Pressure is growing on banks — and the mortgage brokers who bring them business — to step up due diligence when processing mortgage applications in order to halt what one court calls “a serious mortgage fraud plague.”

At the same time, financial advisors can help clients protect themselves from mortgage fraudsters by ensuring that clients have title insurance.

“There is due diligence required on the part of financial institutions that wasn’t required in the past,” says Merlin Chouinard, president of both Saskatoon-based Sentinel Group and the Independent Financial Brokers of Canada.

Chouinard, whose company includes a mortgage brokerage, a life insurance brokerage and a financial-management firm, says that in a world in which mortgage transactions can be done over the Internet, brokers sometimes don’t see the mortgage applicant or the property. In effect, the increased use of technology has weakened due diligence. But this excuse does not pass muster with the courts.

Chouinard is also critical of the practice of “drive-by appraisals,” in which the appraiser stops the car in front of a property and takes a photo. The appraiser doesn’t enter the home, so the identity of the mortgage applicant is not verified.

The role of identity verification in preventing mortgage fraud was noted by the Ontario Superior Court in Rabi v. Rosu, a mortgage fraud decision released in October.

In that case, TD Bank Financial Groupwas the lender. Had bank representatives “appeared at the door of the premises in question or spoken to the owners,” they would have discovered that the owners of the property were not involved in the mortgage transaction, Justice Randall Echlin wrote in his decision.

“Instead,” Echlin continued, “the bank acted pursuant to its ‘usual procedures’ and advanced money to a fraudster in the absence of an interior inspection of the premises to be mortgaged, which would have likely averted the fraud, having chosen to delegate due diligence to a mortgage broker.”

TD is not appealing.

Chouinard says mortgage applicants should be required to appear before the mortgage broker, or at least a notary, who would be responsible for verifying the identity of the applicant.

Part of the reason this systemic problem arose, says Toronto lawyer Morris Cooper, is that the legal system has historically “preferred the integrity of the land registry over the integrity of the homeowner.”

For example, Section 78(4) of the Ontario Land Titles Act states that when an instrument such as a property transfer or mortgage is registered, it is given legal effect.

Cooper and his client, Sarah Lawrence, faced this legal bias head-on after an imposter tried to defraud Lawrence out of her home. At trial, the judge declared void the transfer of the property from Lawrence to the fraudster — but he upheld the mortgage given to the imposter by the Maple Trust Co.

That’s when the Ontario government got involved. First, it amended the Land Titles Act, ensuring that ownership of a property cannot be lost as a result of the registration of a falsified mortgage, fraudulent sale or a counterfeit power of attorney. (Alberta has passed similar legislation.)

Second, the Ontario government obtained intervenor status in Lawrence’s case, and spoke when the case went to the Ontario Court of Appeal. The government’s lawyer argued that the Land Titles Act should be interpreted based on three types of owners: the original owner, the intermediate owner (the party that deals with the fraudster — in this case, Maple Trust) and the deferred owner — an innocent purchaser of the property from the intermediate owner. Based on this interpretation, registering a document such as title obtained by fraud does not validate it.

The Appeal Court agreed and in its decision in Lawrence v. Maple Trust Co. , released in February, ruled that Lawrence did not have to pay the Maple Trust mortgage that had been fraudulently put on her property.

The court had some sympathy for Maple Trust, implying that the trust company might be entitled to compensation from the Ontario Land Titles Assurance Fund. This fund — similar to funds in other provinces — was created to compensate people for financial losses due to real estate fraud and errors and omissions that arise under the land registration system. Currently, the only way that a lender or brokers can get compensation is indirectly through a wronged landowner.

@page_break@Caroline Hubberstey, director of public and community affairs for the Canadian Bankers Association, says it’s important to keep in mind that due diligence is not just the lender’s responsibility. Others involved in real estate transactions include lawyers, mortgage brokers, and title and mortgage insurers, and all have procedures in place to detect fraud.

Cooper says that one of the unintended effects of the Lawrence ruling is that people may think they don’t require title insurance. However, he urges advisors to ensure that their clients buy title insurance: “It’s a one-time payment for insurance that lasts as long as the owner owns the house.” IE