Five Charged With $690,000 in Student Loan Fraud

A ring of five Seattle-area women has been charged with taking out more than $690,000 in fraudulent private student loans, raising concerns by some federal officials that the kinds of abuses that have hammered the subprime mortgage sector may also be lurking in the student lender field.

In an indictment filed in early June in Seattle's federal district court, prosecutors allege that beginning in 2005, Kathy L. Hardy, 59, of Renton, Wash., her two daughters, ages 35 and 20, and two 36-year-old associates filed more than 70 applications for private student loans, often using other people's names or Social Security numbers.

According to the indictment, the vast majority of the women's applications were unsuccessful. But it charges that at least 24 fraudulent loan applications were approved. In a search warrant recently made public, investigators allege that the lenders sent checks—some for more than $40,000—to the women's addresses.

Although made to students, private educational loans are simply standard business transactions, little different from, say, auto loans. Banks typically charge comparatively high interest rates but try to make the applications quick and easy. In contrast, to obtain low-cost federally guaranteed Stafford or Perkins education loans, the federal government requires that students fill out the extensive Free Application for Federal Student Aid, and it requires schools to certify much of that information. The federal government caps the amount it will loan to an undergraduate, typically at a few thousand dollars a year. In addition, federal loan payments are usually made directly to a college and aren't sent to a student's home address.

Investigators and prosecutors say the women took advantage of private lenders' eagerness to make big, higher-interest loans. They also believe the defendants took advantage of a wrinkle that makes fraud in student loans harder to catch than, for example, mortgage fraud. Many lenders allow students to defer payments for as long as they are in school, which can easily mean four or five years. That means borrowers with no intention of paying don't attract lenders' or identity theft victims' attention by defaulting quickly. Finally, the investigators believe the women were able to keep taking out loans for two years despite a trickle of complaints from identity theft victims in part because of the Federal Bureau of Investigation's shift in focus to terrorism, which has slowed prosecution of some other types of cases.

While the credit crunch and some reform proposals may make things tougher for future fraudsters, federal officials say the details of this case raise worries that "there are more cases like this out there." Joseph Velling, the Seattle-based special agent in the Social Security Administration's Office of the Inspector General, who spearheaded the investigation, said lenders approved loans based on applications that should have raised warning flags. "What I found surprising was that these checks were mailed to people living at addresses that hadn't been verified well enough. . . . Banks can check Social Security numbers and names" to make sure they match, for example, he noted.

Some of the fraudulent techniques alleged in the indictment and search warrant appeared to be sophisticated. Velling said, for example, that the defendants used Social Security numbers of people who have the same name or a similar name as the defendants. And the search warrant alleges that the women sometimes provided copies of doctored driver's licenses.

But the search warrant also charges that many loan checks were sent to the same addresses. And it says that in some of the applications, the applicants' names did not match Social Security numbers. Velling added that in at least one case, the Social Security number of a dead person was used.

He said the lenders' investigators became aware of the possible fraud but had trouble persuading federal agencies to take an official interest: "These companies are sitting on more fraud, but they can't get anybody to work them."

Velling said he happened to be working the Seattle FBI office on another case last fall when a call came in from a victim complaining that someone improperly had taken out a student loan in her name. The FBI asked Velling to lead the investigation. By teaming up with other federal and local investigators, as well as the fraud investigators employed by lenders, he says he found many other loan checks that went to the same home addresses or to people with similar-sounding names. "The applications were all done on the Internet. I don't know of one case where there was a face-to-face meeting," Velling added.

The indictment and search warrant charge:

Educated Borrower, a division of Greystone & Co., approved 11 fraudulent applications filed by the women for student loans and sent them a total of $480,000. (Educated Borrower declined comment and has suspended making student loans.)

First Marblehead, mainly through its Astrive brand of student loans, approved seven (out of more than 40) applications for a total of $183,750. (First Marblehead says that it verifies a student's identity using the National Student Clearinghouse and that the firm "contacted local authorities and helped spearhead the original investigation" into the Washington case.)

Sallie Mae approved six applications for a total of $45,000. (Sallie Mae noted that it "was one of the least hit companies dollarwise by the fraud ring" and says it regularly updates security measures.)

My Rich Uncle approved only one of more than 20 applications for a total of $12,700. (MRU called the case "not significant.")

Attorneys for the defendants, who have all pleaded not guilty, either did not return calls asking for comment or said they had no comment.

Norman Barbosa, the federal prosecutor in the case, says he believes that other fraudsters have also taken out private student loans and that a controversial congressional proposal to require students to get their colleges to certify their private loans could make it tougher for people to abuse the student loan system. But that proposal has divided lenders. Some, such as Sallie Mae, support it. Others, such as My Rich Uncle, oppose it, fearing it would make it more difficult for students to get competing loan offers and shop for the best deal.

But even if the new rule never gets adopted, fraudsters may find it tougher to tap student loans, Barbosa said. "The easy credit that played a role in this case seems to have slowed down."