Vol. 31 No. 12 December 2015 DOUGLAS W. BARUCH is a partner, JENNIFER M. WOLLENBERG is a special counsel, and MATTHEW E. JOSEPH is an associate in the Washington, D.C. office of Fried, Frank, Harris, Shriver & Jacobson LLP. The authors routinely represent companies, including financial institutions, in investigations and litigation brought by the Department of Justice under federal fraud statutes, including FIRREA. Their e-mail addresses are [email protected], [email protected], and [email protected] IN THIS ISSUE ● FIRREA ENFORCEMENT TRENDS December 2015 Page 131 FIRREA ENFORCEMENT TRENDS Despite being enacted with an intended purpose of protecting financial institutions, the Department of Justice is with increasing frequency using the Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”) to investigate and bring civil fraud suits against financial institutions. The authors describe the basics of FIRREA’s civil penalties provisions, discuss how FIRREA enforcement interacts with the civil False Claims Act, and describe the Justice Department’s enforcement targets. Douglas W. Baruch, Jennifer M. Wollenberg, and Matthew E. Joseph * For financial institutions, companies that provide financing, companies that do business with financial entities (as most sizable companies do), and individuals who work for such businesses, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”)1 is a statute that should not be ignored. FIRREA creates civil liability for 14 crimes, and empowers the Department of Justice (“DOJ”) to investigate and pursue crippling civil penalties against companies and individuals for violations of those crimes without having to prove culpability beyond a reasonable doubt. Moreover, FIRREA grants broad subpoena power to the DOJ – including the authority to compel pre-litigation depositions, demand production of documents, and share that material with other enforcement agencies – exposing potential defendants to ———————————————————— 1 12 U.S.C. § 1833a. multiple investigations for the same activity. While FIRREA had been in desuetude for most of its existence, there has been an awakening. Today, FIRREA – in part due to its generous 10-year statute of limitations – is fast becoming a favored DOJ enforcement weapon. FIRREA AND ITS SCOPE In the aftermath of the savings and loan crisis of the 1980s, Congress enacted FIRREA with the specific purpose of preventing fraud against financial institutions.2 For most of its history, however, this ———————————————————— 2 H.R. Rep. No. 101-54(I), at 311 (1989) (discussing the enhancement of enforcement powers for, among other things, “pursuing the prosecution of individuals who have acted illegally against financial institutions. It is the intent of the Committee that this action will give a clear signal to those who December 2015 Page 132 statute generated little activity and limited litigation. More recently, the DOJ has been taking advantage of FIRREA in ways that seemingly are at odds with its intended purpose. Rather than a means to protect financial institutions from fraud, the DOJ is using FIRREA as an enforcement tool against financial institutions. Since 2011, such enforcement activities have led to a string of notable FIRREA lawsuits and settlements arising out of alleged fraud with respect to residential mortgage lending and foreign currency exchange rates, and this may be only the beginning.3 Civil Statute with Criminal Predicates FIRREA is a civil statute, but its enforcement foundation arises out of 14 enumerated criminal predicate offenses, including the so-called “catch-all” mail and wire fraud crimes.4 Unlike criminal charges, footnote continued from previous page… would violate federal banking laws that such conduct will not be tolerated.”); Pub. L. No. 101-73, § 101(10), 103 Stat. 187 (1989), codified at 12 U.S.C. § 1811 (discussing a primary purpose of FIRREA, which was “[t]o strengthen the civil sanctions and criminal penalties for defrauding or otherwise damaging depository institutions and their depositors.”). 