During the past 18 months, while the U.S. Department of Justice commenced a number of high-profile cases against financial institutions under the long-forgotten Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), many commentators and legal experts opined that the DOJ’s interpretation of the statute was misplaced and unlikely to survive legal scrutiny. So far, the commentators and experts have been wrong. Two recent decisions by respected jurists have allowed FIRREA claims to proceed against significant financial institutions.
Background of FIRREA
Congress enacted FIRREA in the wake of the savings and loan crisis of the 1980s to provide “enhanced enforcement powers and increased criminal and civil money penalties for crimes of fraud against financial institutions.” FIRREA not only restructured the regulatory agencies responsible for supervision of financial institutions, it also granted broad investigative authority and provided for civil liability and the imposition of civil penalties for violations.
FIRREA Authorizes Broad Investigative Authority
The investigative authority granted by FIRREA includes the right of the U.S. attorney general to take extremely broad pre-complaint discovery. FIRREA authorizes the attorney general to administer oaths and affirmations; take evidence; and by subpoena, summon witnesses and require the production of any books, papers, correspondence, memoranda, or other records that the attorney general deems relevant or material to the inquiry. There is a nationwide venue provision — a subpoena may require the attendance of witnesses and the production of any such records from any place in the United States at any place in the United States designated by the attorney general.
Civil Provisions Under FIRREA
FIRREA authorizes the attorney general to seek civil penalties for the violation of certain criminal statutes, including mail fraud, wire fraud and bank fraud, when the alleged crimes affect federally in¬sured financial institutions or involve false statements to the Federal Deposit Insurance Corp. (FDIC), the Department of Housing and Urban Development (HUD), and other federal entities. The attorney general is required to establish the right to recovery by a preponderance of the evidence. The U.S. government can recover up to $1.1 million per violation, $5.5 million for a continuing violation, or the amount of economic gain or loss resulting from the fraud, whichever is greater. A whistleblower provision was added by the Financial Institutions Anti-Fraud Enforcement Act of 1990, which allows the whistleblower to share in the government’s recovery in a FIRREA lawsuit. Finally, the statute has an extraordinarily long 10-year statute of limitations.
These provisions of FIRREA have gone largely unused over the last two decades. However, its low burden of proof, broad investigative powers and long statute of limitations have made it attractive to the DOJ to address the losses incurred by federally insured financial institutions because of the subprime mortgage and other market failures.
Recent Cases Brought Under FIRREA
The DOJ has filed a number of well-publicized FIRREA cases against financial institutions in the last 18 months. Because FIRREA allows the DOJ to seek civil penalties against anyone who commits a fraud "affecting a federally insured financial institution," the linchpin of all of these suits is the allegation that the defendant financial institution has by its conduct “affected” itself. However, no court had ever interpreted the meaning of the phrase “affecting a federally insured financial institution” to allow the government to bring claims under FIRREA against a financial institution for its own alleged misconduct. In a number of the recently filed cases, financial institutions, including Bank of America Corp., Countrywide Financial, Bank of New York Mellon Corp. (BNY Mellon) and Wells Fargo N.A. have argued that FIRREA cannot apply when the only financial institution “affected” by a fraud is the institution that allegedly committed the fraud. Rather, they have argued, the financial institution must be either the victim of or an innocent bystander to the alleged fraud, and not the entity responsible for the fraud.
So far, the argument that an entity’s own misconduct cannot “affect” itself within the meaning of FIRREA has not been well received. Motions to dismiss in the cases against BNY Mellon and Bank of America were decided within the last few weeks, and in both cases, the FIRREA claims were permitted to go forward.
The DOJ’s complaint against BNY Mellon was filed in the Southern District of New York on October 4, 2011, and amended in February 2012 to expand the basis of the FIRREA claims. The complaint accused BNY Mellon of making false and misleading statements to its clients about how $1.5 billion in foreign currency exchange transactions would be priced, which ultimately “affected” the bank itself. Although the government and BNY Mellon reached a partial settlement last year regarding disclosures to be made to foreign currency exchange customers on a going forward basis, the DOJ is still seeking hundreds of millions of dollars of civil penalties under FIRREA. BNY Mellon moved to dismiss the FIRREA claims. On April 24, U.S. District Judge Lewis Kaplan of the Southern District of New York ruled that BNY Mellon could be sued under FIRREA because the alleged misconduct put the bank’s own federally insured deposits at risk.
