Kabbage, a financial services company, is accused of profiting from fraudulent loans during the COVID-19 pandemic. According to the US Attorney’s statement, the settlement addresses claims that Kabbage profited off of fraudulent loan applications. They’ll pay more than $56 million.

As a former mortgage brokerage owner and current expert in anti-money laundering (AML) and Bank Secrecy Act (BSA) compliance, I find that the practices leading to these allegations against Kabbage mirror defects that often plague the mortgage sector.

So, BSA officers, here’s what you must look out for.

The Kabbage Case: A Quick Summary

The specifics of the settlement, which could see the US recover up to $56.7 million, highlight several critical failures by Kabbage. I think they fall into three buckets - don’t look, don’t tell, don’t ask:

1. Failure to Implement Appropriate Fraud Controls: Kabbage did not comply with its Paycheck Protection Program (PPP) and BSA/AML obligations.
2. Removal of Underwriting Steps: To process a larger volume of PPP loan applications, Kabbage eliminated underwriting procedures that were standard before the PPP.
3. Setting Substandard Fraud Check Thresholds: Kabbage knowingly set low standards for fraud detection.
4. Reliance on Inadequate Automated Tools: The automated tools used were insufficient to identify fraud.
5. Insufficient Personnel for Fraud Reviews: Kabbage did not allocate enough staff to conduct thorough fraud reviews.
6. Discouragement of Fraud Reviewers: Fraud reviewers were discouraged from seeking additional information from borrowers to verify their loan requests.

Parallels in the Mortgage Industry

For those who remember back to the paper file days, processors always kept documents that shouldn’t go to the underwriter on the “left side of the file.” Ecco attached to this left side of the file were the bank statements that showed NSF charges, VOEs that were in need of correction, credit explanation letters that were not useful. One time I asked two unmarried people buying a home together for a “relationship letter” and got a two pager from her about how in love she was. I had to explain that by relationship letter, I meant, “please explain why a lender should regard you two unmarried people as one economic powerhouse.” Basically, the left side of the file was the “never mind that” pile.

BSA officers have to first be aware of, and then remedy, similar lapses in fraud prevention and compliance. Here are four parallels:

1. Inadequate Fraud Controls: Like Kabbage, some mortgage companies may fail to implement robust fraud controls, relying too heavily on automated systems without sufficient human oversight. For example, you check the boxes that you have gift funds verified and a gift letter signed. Are you sure they are related?
2. Low Fraud Detection Standards: Setting low thresholds for fraud checks can be tempting to expedite the loan approval process, but this often results in higher risks of fraud. Do we really believe this person is earning that much while working for a close relative?
3. Insufficient Staffing: Just as Kabbage allocated too few resources to fraud detection, mortgage firms might also skimp on staffing, leading to inadequate fraud prevention. When you are in a down period, as now, cutting QC and audit staff is tempting.
4. Discouragement of Due Diligence: Pressuring staff to minimize due diligence to speed up processes can lead to unchecked fraudulent activities, compromising the company's integrity and client trust. Just being “grateful for the production” can lead to lax oversight.

The Role of BSA Officers

BSA officers play a crucial role in identifying and mitigating these risks. They are tasked with ensuring that financial institutions comply with AML and BSA regulations, which include implementing effective fraud detection and prevention measures. However, their success depends heavily on the support they receive from their organizations.

Key Responsibilities of BSA Officers:

1. Insulation from the Sales Department: BSA officers are to feel no pressure from the origination side of the shop. They have to be able to do their job without pressure to protect top producers.
2. Developing Robust Fraud Prevention Systems: BSA officers are responsible for designing and implementing comprehensive fraud detection systems that go beyond automated tools and incorporate thorough human oversight. So the BSA officer is an expert in the risks your company faces.
3. Conducting Regular Reviews and Audits: Regular reviews and audits are essential to ensure that fraud controls are effective and up-to-date with current regulatory standards. Does someone have production that is odd? High? Geographically strange? Run metrics on production to find patterns that indicate possible fraud.
4. Training Staff: Continuous training for all staff members on recognizing and reporting fraudulent activities is vital. This includes understanding the latest fraud schemes and how to combat them.
5. Allocating Adequate Resources: Ensuring that sufficient personnel and resources are dedicated to fraud prevention activities is crucial for maintaining an effective AML/BSA program.

Conclusion

The Kabbage case to me says that there will always be people who say, “look how much money we can make if we just . . .” In the mortgage industry, similar thinking can lead to significant financial and reputational damage. BSA officers are at the frontline of this battle, but they need the right tools, support, and resources to be effective.

In a world where financial fraud is continually evolving, the role of BSA officers has never been more critical. It is up to organizations to ensure that these officers have everything they need to safeguard the integrity of the financial system and uphold the trust placed in them by their clients and regulators.