3 See, e.g., United States v. Wells Fargo Bank, 972 F. Supp. 2d 593 (S.D.N.Y. 2013); United States v. Countrywide Fin. Corp., 961 F. Supp. 2d 598 (S.D.N.Y. 2013); United States v. Bank of New York Mellon, 941 F. Supp. 2d 438 (S.D.N.Y. 2013). The authors of this article represent Wells Fargo Bank, N.A. in the above-referenced matter. 4 12 U.S.C. § 1833a(c) lists 14 predicate offenses: 18 U.S.C. § 215 (receipt of commissions or gifts for procuring loans); 18 U.S.C. § 656 (theft, embezzlement, or misapplication by bank officer or employee), 18 U.S.C. § 657 (embezzling, abstracting, purloining, or willfully misapplying property of lending, credit, and insurance institutions), 18 U.S.C. § 1005 (false bank entries, reports, and transactions), 18 U.S.C. § 1006 (federal credit institution entries, reports, and transactions), 18 U.S.C. § 1007 (Federal Deposit Insurance Corporation transactions), 18 U.S.C. § 1014 (loan and credit applications generally; renewals and discounts; crop insurance), 18 U.S.C. § 1344 (bank fraud); 18 U.S.C. § 287 (false claims), 18 U.S.C. § 1001 (false statements), 18 U.S.C. § 1032 (concealment of assets from conservator, receiver, or liquidating agent), 18 U.S.C. § 1341 (mail fraud), 18 U.S.C. § 1343 (wire fraud); 15 U.S.C. § 645(a) (fraud in connection with Small Business Administration transactions). which the government must prove by the strict “beyond a reasonable doubt” standard, FIRREA claims can be established by the far less rigorous “preponderance of the evidence” standard.5 As a result, the DOJ views FIRREA as a more viable enforcement alternative in some instances because liability can be more easily proven while still imposing quasi-criminal and punitive financial penalties. FIRREA’s “Affect” Interpreted to Include “SelfAffect” While FIRREA liability is tied to criminal predicates, FIRREA places some limitations on the use of certain of the enumerated offenses. In particular, for the predicate offenses of false claims, false statements, mail fraud, and wire fraud, FIRREA liability can only be imposed if the underlying conduct “affect[s] a federally insured financial institution.”6 However, FIRREA’s text does not itself define the term “affect.” In the absence of a statutory definition, the federal courts have filled the vacuum with their own interpretations, with several courts, primarily in the U.S. District Court for the Southern District of New York, defining the term “affect” to mean “involving” or “to act upon.”7 Relying on this definition, courts have then taken the next step, holding that a financial institution can be liable under FIRREA for misconduct that affects itself – as opposed to affecting another federally insured financial institution. This expansive theory, adopted by some courts, has been referred to as the “self-affecting” theory of FIRREA liability.8 And it has been upheld as viable in extreme situations, even where the “affect” itself arises out of the underlying FIRREA litigation filed by the DOJ. For example, in Bank of New York Mellon, the district court held that the DOJ could move forward on a FIRREA self-affecting theory grounded in assertions that, as a result of the alleged fraud, the bank (1) became defendants in numerous lawsuits (including the FIRREA lawsuit), (2) sustained substantial litigation ———————————————————— 5 12 U.S.C. § 1833a(f). 6 12 U.S.C. § 1833a(c)(2). 7 Bank of New York Mellon, 941 F. Supp. 2d at 456–57. 8 Id.; Wells Fargo, 972 F. Supp. 2d at 630; Countrywide Fin. Corp., 961 F. Supp. at 604–05. RSCR Publications LLC Published 12 times a year by RSCR Publications LLC. Executive and Editorial Offices, 2628 Broadway, Suite 29A, New York, NY 10025-5055. Subscription rates: $650 per year in U.S., Canada, and Mexico; $695 elsewhere (air mail delivered). A 15% discount is available for qualified academic libraries and full-time teachers. For subscription information and customer service call (937) 387-0473 or visit our website at www.rscrpubs.com. General Editor: Michael O. Finkelstein; tel. 212-876-1715; e-mail [email protected] Associate Editor: Sarah Strauss Himmelfarb; tel. 301-294-6233; e-mail [email protected] To submit a manuscript for publication contact Ms. Himmelfarb. Copyright © 2015 by RSCR Publications LLC. ISSN: 1051-1741. All