Avoiding Hard Money Loan Scams

Fall 2010

If someone claiming to be a Nigerian prince asked you to wire him $80,000 to $100,000 in return for an enormous sum of money to be deposited into your bank account, you’d likely laugh it off as a blatant scam. Yet some investors and developers, seeking hard money loans, are falling into the same kind of trap.

To be sure, not all hard money lenders are crooks. But a Google search for hard money lenders and commercial real estate yields 215,000 results and even the sleekest-looking Web sites can’t prove who’s legitimate and who’s not. The fact that conventional loans can be difficult to come by for those who face imminent refinancing or other time pressures has made otherwise-sophisticated owners more vulnerable to fraud.

Here is one cautionary tale:

The development started out with great promise, located along a riverfront in the Southeast. Between the city and county, the development would be granted $4 million in tax credits over a five-year period. The mixed-use development (which had initially been planned as condominiums) had been started in 2007; by 2008, half of the condominiums were sold and then the market "went to pieces," according to Investor X. Between the summer of 2009 and the present, the managing partners found a legitimate lender but the terms were so restrictive that they started looking at hard money lenders and found a number of possibilities through an online search.

"It sounded shady to me; they all wanted money up front," said Investor X, who took it upon himself to have a half-dozen of them investigated. Typically, these fraudulent lenders get borrowers to wire funds to them so that they can perform due diligence on a project. But once the funds are sent, it becomes virtually impossible to reach them. As Investor X pointed out, "these guys do something to justify their cause so that it’s difficult to sue and win. You have to use their appraisers, and then they tell you that you don’t qualify for a loan. Very few deals actually go through."

Bottom line: the partners in this development did not use any of the "lenders" they found and are still looking for financing. Why would they have considered this route at all? Investor X said, "If you look at ’08 and ’09, so many people were far enough along [with their developments] and banks were not lending. You might have to file for bankruptcy unless you could finance the project. It makes you desperate. Why not invest $100,000? The lure of the hard money is that it’s non-recourse."

Olivia Robinson

Olivia Robinson

Olivia Robinson, principal of Background Intelligence, Inc., a private investigation firm specializing in fraud and white collar crime, who conducted this investigation, recalled that "one of the common themes was that they were all frauds. They wouldn’t divulge where their money comes from and they don’t give references."

Some findings: the client did get two references from one lender, the first from someone posing as a borrower but who was actually an employee; and the second from someone who had gotten out of jail and was on parole. One company had been charged with securities fraud by the SEC. One was in bankruptcy and claimed no assets. One was a disbarred attorney using three Social Security numbers. One company’s Web site showed pictures of properties whose owners, contacted during the investigation, reported that they had never heard of that lender.

Neither Investor X nor the other investors and managing partners reported the investigation’s results to any regulatory authorities. "Most of them could say they provided a service for the upfront fee," he said. "We didn’t think it was worthwhile."

Robinson observed that "when people get scammed they’re embarrassed and don’t want to diminish the value of their business."

Do Your Due Diligence

Daniel Purdom

Dan Purdom

Dan Purdom, national practice group leader, white collar crime group, at the law firm Hinshaw & Culbertson, LLP, remarked that the best way to avoid hard money scams is to not give money to strangers. "Do your due diligence," he said. "Fraud knows no limits; it happens in good times and bad times." In short, the old adage "if it’s too good to be true, it probably is" applies.

(If a lender purports to be a broker-dealer, you can search for the firm at www.FINRA.org/investors/Tools- Calculators/BrokerCheck. You can also search for fraudulent firms at www.ripoffreport.com.)

Marie Colmey of Hinshaw & Culbertson noted that if you are an officer of a corporation, you have fiduciary duties, which means that if a deal falls apart, you can face exposure. "It doesn’t mean you won’t get sued if you’ve done something with good intentions. Everyone’s going to sue everyone when the deal goes down."

Marie Colmey

Marie Colmey

The prospect of being sued isn’t your only concern. In one case that Olivia Robinson investigated, the client had already sent three years of tax returns as well as personal and corporate credit information to the "lender." Although he did not wire funds, he was worried that his information would be misused. He contacted existing lenders to alert them to possible identity theft and forwarded Robinson’s report to the FBI.

In this case, Robinson literally had one day to conduct an investigation before the client was to wire funds; at the client’s attorney’s request, she had to verify the authenticity of the "lender." She investigated two corporations: the one that would be receiving funds and the New York brokerage house that had written a letter substantiating that the company had an account balance in excess of $1 billion. The letter proved bogus, the account was a fiction and the person who would have received the funds had spent 32 months in prison for forgery and other misdeeds.

Investigating the lender started with a look at the letter of support. It was from a familiar-sounding financial institution but "it wasn’t quite right," she said. There was no listing with the Secretary of State where the company was allegedly based or with any regulatory agencies. Robinson also did a reverse directory search, Googled the company, called the building manager and tenants at the address shown on the letterhead and there was no one there by that name. She also contacted the investor relations departments of institutions with like-sounding names and examined SEC complaints. There weren’t any because the bank didn’t exist.

The "lender" had filed a bankruptcy proceeding and had felony convictions for forgery and grand theft, as well as a notice of default on his home, with $306,000 in loans outstanding. There were no filings with the Better Business Bureau within the "lender’s" local jurisdiction.

It’s difficult to assess exactly how prevalent hard money fraud is. For example, Jason Boone, research assistant at the National White Collar Crime Center, could not find reliable numbers regarding hard money loan scams, because once discovered, the scam will be prosecuted under a variety of different crimes (such as wire or mail fraud). However, you can report scams to the Internet Crime Complaint Center, run by the FBI and the National White Collar Crime Center. Go to www.IC3.gov or call the FBI at 1-800-CALLFBI, or https://tips.fbi.gov. To find the local field office of the FBI, go to www.fbi.gov. If securities fraud is involved, you can file a complaint with the SEC.

Dan Purdom advised that if you’ve lost money due to fraud, the best thing to do is to try to get the money back. Do the "lenders" have insurance? Do they have property to go after? He pointed out that "the reality is that mail and wire fraud is incredibly amorphous. You have to prove they schemed to defraud, knowingly." He said that the FBI has the longest track record for investigating these crimes, but are often deferring to states because of pressing Homeland Security issues. He also remarked that "you lose control if you turn it over to an investigative agency."

For more information

Background Intelligence 
Hinshaw & Culbertson, LLP