In 2012′s State of the Union address, President Barack Obama announced an initiative to investigate “abusive lending and packaging of risky mortgages.” Three days later, the Department of Justice (DOJ) created a task force, consisting of both state and federal regulators, focusing on residential mortgage-backed securities (the RMBS task force) and issued civil subpoenas to several unnamed banks under 12 U.S.C. § 1833a, a provision created pursuant to the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), Pub. L. No. 101-73, which was passed at the height of the savings and loan crisis.
Although FIRREA had been largely idle in the prosecutor’s playbook for two decades, these subpoenas reflect a growing trend of increased reliance on the older statute in mortgage-related investigations. In addition to the ongoing work of the RMBS task force, the DOJ has brought a number of actions in the last two years seeking civil penalties under 12 U.S.C. §1833a and other statutes for allegations of mortgage-related fraud in an apparent effort to address the economic crisis of several years ago. An examination of these cases raises questions about the government’s emerging new theories, which appear to have turned FIRREA on its head.
Counsel should be aware of this new trend, FIRREA’s basic provisions, and the government’s practices in this area. In particular, counsel should be alert to FIRREA’s differences from criminal investigative process, statute of limitations issues, and recent government interpretations that strain FIRREA’s purpose.
S&L Crisis and Passage of FIRREA
In the late 1980s, the thrift industry experienced unprecedented losses on loans and investments — commonly referred to as “the savings and loan crisis” — resulting in the failure of over 1,000 thrift institutions that, in aggregate, held over $500 billion in assets. As the crisis deepened, Congress enacted FIRREA, a sweeping reform to address systemic weaknesses in government regulation of banking institutions and to provide greater protection to institutions holding federally-insured deposits. In crafting FIRREA, Congress emphasized deficiencies in federal regulation that allowed for people who saw federal insurance as an opportunity to pocket taxpayer money to commit frauds against financial institutions for personal gain, such as through self-dealing, insider trading or usurping profits.
Congress estimated that fraud by insiders and outside affiliates had caused at least one-third of the failures of thrifts during the savings and loan crisis. Consequently, one of its primary goals in enacting FIRREA was to enhance the enforcement powers relating to frauds committed against financial institutions by individuals seeking personal gain. In the criminal context, FIRREA expanded the powers of prosecutors charging violations of fraud offenses committed against financial institutions. For the often-charged mail and wire fraud statutes (18 U.S.C. §§1341 and 1343, respectively), FIRREA extended the statute of limitations to 10 years, 18 U.S.C. §3293, and enhanced the maximum penalties when the violation “affected” a financial institution, 18 U.S.C. §§1341, 1343. Beyond the expansion of the criminal authority of the DOJ to prosecute frauds committed against a financial institution, FIRREA also created a brand new civil penalty provision, 12 U.S.C. §1833a. Congress did so after identifying “serious gaps” in the government’s civil enforcement authority relating to banks. H.R. Rep. No. 101-54 at 465 (1989).
FIRREA Civil Penalty Provision
Title 12, U.S.C. §1833a(c) authorizes the DOJ to obtain civil penalties for violations of 14 different criminal statutes (the predicate offenses). These predicate offenses fall within two categories. For the first category of offenses, a violation of 12 U.S.C. §1833a requires only a showing that the elements of the relevant predicate offense were committed. The offenses in this first category, by virtue of their underlying elements, involve a fraud committed upon a financial institution or a designated governmental entity. The second category of predicate offenses consists of generally-applicable fraud offenses that have no specific nexus to the federal banking sector, such as the federal mail fraud and wire fraud statutes. For this second category, in addition to the elements of the underlying predicate offense, an action under 12 U.S.C. §1833a(c)(2) also requires a showing that the underlying violation “affected a federally-insured financial institution.” In extending the civil penalty provision to certain generally-applicable offenses like mail and wire fraud, but requiring that a financial institution be “affected,” Congress intended to reach the same type of personal gain driven misconduct that caused the savings and loan crisis (e.g., insider abuse and self-dealing by individuals to the detriment of financial institutions).
The penalties for a civil FIRREA violation can be substantial, as the DOJ may recover up to $1 million per violation (or $5 million for a continuing violation) and penalties can even exceed these amounts if the gain to the perpetrator or the loss to the victim is higher. 12 U.S.C. §1833a(b). Unlike the standard five-year limitations period for civil violations and criminal offenses, FIRREA expanded the statute of limitations to 10 years. 12 U.S.C. §1833a(h). As we move further away from the economic crisis, a FIRREA claim may be among the last viable causes of action available to the government. Thus, as time passes and demand for accountability remains high, it is not surprising that the government has begun to use FIRREA to sift through older conduct.
Distinctions from Criminal Process
In light of the government’s increasing use of FIRREA as a tool, counsel should be aware of how it differs in investigative and other process from other types of investigations. The procedures for gathering evidence in a FIRREA investigation differ from a criminal investigation in a number of respects. Title 12, U.S.C. §1833a authorizes the DOJ to issue administrative subpoenas for any evidence that may be relevant to the investigation. 12 U.S.C. §1833a(g). The material collected pursuant to a FIRREA administrative subpoena is not governed by the grand jury secrecy rules and can be shared freely with other regulators, which is likely to lead to greater exposure for entities because of increased coordination efforts among state and federal agencies investigating RMBS conduct. Additionally, prosecutors working on a FIRREA investigation have the ability to obtain grand jury materials from criminal investigations without a court order. 18 U.S.C. §3322(a). Finally, unlike in a criminal investigation, an adverse inference may be applied in instances when a witness asserts the Fifth Amendment privilege against self-incrimination. Baxter v. Palmigiano, 425 U.S. 308, 318 (1976) (“[T]he Fifth Amendment does not forbid adverse inferences against parties to civil actions.”).
