Earlier this summer, the New York State Assembly passed the “Foreclosure Fraud Prevention Act of 2012” which imposes criminal liability on those in the residential mortgage business who use allegedly fraudulent and deceptive practices in connection with a foreclosure action, and the Managers who “recklessly tolerate” any such practices. Despite the swift passage in the Assembly, it is unlikely that the proposed legislation will be taken up by the New York Senate before the 2012 legislative session formally adjourns in January. If this bill is to move forward, the most likely course will be for the Assembly to re-enact it in 2013 and then send it to the Senate for consideration. But because of the committed support of New York Attorney General Eric T. Schneiderman, it is likely that this bill will be kicking around Albany for several more months – so let’s take a closer look at what might end up on the books.

Commentators have championed this bill for criminalizing “robo-signing”, but upon further examination, the wide net cast by this bill might impose felony liability on parties not really responsible for the false documentation that this bill is purported to prevent.

To begin, let’s examine what constitutes a crime under the Foreclosure Fraud Prevention Act. The Act defines Residential Mortgage Foreclosure Fraud (a misdemeanor) to occur when a person, acting as an agent of a residential mortgage business, authorizes, prepares, executes, offers or presents for filing any written instrument, if the person:

● knows or believes the instrument will be filed with a court or other public office in connection with a pending or prospective residential mortgage foreclosure action; and

● knows the instrument contains a material false statement, material false information or a material omission.

The Act includes a felony offense of Residential Mortgage Fraud in the First Degree, if either:

● an individual engages in Residential Mortgage Fraud in connection with at least 5 foreclosure actions in a one year period as a part of a systematic ongoing course of conduct; or

● an individual who, as "a high managerial agent" of a residential mortgage business, knows (or reasonably should know) that one or more agents of such business are engaging in Residential Mortgage Foreclosure Fraud and such managerial agent recklessly tolerates such conduct (or otherwise fails to take reasonable measures to prevent it from continuing).

Let’s parse the foregoing. In order to be convicted of Residential Foreclosure Fraud (the misdemeanor), an agent of a residential mortgage company would have to "know" that a document they are preparing, authorizing and/or executing for filing in court contains materially false information, or a material omission. There is no qualifier with respect to knowledge. A plain reading of the bill would not allow for conviction for mere simple negligence. That’s good. But wait.

The bill included a felony provision. With respect to a felony conviction (obviously the more severe punishment), the standard seems to be less onerous than is required to convict of the misdemeanor of committing Residential Mortgage Fraud, allowing for a felony conviction in the event a Manager knows ("or reasonably should know") that an employee is engaging in residential mortgage fraud (and thereafter, such Manager recklessly tolerates such conduct). Here, knowledge is qualified, so that the standard has dropped from "knows" to "knows or reasonably should know", taking an objective standard and making it very subjective.

How does that make sense?

It seems that in order to convict someone of a Felony, the standard should be something more than "should have known". "Should have known" is a notoriously amorphous standard. Easy to charge. As the trial guys say, "you may not do the time, but you ain’t gonna avoid the ride!" The bill offers no guidance as to what steps a Manager must take in order to avoid conviction for "recklessly tolerating" something they might not know is occurring (but, hey, they "should have known"). If you are a Manager at a residential mortgage business, and you suspect that one of your employees is engaging in Residential Mortgage Fraud, does such suspicion now give rise to a duty of the Manager to take some action against the employee (firing them, placing them on leave, personally verifying every document filed with a court), and if you don’t (because, when was the last time you fired someone based on a suspicion?), are you now guilty of recklessly tolerating such action? I sure hope you didn’t like voting, or other freedoms associated with not being a convicted felon.

Intentionally making false statements in connection with a foreclosure (or any civil proceeding) should not be tolerated. We can also agree that perjury should not be tolerated in any court filing. But to impose criminal liability, and potentially years of jail-time, as a result of the false statement of an employee (that you should have known about) is over the top, especially when the proposed bill does not provide a clear safe harbor for Managers that take reasonable precautions to prevent such conduct. Another example of the trend towards criminalizing merely bad behavior and bad outcomes. Next thing you know, New York City will ban the sale of 16 ounce sodas; oh, wait, they already tried that. This is not good.

By: Ralph Mazzeo and David Pildis