S&L Relic Is Sword of Choice in U.S. Bid to Punish Banks
Weeks after taking over as the U.S. Attorney in Manhattan in 2009, Preet Bharara said he considered whether his office could hold individuals and banks liable for the financial crisis when there wasn’t enough evidence to bring a criminal case.
During an interview in his office overlooking the Brooklyn Bridge, Bharara recalled that he came upon an idea after long talks with staffers: maybe lawyers in the office’s civil division could go after these cases. After months of research, prosecutors dusted off the Financial Institution Reform, Recovery and Enforcement Act of 1989, known as FIRREA.
The law, a relic of the savings-and-loan crisis of the 1980s, allows the government to sue an individual or group, rather than charge them with a crime, for fraud that affects a federally-insured financial institution. FIRREA carries a 10-year statute of limitations, giving the government double the time to bring its case than allowed under other securities laws.
In the two decades following the S&L crisis, the law was used sparingly. Now, because of the push by Bharara’s office, it has become the weapon of choice for federal prosecutors investigating the root causes of the financial crisis that started in 2008.
Since 2010, prosecutors in the Southern District of New York have used the statute at least six times, not just against individuals accused of defrauding a bank, but against banks alleged to have defrauded third parties. In the interview, Bharara talked about FIRREA while declining to discuss pending cases and matters.
One case, in which the U.S. claims Bank of America Corp.’s Countrywide unit defrauded Fannie Mae (FNMA) and Freddie Mac (FMCC) by selling them billions of dollars in bad mortgages, is scheduled to go to trial today with jury selection and opening statements before U.S. District Judge Jed Rakoff in Manhattan.
Using FIRREA, the U.S. Attorney in Los Angeles sued McGraw-Hill Cos. (MHFI) and its Standard and Poor’s unit in February, alleging the companies knowingly understated the credit risks of bonds and derivatives.
JPMorgan Chase & Co. (JPM) disclosed last month that the U.S. Attorney in Sacramento, California, had opened civil and criminal inquiries into mortgage-backed securities transactions initiated by the bank from 2005 to 2007.
The case is a FIRREA prosecution, according to a lawyer briefed on the matter who asked not to be identified because the matter is confidential. Charges related to the sales could be filed as early as today, another person familiar with the matter said.
Brian Marchiony, a spokesman for New York-based JPMorgan, declined to comment on the probe.
“I am proud that other people around the country have seen that success and realized this is a tool,” Bharara, 44, said in the Sept. 10 interview at his office, which is lined with photographs of him with President Barack Obama, Vice President Joseph Biden and Bruce Springsteen posing with Bharara’s mother and one of his children after a concert. “You don’t have to reinvent the wheel, you have to look and see what’s successful elsewhere.”
In addition to FIRREA, Bharara’s team has taken another civil statute, the False Claims Act, or FCA, and repurposed it as a weapon against the alleged perpetrators of the financial crisis. The FCA, which was created during the Civil War to combat fraud against the Union Army, is now aimed at any attempt to defraud the federal government.
The statutes have advantages. Both demand a lower burden of proof than what is needed to win a criminal case. While trying to build FIRREA cases, prosecutors also are allowed access to secret grand-jury evidence developed in the course of separate criminal investigations.
The U.S. can extract hefty penalties as well. The FCA has a provision that allows the U.S. to collect three times the amount of damages suffered by the government. FIRREA allows penalties of more than $1 million for each fraudulent statement or act, and as much as $5 million for continuing violations of underlying criminal statutes.
Since March 2010, Bharara’s office has used the FCA and FIRREA statutes to obtain mortgage fraud recoveries of almost $500 million from CitiMortgage, Deutsche Bank AG (DBK) and Flagstar Bancorp Inc. (FBC)
Such latitude, and the resurgence of the use of FIRREA, has caused some in the legal community to sound the alarm. An August 2012 article in The Banking Journal warned the government’s use of FIRREA posed a “devastating” threat.
“Banks and those affiliated with banks should take these lawsuits as seriously as a criminal grand jury subpoena,” Jay Williams, Valarie Hays and Mir Ali, of Schiff Hardin LLP, wrote.
Four years ago, no federal prosecutor had yet applied the FIRREA statute to a fraud that a bank or a financial institution had itself engaged in.
“A plain reading of the statute as we discussed it internally was, ‘Of course it affects the financial institution,’” Bharara said. “And we were pretty heartened that a few years on, two prominent, well-respected and smart judges have strongly endorsed that plain-meaning interpretation of the statute. And we expect more will.”
U.S. District Judge Lewis Kaplan in April upheld the government’s theory in its foreign-exchange case against Bank of New York Mellon Corp. In August, Rakoff rejected a bid to dismiss a suit filed by Bharara’s office and ruled that Bank of America, based in Charlotte, North Carolina, and its Countrywide unit would have to go to trial in a $1 billion suit that alleged they sold thousands of defective loans to Fannie Mae and Freddie Mac, two home-mortgage finance companies now under government control.
When BNY Mellon contended that the affected institution must be the victim or an innocent bystander to the alleged fraud, not the perpetrator, Kaplan disagreed.
“As alleged here, a federally insured institution has engaged in fraudulent activity and harmed itself in the process, it is entirely consistent with the text and purposes of the statute to hold the institution liable for its conduct,” Kaplan said in a ruling that he called a legal “first.”
Bharara also made staff changes. While the office had a civil division whose attorneys represented the government’s interests in lawsuits and defended the U.S. in civil cases, he created a Civil Frauds unit in March 2010 that combats large-scale financial fraud against the government.
The unit has filed more than two dozen lawsuits and recovered almost $700 million in cases that include pharmaceutical companies and health care and grant fraud.
“We may be outnumbered and outspent but I don’t think we’re outmatched,” he said.
The office has also reached out to lawyers who specialize in bringing whistle-blower suits, Bharara said. Under the FCA, which was passed by Congress in 1863, citizens file so-called qui tam cases that remain sealed from public view as the U.S. Justice Department investigates the claims. The U.S. then decides whether to join the suit. Bharara’s office joined the Countrywide suit as a plaintiff.
“We’ve said, ‘If you’re thinking about places where whistle-blowers can bring suit, one of those places should be the Southern District of New York,’” he said.
Bharara said a fraud suit can be as effective as an indictment in revealing bad behavior to the public.
Some lawyers said FIRREA’s newfound popularity is due in part to attempts by prosecutors to continue filing financial crisis cases more than five years after the collapse of Lehman Brothers Holdings Inc. in September 2008, at a time when a criminal case is no longer feasible.
“Financial institutions are concerned that the government may increasingly use FIRREA as a way to resurrect and invigorate stalled investigations concerning the financial crisis because of the 10-year statute of limitations,” said Keith Miller, who is chairman of the securities enforcement practice at Perkins Coie LLP in New York.
As these FIRREA cases go to trial, the defense bar may have to adjust to a new timeline for prosecutors to build their case.
“Every U.S. attorney has to think about ways to use statutes that are already there as we don’t have the ability to pass laws,” Bharara said. “We have to use the tools we already have -- some of them are pretty powerful and some of them go unused.”
“If you end up bringing a suit where you detail a narrative of bad conduct over time -- whether it’s a financial institution or a toy company -- that’s one of the best services we can provide,” Bharara said.
The case is U.S. v. Countrywide Financial Corp., 12-cv-01422, U.S. District Court, Southern District of New York (Manhattan).
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