Two recent decisions indicate a possible broadening of the scope of the Financial Institutions Reform, Recovery and Enforcement Act of 1989.
In the wake of the financial crisis, the Department of Justice is increasingly turning to civil, rather than criminal, statutes to bring cases against financial institutions. Most notably, the DOJ has broadened its application of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA or the Act),1 and so far the government’s theories appear to have prevailed. In two closely-watched rulings, issued on April 24 and May 8, 2013, respectively, two judges in the Southern District of New York rejected defendants’ motions to dismiss the government’s FIRREA claims. Moreover, similar claims are pending in yet another Southern District of New York case.
Passed by Congress as a response to the savings-and-loan crisis of the 1980s, FIRREA made a variety of sweeping reforms, imposing new regulatory requirements on covered banking institutions and creating civil penalties for violations of pre-existing federal criminal laws. Those reforms notwithstanding, enforcement actions under the statute were relatively rare. Recently, however, the DOJ appears to have rediscovered FIRREA, perhaps because of the Act’s ten-year statute of limitations, lower burden of proof, and prospect of significant penalties—up to $1.1 million per violation, or $5.5 million for a continuing violation.2 As if FIRREA wasn’t appealing enough to prosecutors, a recent decision from the Southern District of New York in United States v. Bank of New York Mellon,3 (Bank of New York) suggests that Federal courts may be willing to read the statute so broadly that it creates civil liability for essentially any financial crime committed by financial institutions and not just those committed against them.
FIRREA imposes civil liability for two types of criminal violations: those that inherently involve financial institutions (e.g., financial institution bribery, false entries in financial institution records etc.) as listed in 12 U.S.C. § 1833a(c)(1), and violations (e.g., mail fraud, wire fraud etc.) enumerated in 12 U.S.C. § 1833a(c)(2) that are triggered only if the violation “affect[s] a federally insured financial institution.”4 In Bank of New York, Judge Lewis Kaplan issued the first opinion interpreting the phrase “affecting a federally insured financial institution” and held that it does not mean “victimize” but rather must be read broadly to allow for liability against any institution whose own fraudulent conduct “affects” that same institution. As applied in Bank of New York, that holding seemingly would allow FIRREA liability in nearly any case where a financial institution has been sued by private plaintiffs for fraud-related conduct.
What Is FIRREA?
FIRREA was passed on August 9, 1989, in response to the savings-and-loan crisis and the resulting strain on the federal deposit insurance programs associated with the failure of such institutions. Among its most notable reforms is its imposition of harsh civil penalties for violations of certain pre-existing federal criminal laws that regulated or affected federally insured financial institutions or other similar entities. Those pre-existing laws include mail fraud (18 U.S.C. § 1341), wire fraud (18 U.S.C. § 1343), false-entries fraud (18 U.S.C. §§1005, 1006), and bank fraud or concealment of assets and other frauds as against a federally-insured banking institution (18 U.S.C. § 1344).5
The incorporation of those existing criminal statutes—particularly mail fraud and wire fraud—into a civil enforcement regime makes FIRREA a useful tool for regulatory action. The criminal statutes allow FIRREA investigations to work in tandem with ongoing criminal investigations and yet, because FIRREA is a civil statute, the government need only establish its claim by a preponderance of the evidence as opposed to the “beyond a reasonable doubt” standard that applies to criminal actions.6 Moreover, the statute’s limitations period (ten years after the cause of action accrues) gives the DOJ a longer time to develop its investigation, greater visibility into the effects of allegedly wrongful conduct before bringing suit, and the ability to reach back to past conduct other provisions may miss. FIRREA’s hefty civil penalties allow regulators to seek over a million dollars in penalties for each transmission of a fraudulent statement or other discrete act.7 In sum, the sizable per-violation penalty, and the open-ended definition of “violation” under the Act, can lead to potential billion-dollar aggregate penalties against alleged violators.
