Disclosures reveal FRM never compliant

Five examination reports released by the New Hampshire Banking Department yesterday reveal that Financial Resources Mortgage, Inc. (FRM), which a bankruptcy trustee found ran a Ponzi scheme since 2005, regularly failed to comply with state and federal statutes regulating its mortgage banking operation for the past six years.

FRM was a licensed mortgage banker, examined and regulated by the Banking Department, which engaged in private mortgage brokerage by matching private investors to borrowers seeking commercial and construction loans, which they secured with real estate. The firm was owned and operated by Scott David Farah of Meredith in conjunction with CL and M, Inc., a loan servicing company headed by Donald Dodge of Belmont. Both companies are in bankruptcy and under investigation by federal law enforcement agencies.

Although examiners cited FRM for numerous and repeated violations over the past six years, the department not only refrained from enforcement action against the company and routinely renewed its mortgage banking license but also, according to several investor bilked by the firm, represented FRM as in "good standing."

Bank Commissioner Peter Hildreth posted the reports on the department's website soon after Mark Connolly, director of the Bureau of Securities Regulation, called for him to disclose all records bearing on the operation, condition and regulation of FRM.

Since the firm collapsed, leaving more than 500 investors as much as $100-million out of pocket, Hildreth has said that the fraudulent transactions that destroyed it fell within the jurisdiction of the securities bureau. Bristling at the suggestion, Connolly told The Daily Sun "I have reason to believe that the Bank Department failed to fulfill its regulatory duties and that is why we are asking for the records as well as to confirm that this is not a state securities matter." He said that without full disclosure, he would subpoena the Bank Department's records.

The reports of examinations in 2003, 2004, 2006, 2007 and 2008 are relative narrow in scope, bearing on FRM's "regulated business activities, operational practices and financial condition . . . to determine compliance with RSA 397-A," the statute governing originating, brokering or funding of first and second residential mortgage loans secured by real property. FRM's residential operations, which targeted the sub-prime market, appears to have been a relatively small and steadily shrinking part of its business.

Every report cites FRM for failing to properly disclose the terms of loans to borrowers. Good faith estimates of closing costs were not made and brokerage fees, balloon payments and yield spread premiums (rebates paid brokers for selling borrowers an interest rate above the rate for which they are qualified) were not disclosed. The company appears never to have fully complied with the privacy protections and security measures stipulated by federal law. FRM also routinely failed to provide timely or complete annual and quarterly financial statements.

When the company was the subject of an investigation by the securities bureau, which was closed only when FRM redeemed more than $1-million worth of illicit promissory notes it issued without a license, it failed to inform the Bank Department. Likewise, the firm twice failed to inform the department it was involved in civil suits alleging that it engaged in fraudulent activity.

in 2007 and 2008 FRM was cited for dealing with unlicensed lenders and an unlicensed servicer, namely CL & M, Inc., the firm established in 2005 through which the money driving the alleged Ponzi scheme flowed. In 2008 examiners found that residential loans, which are subject to regulation, were represented as commercial or construction loans beyond the reach of regulation.

"It wasn't good," Hildreth said yesterday. "But, it is not that I haven't seen this sort of thing before. There are a lot of mortgage licensees that are very good at compliance, but there are others for which compliance is not a priority." He said that some of the violations cited were "common." For example, with the enactment of federal laws safeguarding financial privacy, he said many licensees failed to comply. "It was the violation du jour," he remarked. Likewise, he considered lapses in documentation relatively common.

Hildreth said he thought the department issued an order asking FRM to show cause why its license should not be suspended or revoked, but could not recall the specifics of the case. At the same time, he said that he was not aware that any examiner or employee of the department recommended enforcement against FRM.

From the outset, Hildreth has insisted that the department's authority is strictly confined to residential mortgages as defined by the statute regulating mortgage bankers and brokers, which is reflected in the scope of the examinations. He said that the violations cited by the examiners arose from the company's management of residential mortgages, which represented a small fraction of its total loan volume. Furthermore, he said that apart from six loans that FRM funded in the last 12 years, the company sold all the residential mortgages it originated.

Meanwhile, the statutory duties of the bank commissioner include "general supervision" of licensed institutions and the law requires the department to examine licensees "as may be necessary to determine the true condition of the institutions and their ability to perform their engagements, and whether they have violated any provision of law."

Moreover, the department's website advises licensees that they are required to provides abundant information and documentation about the operation and condition of their companies. The list includes: financial statements, including and balance sheet and profit and loss statement; federal income tax returns, work papers supporting annual reports; policies and procedures manuals; operating and escrow account journals, including corresponding bank statement; a list of all affiliates; and copies of all contracts.

Nevertheless, Hildreth cleaves to the limited view of his authority, which does not extend beyond residential loans. Since FRM sold virtually all these loans, he said that its financial condition posed no risk and its ultimate collapse did no damage to residential borrowers. "I do think it is that narrow," the commissioner said.