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From Banking and Finance Law Daily, August 5, 2016

Government won’t give up on Countrywide Hustle suit

By Richard A. Roth, J.D.

The federal government has asked the U.S. Court of Appeals for the Second Circuit to reconsider its decision that Countrywide Financial Corporation and one of its executive officers did not commit fraud when the company sold Fannie Mae and Freddie Mac mortgages that did not meet the standards set by their contracts. The Second Circuit determined that the government proved only breaches of contract, not fraud, because there was no proof that the company intended to sell nonconforming mortgages at the time the contracts were signed (U.S. v. Countrywide Home Loans, Inc., discussed in Banking and Finance Law Daily, May 23, 2016). The government’s petition for rehearing, however, contends that the appellate court "overlooked a wealth of evidence" that relevant fraudulent misrepresentations were made each time loans were sold.

The appellate court opinion said that Countrywide’s contracts with the GSEs required the mortgages it sold to meet standards that would make them "acceptable investments" or to have the characteristics of investment quality mortgages as of the date they were delivered. The government presented no evidence that Countrywide intended not to meet that standard when it signed the contracts, said the court. Countrywide later delivered to the GSEs many unacceptable mortgages—those originated through the company’s "High Speed Swim Lane" (HSSL, commonly pronounced "hustle") without disclosing any deficiencies.

The Second Circuit concerned itself only with the absence of fraudulent intent when the contracts were signed. The contracts between Countrywide and the GSEs made clear that only representations made at that time mattered, the court said. Misrepresentations made when the mortgages were delivered were irrelevant.

Misrepresentation timing. In its petition for rehearing, the government contests the position that only misrepresentations made when the contracts were signed matter. For example, the Fannie Mae master contract says that warranties about loan quality "are made as of the date transfer is made to us," the government points out. Also, the GSE’s Seller and Servicer Guide makes clear that some warranties are deemed to be made at the time a mortgage is delivered.

Freddie Mac’s contract with Countrywide also was governed by a Seller and Servicer Guide. That document said that warranties and representations were made "as of the Delivery date." Also, Countrywide and Freddie Mac entered into a separate contract for each sale, and misrepresentations at that time could constitute fraud, the government argues.

Misrepresentation by omission. Only three weeks after the Second Circuit’s decision, the Supreme Court decided Universal Health Services v. United States ex rel. Escobar, 136 S.Ct. 1989 (2016), which addressed fraudulent omissions. The government interprets that opinion as saying representations that are truthful as far as they go but omit "critical qualifying information" can constitute misrepresentations. Specifically, making representations in submitting a claim for payment that does not disclose a violation of contractual requirements can render the representations misleading.

Under that standard, Countrywide committed fraud, the petition says.

Chance for new trial. In the alternative, the government says that the appellate court should not have ordered that a judgment be entered in favor of the company and officer without giving the government an opportunity to ask for a new trial. If the appellate court ruling stands, the petition says, the government deserves a chance to present evidence and arguments that satisfy that ruling.

The petition was filed in consolidated cases No. 15-496 and No. 15-499.

Attorneys: Kannon K. Shanmugam (Williams & Connolly LLP) for Bank of America, N.A., and Countrywide Bank, FSB. E. Joshua Rosenkranz (Orrick, Herrington & Sutcliffe LL) for Rebecca Mairone. Pierre G. Armand, Assistant United States Attorney, and Preet Bharara, United States Attorney. Seth P. Waxman (Wilmer Cutler Pickering Hale and Dorr LLP) for amici curiae The Clearing House Association, L.L.C., American Bankers Association, Financial Services Roundtable, and Chamber of Commerce of the United States of America. Dennis M. Kelleher for amicus curiae Better Markets, Inc.

Companies: Bank of America Corp.; Bank of America, N.A.; Countrywide Bank, FSB; Countrywide Financial Corp.; Countrywide Home Loans, Inc.; Fannie Mae; Freddie Mac

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