BofA’s Dilemma of Right and Wrong in Mortgage-Fraud Case

Bank of America Corp. lawyers face a legal paradox, arguing a judge was right and wrong at the same time. The U.S. faces the same hurdle.

The bank praised U.S. Magistrate Judge David S. Cayer in Charlotte, North Carolina, for recommending the dismissal of a U.S. Justice Department fraud lawsuit over the lender’s issuance of mortgage-backed securities valued at $850 million. But it says he was wrong in recommending a related U.S. Securities and Exchange Commission suit should continue, just as the government argued the opposite.

“One side thinks he’s a genius and the other thinks he’s just plain wrong” on each of the cases, U.S. District Judge Max O. Cogburn Jr., in federal court in Asheville, North Carolina, said at the start of today’s hearing to determine whether he’ll accept Cayer’s recommendations.

The suits are part of a U.S. bid to punish companies for actions the government says helped trigger the financial crisis. Charlotte-based Bank of America is accused in the SEC case of violating securities laws by hiding what it knew about the shaky future of the mortgages that backed the securities. The Justice Department says the government was a victim of fraud.

Key Element

Cayer, in a March 27 recommendation to dismiss the justice department’s case, said the government hadn’t properly supported its claim that the bank lied to the Federal Housing Finance Board -- a key element of a claim under the Financial Institutions Reform, Recovery and Enforcement Act of 1989. If the case is dismissed, it will be a first for about a dozen companies that have been targeted under the law.

By contrast, Cayer said in a March 31 recommendation that the SEC’s lawsuit was “sufficient to withstand dismissal.”

“It’s a little delicate, but not impossible,” Peter Henning, a former SEC lawyer and a professor at Wayne State University Law School in Detroit, said of the bank’s challenge to argue the judge interpreted the law correctly in one case and misinterpreted it in the other. “Lawyers don’t want to get caught talking out of both sides of their mouths, but they can do that here.”

Arguments over both of Cayer’s non-binding recommendations were heard today by Cogburn in a hearing that lasted about two hours. Cogburn will decide whether Cayer was on the mark, although he didn’t indicate at the end of today’s hearing when he would issue a decision. Magistrates are called upon in some federal-court cases to offer preliminary opinions. Either party may object before a final ruling is made.

‘Little Awkward’

The situation is “a little awkward” for Bank of America, said Jay Williams, a lawyer at Schiff Hardin LLP who represents financial institutions in civil cases and isn’t involved in the matter. “It’s always a little delicate when you’re trying to argue the same person got it right and got it wrong.”

Lawrence Grayson, a spokesman for Bank of America, declined to comment on the hearing or Cayer’s recommendations. Lia Bantavani, a spokeswoman for the Justice Department, and John Nester, a spokesman for the SEC, also declined to comment.

Bank of America has reason for concern. In a related case, a federal jury in New York in October found the lender’s Countrywide unit was liable for defrauding Fannie Mae and Freddie Mac in the first mortgage-fraud case brought by the government to go to trial. The judge in that case heard arguments in March over whether Bank of America owes as much as $2.1 billion -- or nothing -- for selling thousands of defective mortgage loans.

Shoddy Mortgages

Chief Executive Officer Brian T. Moynihan, seeking to move on from the housing-bubble fallout, has spent more than $50 billion to resolve claims related to shoddy mortgages, most tied to his predecessor’s 2008 purchase of Countrywide, once the biggest U.S. mortgage lender.

“There’s more at stake for Bank of America because it’s another headline for them and it makes it harder to put the financial crisis behind them,” Henning said. Survival of either case “keeps this issue alive.”

When the suits were filed on Aug. 6, Attorney General Eric Holder said in a statement that his agency’s complaint was part of an effort “to hold accountable those who engage in fraudulent or irresponsible conduct.”

Bank of America is accused of failing to tell investors that more than 70 percent of the mortgages were from a wholesale channel of unaffiliated brokers. Some were “PaperSaver” loans that didn’t require proof of borrowers’ income, the U.S. said.

By the time the securities were being sold in early 2008, then-CEO Ken Lewis had referred to such loans as “toxic waste,” the U.S. said.

Less Risky

The SEC claims the bank misrepresented in loan documents “material facts about the underlying mortgages” and made them appear less risky.

The Justice Department took a different route using the same facts, seeking to hold the bank liable under Firrea, a previously little-used law stemming from the savings-and-loan crisis of the 1980s.

Bank of America engaged in a “massive, but straight-forward fraud” by lying to investors about the health of the securities, the Justice Department said in its complaint.

Firrea allows the U.S. to punish actions taken too long ago to be covered by other laws and seek larger damages awards. It also permits the government to sue an individual or group, rather than charge them with a crime, for fraud that affects a federally insured financial institution.

Sophisticated Buyers

The lender has denied the claims in both government lawsuits, arguing the securities were sold to “sophisticated” financial institutions that haven’t sued over the deals.

In separate court filings before today’s hearing, Bank of America urged Cogburn to adopt Cayer’s recommendation in the Justice Department case, while saying the magistrate was “mistaken” in the SEC lawsuit.

Prosecutors in the Justice Department case argued Cayer’s findings were “erroneous,” while the SEC lawyers said Cayer made the right call.

The case is U.S. v. Bank of America Corp., 13-cv-00446, U.S. District Court, Western District of North Carolina (Charlotte).

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