United States v. Bank of New York Mellon
In Bank of New York, the United States Attorney for the Southern District of New York (USAO) alleged that The Bank of New York Mellon (BNYM) and David Nichols, a BNYM executive, violated the mail and wire fraud statutes by, inter alia, fraudulently representing to BNYM’s clients that its foreign exchange standing instruction service would execute currency transactions according to the “best execution standards” or at the “best rate of the day,” and that they would be completed free of charge.8 The USAO’s Second Amended Complaint (the Complaint) alleged that these misrepresentations affected both the clients of BNYM that are federally insured financial institutions and BNYM itself, also a federally insured financial institution.9 According to the Complaint, BNYM was “affected” through its exposure to potential legal liability, the legal costs of fighting such liability, its lost foreign exchange revenue due to clients deciding to opt out of the standing instruction service, a downgraded credit rating, and the reputational harm that could affect its stock price and influence clients to leave BNYM.10 BNYM and Nichols filed motions to dismiss, arguing, inter alia, that BNYM could not be both the perpetrator of the fraud and the “affected institution” for the purposes of Section 1833a, and that the government’s reading of the statue was overbroad, inconsistent with the natural reading and organizational structure of the statute, and contravened the statute’s purpose.11
Judge Kaplan rejected the defendants’ interpretation of “affected,” denying in part the defendants’ motions to dismiss.12 The court ruled that “affecting” should not be viewed as synonymous with “victimizing,” a narrow reading which, had it been adopted, would have imposed a requirement that any alleged fraud had to be directed at a federally insured institution; indeed, Judge Kaplan indicated that actions that benefit a financial institution can serve as a basis for Section 1833a liability.13
In reaching his ruling, Judge Kaplan relied on the dictionary definitions of the word “affect,” noted that none of those definitions support the notion that “‘affecting’ may mean only victimizing,” and held that the “singularly broad word” chosen by Congress did not convey an intent to limit the application of the statute.14 The opinion also cites the Second Circuit’s opinion in United States v. Bouyea,15 interpreting a different provision of FIRREA, for the proposition that an institution could be “affected” even it were not itself the victim of the defendant’s acts.16
Looking at the statutory structure of FIRREA, the court dismissed the defendants’ claim that the language “affecting a federally insured financial institution” in Section 1833a(c)(2) was added to ensure that subsection (c)(2) would, like subsections (c)(1) and (c)(3), be limited to circumstances in which the victim of the wrong doing was a federally insured financial institution.17 The court noted that several of the offenses in subsections (c)(1) and (c)(3) do not require that any financial institution be victimized, and that nothing in the text forecloses the possibility that an institution could participate in and benefit from a proscribed act.18 To that end, the opinion suggests that in passing Section 1833a, Congress was not exclusively focused on harm to financial institutions, but also sought to address the “presence of criminal activity in matters meaningfully involving financial intuitions, however that activity may affect them.”19
The court additionally held that Section 1833a liability can extend to the “affected” financial institution itself—and not just the third parties that affect the financial institution. According to the opinion, the question of whether a financial institution was affected by an act is a distinct question from whether the institution participated in the act: “The former concerns the effects on the institution that proximately flowed from the charged scheme; the latter relates to the institution’s culpability in the scheme in the first place.”20 The court observed that the textual basis for determining who may be found liable under FIRREA resides in Section 1833a(a), which prescribes liability to “whoever” violates the enumerated statutes, and “whoever,” as elsewhere defined in the United States Code, includes any person, corporation or other entity.21 The court also relatively quickly dismissed BNYM’s arguments that the natural reading of “affecting” a financial institution precluded the possibility that an institution can affect itself; and that the penalty scheme set forth by FIRREA in 12 U.S.C. § 1818(i), assigning penalties to be imposed on institutions by their regulators, forecloses the imposition of additional penalties under Section 1833a.22
Finally, the court rebuffed BNYM’s argument that assessing penalties against a financial institution would defeat the purpose of FIRREA by weakening the financial institution, creating additional risk to insured deposits—in other words, that a penalty would simply compound the effect of the fraud. The court did so by speculating that Congress may “have concluded that the deterrent effect of meaningful penalties is more important” than the risk of harm to the financial institution, and that courts can tailor the penalties to avoid such harm.23 That logic, of course, raises the question of whether deterrence can work at the corporate level or only the individual.
Application to the Allegations
The court’s application of its interpretation of FIRREA to the particular facts in question even further expands the scope of the Act, suggesting that financial institutions will face great difficulty in making successful motions to dismiss FIRREA claims when there are also accompanying private civil suits that allege fraud in connection with the same conduct.
After concluding that the defendants’ proposed construction of the “affecting a federal insured financial institution” language was unpersuasive, the court held that the Complaint sufficiently pled that the alleged fraud “affected” BNYM by alleging that the foreign exchange standing instruction program : (1) exposed BNYM to legal risk in cases pending against it in federal and state court, (2) forced BNYM to incur legal costs with respect to those suits, (3) damaged BNYM’s business prospects by prompting the departure of a number of clients and (4) forced BNYM to adopt a less profitable business model due to increased scrutiny of its services.24 The court disagreed with BNYM’s argument that including litigation risk and costs under the “affecting” rubric would unfairly expose financial institutions to FIRREA’s enhanced penalties even when the private cases were meritless, holding instead that such associated costs are an effect.25 Without a detailed explanation, the opinion simply notes that if an individual’s fraudulent act caused the bank to incur litigation costs defending itself against a meritless suit, the bank would still have been “affected” by the individual’s fraud.26 As a result, the ruling substantially increases the odds that the USAO will be able to survive a motion to dismiss by bootstrapping off the existence of private civil litigation, even when such litigation has not even passed the pleading stage.