Beyond the differences in the collection of evidence, a FIRREA claim also differs with respect to the burden of proof needed to establish a violation. The elements of the underlying predicate offense that triggered the FIRREA charge need only be proven by a preponderance of the evidence, 12 U.S.C. §1833a(f), rather than the higher criminal standard of “beyond a reasonable doubt.” Indeed, the recent emergence of FIRREA’s use by the government may be attributable, at least in part, to the challenges of establishing the higher burden of proof for a criminal violation. During the announcement of the creation of the RBMS task force in January 2012, Attorney General Eric H. Holder Jr. all but admitted that the absence of criminal conduct related to the economic crisis had led the government to turn to civil enforcement.
FIRREA Mortgage Cases
In the last two years, the DOJ has filed several actions alleging FIRREA violations based on conduct relating to mortgages, including the following:
• United States v. Buy-a-Home, No. 1:10-cv-09280 (S.D.N.Y.) (PKC), alleging false statements and certifications to the U.S. Department of Housing and Urban Development (HUD), regarding the eligibility of loans for HUD insurance, and misrepresentations to financial institutions that purchased the loans;
• United States v. Allied Home Mortgage, No. 1:11-cv-05443 (S.D.N.Y.) (VM), alleging false statements and certifications made to HUD regarding the eligibility of loans for HUD mortgage insurance;
• United States v. CitiMortgage, No. 1:11-cv-05473 (S.D.N.Y.) (VM), alleging false statements and certifications made to HUD regarding the eligibility of loans for HUD mortgage insurance, and faulty mortgage origination;
• U.S. v. Wells Fargo Bank, No. 1:12-cv-07527 (S.D.N.Y.) (JMF) (JCF), alleging false statements and certifications made to HUD regarding the eligibility of loans for HUD mortgage insurance, and faulty mortgage origination (Fried Frank represents Wells Fargo Bank in this pending action); and
• U.S. v. Bank of America, No.1:12-cv 1422 (S.D.N.Y.) (JSR), alleging misleading representations regarding the quality of loans sold to government-sponsored enterprises (or GSEs).
Investigations of other institutions are also believed to be ongoing. Notably, in the charged cases, the False Claims Act, 31 U.S.C. §§3729-3733, is the lead violation, and the FIRREA claims appear to be tacked on as subsidiary claims. Other than the action brought against CitiMortgage, which settled via consent judgment in February 2012, the other matters listed above are currently being contested in federal district court. The outcome of these matters is likely to have a significant impact on the scope of the DOJ’s use of FIRREA going forward.
Emerging New Theories
The recent civil actions filed by the government raise several issues of which defense counsel should be mindful. For many of the predicate offenses that can trigger a FIRREA civil penalty, the government must show either that a financial institution was defrauded or that a federally-insured financial institution was “affected.” The term “financial institution” is defined in the criminal code under 18 U.S.C. §20. This definition includes a wide swath of banking-related entities but does not, on its face, encompass entities that are the alleged victims in many of the cases listed above, namely HUD and the GSEs (e.g., Fannie Mae, Freddie Mac). For those cases, the DOJ’s ability to proceed — at least for claims that require the involvement of a financial institution — will depend upon whether the courts will permit the requisite financial institution to be an entity that was not the direct victim of the alleged fraud.
In an apparent effort to address this deficiency in these actions, the government has adopted several new, and strained, interpretations of FIRREA. In its complaint against Bank of America, the DOJ did not allege that GSEs Fannie Mae and Freddie Mac, the alleged victims of the fraud, were “financial institutions.” Instead, the complaint attempts to satisfy the requirement by alleging that federally-insured financial institutions were investors in the GSEs (as preferred shareholders). Further, the government is now also beginning to allege — for purposes of the predicate offenses that require that a federally-insured financial institution be affected — that a financial institution can “affect” itself through commission of a fraud on another party.
The potential implications are significant. If the law were to recognize that a financial institution can “affect” itself for FIRREA purposes, this may result in the DOJ seeking substantial civil penalties for virtually any mail or wire fraud offense committed in connection with the business of a federally-insured financial institution. To date, no court has ruled on the viability of this “affect” theory in the FIRREA context, although it is now the formal theory of at least two federal district court actions.
One of those actions, unrelated to the mortgage business, may provide the first test of this new theory. The DOJ has alleged that misrepresentations that the Bank of New York Mellon made to customers regarding exchange rates, in violation of the mail and wire fraud statutes, “affected” the bank itself in the form of reputational harm, potential private litigation liability and legal expenditures. United States v. The Bank of New York Mellon, No 1:11-cv-06969 (S.D.N.Y.) (LAK) (filed Oct. 4, 2011). As precedent for this new theory of FIRREA, the government has pointed to criminal cases where a financial institution pleaded guilty to a crime or admitted criminal conduct as part of a nonprosecution agreement. In the cited criminal actions, however, an individual, and not the institution itself, was charged with violating a provision that required proof that a financial institution was “affected.” In adopting this new theory, the government has apparently come full circle from FIRREA’s legislative purpose — giving the government more tools aimed at protecting financial institutions from harm caused by individuals engaged in self-dealing for personal gain — to something entirely different: charging those institutions with FIRREA violations that carry substantial civil penalties.
As regulators continue to prioritize efforts to investigate and charge conduct relating to mortgage lending, FIRREA can be expected to remain a commonly-used tool. In advising and representing clients, counsel should consider FIRREA’s differences from other investigative practices and be cognizant of the government’s emerging theories on FIRREA’s scope. The government’s new use of FIRREA will be shaped, in part at least, by rulings in the pending actions. •