rights reserved. Reproduction in whole or in part prohibited except by permission. For permission, contact Copyright Clearance Center at www.copyright.com. The Review of Banking & Financial Services does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions, or for the results obtained from the use of such information. December 2015 Page 133 costs, (3) lost clients, (4) changed its business model, and (5) damaged its reputation.9 While this broad theory has not been tested outside of the Second Circuit, this interpretation and application of FIRREA’s “affect” provision raises the prospect of significant exposure to financial institutions as the DOJ continues to launch new FIRREA investigations.10 FIRREA Subpoenas The investigative tools available to the DOJ under FIRREA include the authority to issue subpoenas compelling testimony and document productions, all in mere “contemplation” of filing suit and with no prior judicial review.11 The DOJ has capitalized on this authority in several cases. For instance, the DOJ itself announced that prior to filing a FIRREA complaint against Standard & Poor’s, it had conducted a multi-year investigation that included the issuance of hundreds of subpoenas, the production of millions of pages of documents, and interviews of dozens of current and former Standard & Poor’s employees.12 Unlike evidence gathered in the course of a federal grand jury investigation, where grand jury secrecy rules place strict limitations on the government’s use of material subpoenaed by the grand jury, no such restrictions limit the DOJ’s ability to disseminate evidence compelled pursuant to FIRREA subpoenas. Nor is there any reason to believe that courts will, in any meaningful way (in response to a motion to quash or a DOJ motion to enforce), rein in the DOJ’s ability to gather such information in the course of a pre-suit FIRREA investigation. FIRREA PENALTIES: WHAT’S AT STAKE? Defendants found liable under FIRREA face civil penalties. Those penalty provisions, unique to FIRREA, can be harsh. It is not surprising that when faced with ———————————————————— 9 Bank of New York Mellon, 941 F. Supp. 2d at 458–60. 10 Although the “self-affecting” interpretation has not been decided by the appellate court, the Second Circuit recently authored a per curiam opinion that endorsed an expansive reading of FIRREA’s “affect” provision. United States v. Heinz, No. 13-3119 (2d Cir. June 4, 2015) (per curiam). 11 12 U.S.C. § 1833a(g). 12 Stuart F. Delery, Assistant Attorney Gen. for the Civil Div., U.S. Dep’t of Justice, Remarks at Press Conference Announcing Lawsuit Against S&P (Feb. 5, 2013), available at http://www.justice.gov/iso/opa/civil/speeches/2013/civ-speech- 130205.html. the prospect of such penalties being imposed by a court, many companies have opted to settle.13 FIRREA provides for three alternative penalty possibilities: first, for each violation, the maximum civil penalty amount is $1,100,000;14 second, in the case of a continuing violation, the amount may exceed $1,100,000, but not exceed the lesser of $1,100,000 per day or $5,500,000;15 third, these penalty “caps” can be (and have been, as discussed below) exceeded if they are less than the defendant’s “pecuniary gain” or the victim’s “pecuniary loss.”16 As was the case with the term “affect” discussed above, FIRREA’s text provides no definition or guidance with respect to the terms “gain” or “loss,” nor does it specify the criteria to be used in assessing penalties within the permissible broad range. Only two cases have addressed substantively the FIRREA penalties provision – United States v. Menendez17 and United States ex rel. O’Donnell v. Countrywide Home Loans Inc., 18 with each focusing on a different penaltiesrelated question. However, neither decision offers much comfort to most defendants facing a FIRREA lawsuit. ———————————————————— 13 Since 2012, DOJ has settled multiple major FIRREA litigations with prominent financial institutions. For example, the Citigroup $7 billion global settlement attributed $4 billion to a FIRREA penalty. Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Justice Department, Federal and State Partners Secure Record $7 Billion Global Settlement with Citigroup for Misleading Investors About Securities Containing Toxic Mortgages (July 14, 2014), available at http://www.justice.gov/opa/pr/justice-department-federal-andstate-partners-secure-record-7-billion-global-settlement. 14 12 U.S.C. § 1833a(b)(1) (incorporating increased amounts per subsequent federal regulations). However, these amounts likely will increase again in the near future as the new budget act calls for cost-of-living adjustments to civil penalties by August 2016 and each year thereafter. Bipartisan Budget Act of 2015, Pub. L. No. 114-74 § 701, ___ Stat. ___ (2015), available at https://www.congress.gov/114/vbills/hr1314/ BILLS-114hr1314enr.pdf. 15 12 U.S.C. § 1833a(b)(2). 16 12 U.S.C. § 1833a(b)(3)(A) (“If any person derives pecuniary gain from the violation or if the violation results in pecuniary loss to a person other than the violator, the amount of the civil penalty . . . may not exceed the amount of such gain or loss.”). 17 United States v. Menendez, No. 11-cv-6313 MMM (JCGx), 2013 WL 828926 (C.D. Cal. Mar. 6, 2013). 18 United States ex rel. O’Donnell v. Countrywide Home Loans Inc., 33 F. Supp. 3d 494 (S.D.N.Y. 2014). December 2015 Page 134 Menendez Factors for Assessing a FIRREA Penalty In a FIRREA case brought against an individual, the DOJ sought a $1.1 million penalty, allegedly matching the amount of the U.S. Department of Housing and Urban Development’s loss from the fraud. The Central District of California district court rejected this request, but acknowledged that the statute’s text provided no guidance for how courts should assess a FIRREA civil penalty. In the absence of direction from the statute, that court borrowed concepts from other civil penalty contexts and created a list of eight factors for consideration: (1) the good or bad faith of the defendant and the degree of his scienter; (2) the injury to the public, and whether the defendant’s conduct created substantial loss or the risk of substantial loss to other persons; (3) the egregiousness of the violation; (4) the isolated or repeated nature of the violation; (5) the defendant’s financial condition and ability to pay; (6) the criminal fine that could be levied for this conduct; (7) the amount the defendant sought to profit through his fraud; and (8) the penalty range available under FIRREA.19 Using these factors, the Menendez district court imposed only a $40,000 civil penalty, matching the defendant’s profits from the alleged fraud. In crafting its penalty, the court first reasoned that $1 million was the maximum criminal fine for the underlying predicate offense – bank fraud. Then, it decided that a heavy penalty was not appropriate because the defendant had limited assets and had filed a petition for bankruptcy. The court’s rationale reflects judicial flexibility and discretion – principles that worked well for that particular defendant based on his unique financial circumstances – but provides little certainty for other defendants (both institutions and individuals) in terms of predicting FIRREA penalties that could be imposed in other circumstances. ———————————————————— 19 Menendez, 2013 WL 828926, at *5. O’Donnell: “Net” vs. “Gross” Gain or Loss The ambiguity and lack of certainty concerning the imposition of FIRREA’s penalties led to a much different outcome in a more recent case. In O’Donnell, following a lengthy trial, a federal jury found that Bank of America was liable under FIRREA. The allegations involved mortgage loan origination practices, which (according to the DOJ) led to faulty mortgages being sold to Fannie Mae and Freddie Mac. U.S. District Court Judge Jed Rakoff then had to determine the appropriate FIRREA civil penalty. Given the amounts involved, the court bypassed the $5.5 million capped penalty and focused instead on FIRREA’s alternative pecuniary gain or loss penalty provision as the appropriate standard. While the bank urged the court to apply the damages methodology adopted by courts under the civil False Claims Act (“FCA”),20 wherein losses are measured by traditional principles to calculate the net loss