The DOJ’s complaint against Bank of America and Countrywide was filed in the Southern District of New York in October 2012. According to the complaint, Bank of America and Countrywide are responsible for more than $1 billion in losses incurred by Fannie Mae and Freddie Mac because they sold them thousands of toxic mortgage loans that were originated through a program begun at Countrywide and continued at Bank of America in which lending safeguards were eliminated to permit high volumes of loans to be made quickly. Despite that, Judge Jed Rakoff had told counsel during the oral argument in late April that he was “troubled” by the government’s use of FIRREA in this context; Rakoff denied Bank of America and Countrywide’s motion to dismiss the FIRREA claims May 13.
The BNY Mellon and Bank of America/Countrywide cases have been closely watched as a potential bellwether as to the viability of FIRREA under these circumstances. Two other FIRREA cases against financial institutions — against Wells Fargo and S&P Financial Services LLC — each asserting hundreds of millions of dollars of losses, are still awaiting decision on motions to dismiss.
In October 2012, the DOJ filed a lawsuit against Wells Fargo, the fourth-biggest U.S. bank as measured by assets, in the Southern District of New York, seeking damages and civil penalties under the False Claims Act and FIRREA for alleged misconduct in connection with Wells Fargo’s participation in the Federal Housing Administration’s Direct Endorsement Lender Program.
According to the DOJ’s complaint, the FHA paid hundreds of millions of dollars in insurance claims on thousands of defaulted mortgages because of Wells Fargo’s false certifications. The complaint also alleges that Wells Fargo failed to properly train its staff, hired temporary workers and paid improper bonuses to its underwriters to encourage them to approve as many loans as possible. Wells Fargo has argued, among other things, that FIRREA is inapplicable and that a $5 billion settlement with the government in 2012, which was part of a $25 billion multibank mortgage misconduct accord, barred all claims alleged by the DOJ in the lawsuit.
The only exception to the settlement, the bank argued, is if the government “could establish that specific, individual Wells Fargo underwriters” executed the individual loan-level certifications knowing that some were not eligible, but the complaint here contained no such specific allegations. The DOJ argued that the settlement bar argument is precluded by a February 2012 decision by U.S. District Judge Rosemary Collyer of the District of Columbia. Collyer held that the settlement language did not have the meaning ascribed to it by Wells Fargo and denied the bank’s request for an order enforcing the settlement. Wells Fargo’s motion to dismiss is still pending.
In February, the DOJ filed a $5 billion suit in the Central District of California against S&P and its corporate parent, McGraw-Hill, arising from S&P’s ratings of collateralized debt obligations. The complaint asserts claims for mail and wire fraud, as well as financial institution fraud, and is premised on the losses incurred by a failed California credit union — Western Federal Corporate Credit Union — that was an investor in a number of collateralized debt obligations that had been rated by S&P. The thrust of the allegations is that S&P misled investors by stating that its ratings on mortgage products were objective and not influenced by conflicts of interest, when, according to the DOJ, S&P executives delayed upgrading the computer models that the analysts use to rate collateralized debt obligations and avoided giving analysts information about the deteriorating condition of the subprime market because S&P did not want to lose rating business. S&P moved to dismiss in April, arguing, among other things, that FIRREA was inapplicable and that S&P’s professed “objectivity, integrity and independence” of its ratings were claims of “puffery” that were not actionable.
The DOJ has announced that the FIRREA litigation “marks an important step forward in the administration’s ongoing efforts to investigate — and punish — the conduct that is believed to have contributed to the worst economic crisis in recent history.” The decisions upholding the use of FIRREA against BNY Mellon and Bank of America certainly will encourage continued use of FIRREA as an enforcement tool. ,/p>
David Smith is the chairman of Schnader Harrison Segal & Lewis and a member of the financial services litigation practice group, resident in the Philadelphia office.
Theresa E. Loscalzo is the co-managing partner of the firm and a member of the financial services litigation practice group, resident in the Philadelphia office.