The court further reasoned that because the government’s Complaint “plausibly” alleged that the defendants committed fraud, it was equally plausible that BNYM was potentially exposed to real, not meritless, legal liability.27 Instead of setting a standard of robust review of the sufficiency of allegations in a FIRREA complaint, the holding essentially reasons that where the USAO sufficiently pleads an underlying fraud, it has also pled an effect on the financial institution ipso facto.
The court’s finding that BNYM’s switch to an allegedly less profitable business model was sufficient to satisfy the “affects a financial institution” requirement is equally expansive.28 Although Judge Kaplan noted that it “might not be sufficient to allege only that an institution no longer is receiving the allegedly fraudulent profits it had been deriving from the scheme,”29 he found the allegation sufficient based on a view that BNYM may have made larger non-fraudulent profits going forward had the alleged fraud never occurred.30 Finally, Judge Kaplan also held that the Complaint alleged that the fraudulent scheme affected BNYM by damaging its reputation,31 setting a standard that the USAO likely will meet easily in almost any FIRREA pleading.
One area where the ruling expressly declined to extend the application of FIRREA was to situations where the only effects alleged are positive.32 However, given that any legal action by a government agency is likely to prompt litigation by shareholders or other interested parties, thus forcing the interested institution to incur litigation costs, that restraint carries little practical weight.
Other Pending Cases
While Bank of New York Mellon may be the first case to interpret “affecting a financial institution,” the issue will likely be addressed again in two other currently pending Southern District of New York FIRREA cases: United States ex rel. O’Donnell v. Countrywide Financial Corporation33 and United States v. Wells Fargo Bank, N.A.34 In Wells Fargo Bank, the USAO alleges that defendant Wells Fargo Bank, N.A. (Wells Fargo) violated the mail and wire fraud statutes by, inter alia, making fraudulent representations to the Department of Housing and Urban Development (HUD) and fraudulently certifying to HUD that certain loans were eligible for Federal Housing Administration insurance.35 As in Bank of New York Mellon, the complaint alleges that Wells Fargo’s conduct “affected” the bank by exposing it to legal liability and related expenditures, and by leading to actual financial loss and increased risk of loss.36 In Countrywide Financial Corporation, the government alleges that the defendant banks violated the mail and wire fraud statutes by originating loans in violation of Freddie Mac and Fannie Mae (the government-sponsored entities or GSEs) guidelines and then selling those loans to the GSEs while misrepresenting that they had complied with the guidelines.37 The “affected” institutions include the federally insured financial institutions that held preferred stock in the GSEs, as well as the defendant banks themselves, which have “directly or indirectly paid billions” to settle claims relating to the sale of the defective loans.38
Though the issues are similar to those in Bank of New York Mellon, the impact of recent motions to dismiss in these two cases is far from certain. The Countrywide Financial Corporation motion to dismiss oral argument took place on April 29, 2013, after the Bank of New York opinion was issued, and Judge Rakoff stated he was “more troubled, notwithstanding Judge Kaplan’s opinion, by the affecting argument.”39 Despite this hesitation, Judge Rakoff issued an order on Wednesday, May 8, denying the motions to dismiss the FIRREA claims but dismissing the related False Claims Act counts.40 The order stated that a reasoned opinion would be forthcoming, but the court’s analysis is not yet available.41 In recent years, however, Judge Rakoff has established that he is quite willing to break from precedent and conventional practice where he feels necessary, and the forthcoming opinion will be of great interest in framing the parameters—to the extent any meaningful ones remain—for future FIRREA actions. Likewise, a decision on Wells Fargo’s motion to dismiss, which was argued before the Bank of New York opinion was handed down, may also prove instructive.
Whether or not the Wells Fargo and Countrywide courts adopt the Bank of New York holding that FIRREA can create liability for financial institutions for conduct that affects themselves, the issue will undoubtedly be taken up to the Second Circuit. If BNYM does not raise the issue on appeal, it is only a matter of time before a different financial institution, or the USAO, takes it up in another case. The broadening of FIRREA’s scope pursuant to such an expansive interpretation of the statute—particularly as applied in Bank of New York to hold, in substance, that any pleading can satisfy the “affects a financial institution” requirement by virtue of being accompanied by private civil litigation or reputational harm—is too significant not to be appealed.
Notably, the uncertainty that will remain will have little effect on the day-to-day operations of financial institutions, as civil violations of Section 1833a are predicated on violations of pre-existing, established law. Still, the residual uncertainty will undoubtedly affect the negotiating positions of financial institutions that find themselves in the government’s FIRREA cross-hairs. And, in the interim, the government will almost certainly be emboldened to continue expanding its use of FIRREA’s powerful enforcement mechanisms.