sustained as a result of the conduct, Judge Rakoff rejected that approach, noting that the different statutory purposes underlying the FCA and FIRREA rendered that analogy “inapt.”21 Specifically, Judge Rakoff reasoned that FCA damages are meant to compensate for losses by restoring the government to pre-violation status, whereas FIRREA penalties are designed to deter and punish, and thus would be measured by gross gains or losses.22 Analyzing the parties’ evidence and considering the parties’ arguments regarding the appropriate amounts, Judge Rakoff held that the gross loss and the gross gain were the same – nearly $3 billion – because that amount represented the entire price Fannie Mae and Freddie Mac paid for the entire set of mortgage loans at issue.23 Judge Rakoff then reasoned that he had discretion to depart downward from the upper limit based on mitigating factors. Exercising that discretion, he reduced the gross penalty by 57 percent – based on evidence that 57 percent of the at-issue Countrywide loans purchased by Freddie Mac and Fannie Mae were of acceptable quality. The result was a $1.3 billion civil penalty.24 Whether or not Judge Rakoff’s approach ———————————————————— 20 31 U.S.C. §§ 3729-3733. 21 O’Donnell, 33 F. Supp. 3d at 500 n.6. 22 Id. 23 Id. at 501–502. 24 Separately, Judge Rakoff imposed a $1 million FIRREA penalty on co-defendant Rebecca Mairone, a former Countrywide officer. Id. at 504. December 2015 Page 135 withstands scrutiny remains to be seen, as both the jury verdict and the penalty amount are being appealed to the Second Circuit.25 However, unless and until some court holds otherwise, Judge Rakoff’s application of “gross” gain or “gross” loss as the proper starting point for FIRREA civil penalties certainly will foster continued DOJ reliance on FIRREA and expose defendants to the possibility of both large and largely unpredictable penalties. FIRREA AND THE FCA As evidenced by the result in the O’Donnell case, FIRREA civil penalties offer a powerful alternative to traditional civil damages methodologies, even those under the civil FCA, with its treble damages provision. With increasing frequency, the DOJ is taking maximum advantage of these alternatives by alleging both FIRREA and FCA claims in the same action, thereby hedging its bet, so to speak.26 To be sure, FIRREA claims, where viable, provide other enforcement advantages as well. As noted, FIRREA has a standard 10-year statute of limitations, as opposed to the FCA’s six-year default statute of limitations.27 Moreover, unlike the FCA, FIRREA liability does not require proof of any “claim for payment” to the United States, nor does it require proof of any government involvement at all, let alone any losses sustained by the government. FIRREA and FCA differ in another respect. The FCA provides for qui tam actions to be brought by private parties (“relators”) on behalf of the United States, and incentivizes such actions by awarding a ———————————————————— 25 Specifically pertaining to FIRREA penalties, Bank of America’s appellate brief argues that Judge Rakoff’s use of gross revenue rather than net revenue to determine “gain” under FIRREA is incorrect. Brief of Defendants-Appellants at 82-85, United States ex rel. O’Donnell v. Countrywide Home Loans Inc., No. 15-499-cv (2d Cir. April 22, 2015). 26 In the O’Donnell case discussed above, this “hedging” occurred, and when the FCA causes of action were dismissed for failure to state a claim, DOJ proceeded under its FIRREA claims. United States ex rel. O’Donnell v. Countrywide Home Loans Inc., 961 F. Supp. 2d 598, 609–610 (S.D.N.Y. 2013). 