“Ripe for abuse”: Real estate escrow funds may not be so secure after all
Case of landlord attorney Mitch Kossoff and the missing millions reveals lax oversight
Real estate lawyers routinely hold millions of dollars in escrow for their clients, serving as trusted third parties to ensure funds are delivered and deals close properly. The attorneys safeguard the money for days, weeks and sometimes years.
But how strong are the regulations preventing lawyers from looting that lockbox? Not very, it turns out.
“It’s ripe for abuse,” attorney Si Aydiner said. “There is an avenue for people to take advantage of this type of account if they want to.”
That’s exactly what happened in the case of New York real estate attorney Mitch Kossoff, at least 10 former clients contend. The multifamily landlords and real estate investors say Kossoff has failed to account for roughly $10 million of their money he held in escrow, The Real Deal first reported in April. Kossoff has been unreachable for weeks; the former clients are now suing in state and federal court with some trying to push his firm into bankruptcy. The Manhattan district attorney’s office is also said to be investigating.
The Kossoff case may be an outlier given the scope of the alleged theft, but it puts lax regulatory oversight regarding escrow funds into the spotlight. Federal and state policies mostly direct the process that attorneys must follow but generally let the law firms police themselves, according to several attorneys who are experts in the field.
The toughest laws, they said, are mostly punitive, not preventative.
By the book
A federal law stipulates that banks consider attorneys — not their clients — the escrow account owners. The Financial Crimes Enforcement Network’s measure exempts banks from the “know your customer” mandate, which requires the financial institution determine the true owner and origin of money in most accounts.
States like New York and Florida guide how attorneys should handle escrow. But they keep a narrow focus, deciding which banks can hold the funds, ensuring that records of deposits and withdrawals are kept — without tracking the money’s destination — and creating consequences for misappropriating money.
Some rules do put up roadblocks, but experts say those aren’t enough. In Florida, law firms are required to have more than one person in the firm sign off on a withdrawal, attorney Dan Gonzalez of Meland Budwick said. In New York, law firms must audit their own escrow accounts but are not required to hire an outside firm, said Scott Bush, who has defended lawyers facing disciplinary action.
New York also maintains a Lawyers’ Fund for Client Protection that reimburses a consumer up to $400,000 in the event an attorney misuses money. Of the $8.5 million the fund paid out across 114 cases last year, escrow claims totaled $3.4 million, according to the organization.
So while some protection exists for a client who has been wronged, “part of it is trust with respect to what the attorney is doing,” said Bush, of the firm Corrigan, McCoy & Bush. “Just like you trust your doctor.” He added, “The only way to get around it, technically, is to say, ‘Lawyers can’t hold any escrow funds.’”
Escrow accounts are difficult to audit because millions of dollars flow in and out as property owners and investors deposit and withdraw money, Aydiner said.
Typically, law firms open an account holding funds from multiple clients. For real estate escrows that hold money long term — like security deposits for renters — clients may go years without having to withdraw that money, making the funds more susceptible to embezzlement. Typically, an accountant will review whether the withdrawals match the amount in the account but will not verify whether the money was transferred to someone other than the original client, Bush said.
Widespread escrow fraud is rare, attorney Joe Pack said, with laws and professional ethics rules punishing such criminal behavior.
“It all eventually catches up,” he said. Pack, who has his own Miami practice, noted the allegations against Kossoff are “unfortunate” but not unheard of. “The house of cards will eventually fall. People always come back looking for their money.”
In Kossoff’s case, Westchester, N.Y.-based investor Rob Yaffa sued after $590,000 held in escrow for a building sale didn’t get transferred days later, as it was intended.
Aydiner, who has served on the New York Grievance Committee, which takes up disciplinary cases against lawyers, said he has “never seen” a case like the one involving Kossoff.
“Because now we are talking about bankruptcy hard on the heels of the attorney disappearing, hard on the heels of questions concerning what happened to the money in escrow, this is a major situation,” he said.
And despite federal and state penalties for stealing funds from escrow accounts, the opportunity to commit the crime is there if a lawyer chooses, Bush said.
“A thief is a thief is a thief,” he said. “I can have all the bells and whistles and security alarms in my house. But if someone wants to break into it, they are going to break into it. Plain and simple.”