Feds Are Using FIRREA to Pursue Bank Fraud; Are Non-Banks Next?

The Department of Justice has repurposed a 24-year-old law, which it is using to bring civil cases against big banks for misdeeds that led to the financial crisis. Now, non-banks could be next.

Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act in 1989 as a tool to pursue banks responsible for the savings and loan crisis. FIRREA established the Resolution Trust Corp., used to shutter hundreds of insolvent thrifts, and created the Office of Thrift Supervision. But it is other aspects of the legislation that have appealed to the Justice Department so many years later.

It empowers federal prosecutors to seek civil penalties for a wide range of offenses—including mail and wire fraud, bank fraud, and false statements made to the government—that specifically affect federally insured financial institutions. Civil claims brought under the law only have to meet the “preponderance-of-evidence” standard, rather than the much harder to prove “beyond-a-reasonable-doubt” threshold that criminal cases require. The law also has a 10-year statute of limitations, instead of the typical five-year statute for most fraud cases.

FIRREA has been used to pursue Citigroup, Bank of America, Wells Fargo, Bank of New York Mellon, and others for an array of transgressions from improper lending practices to money laundering. And it recently got an important endorsement from the courts. After Bank of America contested the use of the law, a federal jury found that the law could be broadly applied to pursue the kinds of cases the Justice Department was bringing.

Some lawyers say the broad application of the law could spell problems for non-banks that may face similar cases. According to Reid Schar, a partner at Jenner & Block and co-chair of the law firm's white-collar defense and investigations practice, wrongdoing by a company that affects its ability to repay a loan to a federally insured bank, for example, could lead to civil charges, based on the positions expressed by the Justice Department in recent FIRREA-related legal actions.

“From a jurisdictional scope, that it is huge,” Schar says. “It would need to have an effect on a financial institution, but it could be fairly remote and still fall within it.” If the government prevails with its interpretation, “we are looking at a potentially massive expansion of the applicability of this statute in disputes between private companies,” he says.

Lower Standard of Proof

Typically, when a company is charged with mail fraud, it is a criminal case with a high standard of proof, the right to counsel, and other protections. “You don't have those in a civil case under FIRREA and the burden of proof is so much lower,” says Richard Zack, a partner with the law firm Pepper Hamilton and former chief of commercial and consumer fraud and deputy chief of economic crimes for the U.S. Attorney's Office for the Eastern District of Pennsylvania. “The government can prove you committed fraud by a preponderance of the evidence, you don't have to prove it beyond a reasonable doubt, and there can still be huge judgment.”

Often used in tandem with the False Claims Act, penalties under FIRREA can reach up to $1 million per violation or $5 million for continuing violations, with additional civil penalties equal to the amount of the gain or loss that resulted from the underlying fraud. These amounts could, for a big Wall Street bank, be in the billions.

FIRREA's renaissance as an enforcement weapon began in February 2012, when Citigroup agreed to pay $158 million to settle allegations that its CitiMortgage subsidiary falsely stated that some loans met Federal Housing Administration standards for mortgage eligibility, a catalyst for homeowner defaults. 

“The government can prove you committed fraud by a preponderance of the evidence, you don't have to prove it beyond a reasonable doubt, and there can still be huge judgment.”

—Richard Zack,

Partner,

Pepper Hamilton

Last year, the government also invoked FIRREA in a lawsuit against Countrywide Financial Corp. and Bank of America, alleging that mortgage loans were misrepresented to Fannie Mae and Freddie Mac. The Justice Department successfully argued that banks can face a claim for “self-affecting behavior”—in other words, penalized for committing fraud against itself. Countrywide's actions “affected a federally insured financial institution,” namely itself and subsequent owner Bank of America when repurchase demands cost billions, the government said. A federal district court ruling in the case of United States v. The Bank of New York Mellon further solidified the stance that a federally insured financial institution can be held liable for fraudulent conduct affecting itself, as opposed to fraud by third parties that victimized it.

