution sound, there is a lot that would have to change about the title industry for it to become wide spread. For one, it seems unlikely any underwriter would step out and become the first to adopt a third-party escrow account solution for fear of losing agent business. That fear isn’t without reason, as an informal poll on The Title Report website showed 62.5 percent of respondents believed escrow responsibilities were an essential part of their duty. However, about 33 percent believed it was nonessential in some way — 12.5 percent said every state should be an escrow agent state, 10.5 percent said underwriters should handle the responsibility, and 10.5 percent said there should be a third-party technology that handles it to minimize risks for everyone. Four percent were unsure.
One respondent noted how well escrow works in North Carolina, which runs through attorneys instead of title companies. Another noted that large title companies can use bundled pricing for their centralized closing services which put smaller operations at a disadvantage. Others mentioned the increased costs of a third-party for either themselves or the consumer.
“The true value of what we deliver from a service perspective, and the primary manner in which we can differentiate ourselves from our competitors, is in the escrow/settlement/closing arena,” remarked one respondent.
“The handling of the closing process does not need to be complicated by adding an escrow agent or the underwriter to the current closing process. Title agents need to raise their standards of protection to the consumer, or the underwriter should be responsible for their agent’s escrow actions,” stated another respondent.
“I worked as an escrow agent alongside a title agent for many years. Many people said my one trait was I was too honest, but many are not. Take the responsibility from that girl or guy who is handling the large monies and make it a three-person obligation,” said another.
PCN acknowledged the competitive concern on the part of underwriters but believes the tone in the industry is starting to change and that some of the notable lenders might start pushing everyone in this direction. Advani also made a point about the advantages independent agents might see because, suddenly, direct shops might not be the safest option.
“A lot of large underwriters are cutting back on smaller agents saying it’s too expensive because there is not enough volume. Now, 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,” Advani said.
There could also be cost savings for agents by not needing a staff to do disbursements or manage escrow accounts or by not needing the 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 is working with PCN to expand its efforts. “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.”
Continue improving agent controls
The biggest concern for agents in hypothetically giving up their escrow accounts is giving up that relationship with the local bank. Even if such a solution could solve other headaches, it could be a huge business risk in an already unforgiving market place.
Another solution to help prevent title agent defalcation just entering the industry from a company called ATS Secured attempts to keep the escrow responsibility with the agent but more securely lock down the disbursement process with a streamlined digital check delivery system.
“Agents have the fiduciary responsibility to make sure funds go out appropriately but they don’t actually have all of the systems in place to manage that process,” said Wes Miller from ATS Secured. “They get paid to close loans, and having spent many years as an originator, I understand the pressures they’re under to make sure the loans close on time. But it seems once the loan is closed, it’s time to move on to the next one. In that process, I think there’s a big chance for errors to happen and for things to get misallocated.”
The software Miller is introducing serves several functions: it will be a communication portal for all stakeholders in a transaction, it will monitor the escrow account, it will handle the funding and disbursement functions by creating digital checks directly from the agent’s escrow account, and it will automatically reconcile the account each time a check is created.
Agents submit HUD-1s within the system, lenders view them within the system and approve funding instructions within the system. Based off those documents, agents then create those checks — within the system.
“A lot of offices have dual signatures on checks, and we can accommodate that in a couple different ways. We can have them actually do digital signatures on the checks,” Miller said.
Miller said his company has a lengthy on-boarding process to ensure that the escrow account used within the system is legit, and the company is currently set up with about 90 percent of the lending institutions in the country.
“The agent has to create the physical checks, and they do that through a digital check technology where we have them sign their checks and it runs through the same kind of bank process,” Miller said. “With it being a check, it’s much more difficult to get that money. There’s more control over where it’s going, who deposited it, and which account it went into. And you can get it back. When a wire goes out, you can’t get that back.”
The dual digital signature process is meant to provide that added layer of security for the agent and also, possibly, the underwriter because an underwriter can be given the second authentication signature on every disbursement. It’s a way for the title underwriter to control the secure disbursement of escrow funds but still leave the responsibility in the hands of the agent.
“This system allows for the agent to maintain those banking relationships, be in control, and also for the underwriters to have control, visibility and transparency as to where those funds are at all times, if they want to,” Miller said. “And by reconciling before money ever leaves the account and looking to make sure the money is going where it’s supposed to go, you’re avoiding those post-closing errors and problems. It allows the agent to focus on what they need to do — closing loans.”
Title agent defalcation, even if it’s just one agent, hurts the entire industry, and ATS Secured and PCN Network are just two contending big-picture solutions attempting to rethink the industry’s processes to solve the problem. Whether it’s one of these two concepts or something else, it’s apparent the industry needs some sort of change in order to better protect consumers, customers and itself from the inherent risks of handling escrow responsibilities.
“Controversy isn’t the worst thing in the world,” Lipshutz said of the radical solution he’d like to see adopted. “Any time you want to do something new there is controversy. I think this pulls a lot of very serious risk out of the system, and from the point of view of stability of real estate finances, it’d be a great advantage.”