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From Banking and Finance Law Daily, August 20, 2013

Although Government’s False Claims Act allegations dismissed, FIRREA “civil fraud” claims against banks survive

By Thomas G. Wolfe, J.D.

In connection with the U.S. Government’s civil fraud action against two major banks and their pertinent affiliates for alleged misrepresentations and fraudulent conduct during loan sales to Fannie Mae and Freddie Mac, the U.S. District Court for the Southern District of New York has issued an opinion dismissing the Government’s claims under the False Claims Act (FCA) but allowing the Government’s claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) against the banks and a bank executive to proceed (United States of America v. Countrywide Financial Corporation, et al., Aug. 16, 2013, Rakoff, U.S. District Judge).

In issuing its recent opinion, the federal district court sought to confirm and explain the rulings it made in its prior May 8, 2013, “bottom-line” order.

Background. In its action against the banks, the Government’s complaint alleged that the banks engaged in fraud and made false representations in connection with the sale of loans by Countrywide and Bank of America to the government-sponsored entities (GSEs), Fannie Mae and Freddie Mac. In particular, the Government claimed that the banks violated FIRREA, premised on violations of federal mail fraud and wire fraud provisions, and the FCA.

In requesting the federal trial court to dismiss the Government’s complaint, the banks contended that the FIRREA counts should be dismissed because: (i) the sale of loans to the GSEs did not directly “affect” a federally insured financial institution as required by FIRREA; and (ii) the predicate mail and wire fraud violations were premised on statements that did not, as a matter of law, constitute fraudulent misrepresentations. In addition, the individual bank executive of Countrywide’s “Full Spectrum Lending” division argued that the Government’s FIRREA claim against her contained insufficient facts to support an inference that she acted with the requisite intent.

Further, the banks contended that the Government’s FCA claim should be dismissed because the Government failed to state a cause of action under the FCA for false claims made after May 20, 2009, the date on which liability under the FCA was broadened to reach false claims made to GSEs.

Court’s FIRREA analysis. Among other things, FIRREA (12 U.S.C. § 1833a) empowers the Attorney General to bring a civil case to recover civil penalties for violations of a number of criminal offenses—including mail and wire fraud—“affecting a federally insured financial institution.”

In rejecting the banks’ argument that their sales and representations to the GSEs did not “affect a federally insured financial institution,” the court noted that it did not need to engage in a lengthy discussion of the relative merits of a “derivative theory” of liability. Rather, in ruling that the Government’s FIRREA claims should proceed, the court looked at the plain meaning of the word “affect,” and emphasized that Bank of America itself was a federally insured financial institution and that the alleged fraudulent misrepresentations and conduct affected the bank itself and its shareholders; this was enough to sustain the Government’s FIRREA claims.

In addressing the banks’ position that the Government did not adequately allege “the predicate offenses of mail and wire fraud” for the FIRREA counts of the complaint, the court rejected the banks’ argument that the allegedly fraudulent misrepresentations made to the GSEs were, at worst, “mere breaches of contract that cannot separately support an action for fraud.”

Instead, the court determined that the Government’s complaint adequately alleged that the defendants: (i) knew they were selling defective loans; (ii) perpetrated their scheme by designing and implementing the loan program in such a way as to remove meaningful supervision of loan underwriting; (iii) imposed quotas and a compensation system designed to remove the incentive to approve loans based on quality; and (iv) after their own quality control reports showed high defect rates, the defendants concealed that information. Moreover, the court asserted, the complaint described, “with the requisite particularity, seven representative defective loans that, through the use of the mails and interstate wires, were fraudulently sold to [the GSEs] as investment-quality loans.”

Court’s FCA analysis. The court observed that a May 20, 2009, amendment to the FCA “arguably extends the FCA to false claims made to Fannie Mae and Freddie Mac …, but it did not have retroactive effect.” The court further noted that, unlike the complaint’s detailed factual support of allegations pertaining to defective loans by Countryside before its acquisition by Bank of America, the complaint “did not make a similar showing about the submission of defective loans by Bank of America to Fannie Mae and Freddie Mac after May 20, 2009.”

Accordingly, the court concluded that the FCA claims did not satisfy the pleading standards of the Federal Rules of Civil Procedure. Since the Government had already amended its complaint several times and was put on notice of an alleged deficiency of its FCA claims by the defendants’ motions, the court dismissed the Government’s FCA claims with prejudice.

The case is No. 12 Civ. 1422 (JSR).

Attorneys: Carina Hyatt Schoenberger, Ellen Melissa London, Jaimie Leeser Nawaday, Jeannette Anne Vargas, Joseph Nicholas Cordaro, Pierre G. Armand, and Shane Patrick Cargo of the U.S. Attorney’s Office for plaintiff United States of America. David Gerard Wasinger (The Wasinger Law Group, P.C.) for plaintiff United States of America ex rel. Edward O’Donnell. Brendan V. Sullivan , Jr. (Williams & Connolly) for defendant Bank of America Corporation. Derek M. Adams, Gus P. Coldebella, Kelly E. Phipps, Meghan K. Spillane, Ryan P. Lirette, and Tamara H. Schulman (Goodwin Procter, LLP) for defendant Countrywide Bank, FSB. Daniel Seth Meyers, Konstantin Chelney, Marc Lee Mukasey, Marvin Robert Lange, Michael C. Hefter, Ryan Michael Philp, and Seth Michael Cohen (Bracewell & Giuliani, LLP) for defendant Rebecca Mairone.

Companies: Bank of America Corporation; Bank of America, NA; Countrywide Bank, FSB; Countrywide Financial Corporation; Countrywide Home Loans, Inc.; Fannie Mae; Freddie Mac

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