In fact, the Justice Department's $13 billion settlement with JPMorgan for misrepresentations of mortgage-backed securities—the largest settlement with a single entity in American history—included $2 billion as a civil penalty to settle added-on FIRREA claims.

“Today's global settlement underscores the power of FIRREA and other civil enforcement tools for combating financial fraud,” Assistant Attorney General Stuart Delery said in a statement, which could signal that FIRREA will be used more frequently. “We will continue to use every available resource to aggressively pursue those responsible for the financial crisis.”

Is FIRREA ‘Limitless?'

The following is a selection from an Aug. 19 ruling by U.S. District Judge Jed Rakoff in the case of U.S. v. Bank of America. In it, he upholds the government's involving the Financial Institutional Reform Recovery and Enforcement Act on the grounds that the underlying fraud was “self-affecting.”

The Government's alternative theory of FIRREA applicability—the “derivative” theory—squarely raises the question of whether a fraud that does not directly or immediately affect federally insured financial institutions is too attenuated to give rise to a FIRREA claim.

In this respect, the Amended Complaint alleges that the defendants' defrauding of Fannie Mae and Freddie Mac proximately caused their eventual receivership, which in turn wiped out the preferred securities that composed the core capital reserves of several federally insured smaller banks.

The defendants argue that if this is enough to meet the requirements, FIRREA liability is “limitless” and “contrary to case law.” While clearly an overstatement, the argument is not without some force, for while “affecting” is a very broad term, Congress did not include the modifying language “directly or indirectly” that it typically employs to reach derivative effects.

On the other hand, the effect that the fraud here had on the federally insured banks that invested in Fannie Mae and Freddie Mac was, according to the Government's allegations, both substantial and foreseeable, the classic components of proximate cause, let alone of mere “affect.”

Fortunately, however, the Court need not resolve this issue here, because the Court's determination that the effect of the defendants' fraud on BofA itself is sufficient to sustain the FIRREA counts of the Amended Complaint against defendants' first argument for dismissal.

Source: U.S. v. Bank of America ruling.

The “self-affecting doctrine,” made concrete by the courts, applies only to financial institutions. However, FIRREA can also extend beyond them to vendors, third parties, and—if courts ultimately validate the Justice Department's stance—any company in the United States that does business with a bank.

If a company commits a fraud that ultimately affects an institution insured by the Federal Deposit Insurance Corp., it could be liable under FIRREA, based on how the government has articulated its interpretation of FIRREA.

“Many companies do business with banks—perhaps they process payments, or some of the flow from their operations goes through a bank—and that is enough to subject that non-bank to a FIRREA lawsuit because it had an effect on a financial institution language,” Zack says, describing the Justice Department's efforts as “regulation by litigation.”

The reinvigorated and expanded use of FERRIA is a call to revaluate anti-fraud efforts and compliance programs.

The government's position is that banks, and those that do business with them, have an affirmative obligation to seek out and stop fraud. Even if a bank doesn't participate in the fraud, but just wasn't diligent enough to stop it, it can still face a claim, Zack explains.

He uses the example of payment systems. They are set up to be efficient, quick, and cheap, which means less oversight. Now, banks have an affirmative obligation to monitor those transactions and make sure no one is committing fraud. “It increases compliance costs for banks and their vendors tremendously,” he says. Financial institutions may need to bolster staff dedicated to anti-money laundering and Bank Secrecy Act compliance.

Concerned non-banks may take limited solace in that courts have thus far “punted on the issue,” of broadly applying the law to non-banks, Schar says. Also up for future interpretation, he says, is how direct the fraud must be. A loan default with a clear, direct affect on a bank would be one thing, “but what if you are now several steps removed and the fraud ultimately effects the financial institution?”

“The government has proven that when things go wrong they will be creative at finding ways to punish you,” he cautions. “It's another reminder that you really have to have a compliant mindset, be diligent in your compliance policies, and make sure you are doing everything you need to do.”