27 31 U.S.C. § 3731(b)(1). On May 26, 2015, the Supreme Court squarely rejected the use of the Wartime Suspension of Limitations Act (“WSLA”) in the civil FCA arena, thereby reversing prior court decisions and ending the DOJ practice that allowed the WSLA to virtually nullify the FCA’s statute of limitations. Kellogg Brown & Root Services, Inc. v. United States ex rel. Carter, No. 12-1497 (U.S. May 26, 2015). bounty of between 15-30 percent of the government’s ultimate FCA recovery, depending on whether the government intervenes in the relator’s action.28 Congress did not provide for any such qui tam provision in FIRREA, although there have been some recent DOJ efforts to provide such a remedy.29 Instead, federal law30 provides that FIRREA whistleblowers can receive a maximum of $1.6 million (20-30 percent of any recovery up to the first $1,000,000 recovered; 10-20 percent of the next $4,000,000; and 5-10 percent of the next $5,000,000).31 If more than one FIRREA whistleblower contributed to an initial report, the total award is apportioned according to the contribution of each individual. Unlike the FCA, there is no provision for FIRREA whistleblower counsel to recover their fees and costs. This disparity in the potential whistleblower recovery between FCA and FIRREA claims likely means that the FCA will remain the favored statute of relators and their counsel. Nonetheless, the prospect of hefty recoveries under both FIRREA and the FCA, along with the variables discussed above, mean that defendants can expect the DOJ to advance claims under both statutes wherever possible, for the same underlying conduct.32 ———————————————————— 28 31 U.S.C. § 3730. 29 Recognizing the disparity, former Attorney General Eric Holder proposed amending FIRREA to increase whistleblower awards to resemble the larger FCA level. Eric Holder, U.S. Attorney Gen., U.S. Dep’t of Justice, Remarks on Financial Fraud Prosecutions at NYU School of Law (Sept. 17, 2014), available at http://www.justice.gov/opa/speech/attorney-general-holderremarks-financial-fraud-prosecutions-nyu-school-law. 30 FIRREA allows for whistleblower reports and recovery through the Financial Institutions Anti-Fraud Enforcement Act of 1990 (“FIAFEA”). 12 U.S.C. § 4201 (any “person may file a declaration of a violation giving rise to an action for civil penalties under section 1833a …”). 31 12 U.S.C. § 4205. 32 Although the statute FIRREA is most commonly paired and compared with is the FCA, DOJ also has boosted FIRREA’s breadth by including FIRREA claims alongside traditional Securities Exchange Commission (“SEC”) lawsuits. Even though securities violations are not contemplated by the text of FIRREA, DOJ sued Bank of America under FIRREA alleging violations of the federal false statements statute, 18 U.S.C. § 1001, and the statute prohibiting fraud in loan and credit applications, 18 U.S.C. § 1014, based on a prospectus supplement for a securities offering by the bank that allegedly contained material misstatements. Complaint, United States v. Bank of Am. Corp., 13-cv-446, (W.D.N.C. Aug 6, 2013). SEC also brought an action against Bank of America citing the same December 2015 Page 136 LENDERS REMAIN IN THE DOJ’S FIRREA CROSSHAIRS At least initially, the DOJ’s FIRREA enforcement efforts were focused primarily on financial institutions involved with residential mortgage lending. While the DOJ continues to place emphasis on claims arising out of that industry, the DOJ’s initial “success” with those cases has led it to launch FIRREA investigations in other sectors as well. Based on published reports, the auto loan industry is being investigated under FIRREA with subpoenas issued to General Motors Financial, Santander USA, Consumer Portfolio Services, and Capital One Financial Corporation.33 Businesses involved with financing and securitization arrangements are likely FIRREA investigation targets as well, especially those involved in the credit card and student loan industries. footnote continued from previous page… underlying conduct. Complaint, SEC v. Bank of Am. Corp., 13- cv-447, (W.D.N.C. Aug 6, 2013). Ultimately, the combined actions resulted in a settlement agreement that required Bank of America to pay $16.65 billion ($5 billion related directly to the FIRREA claims), the largest civil settlement with a single entity in U.S. history. Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Bank of America to Pay $16.65 Billion in Historic Justice Department Settlement for Financial Fraud Leading up to and During the Financial Crisis (Aug. 21, 2014), available at http://www.justice.gov/opa/pr/bank-america-pay- 1665-billion-historic-justice-department-settlement-financialfraud-leading. 33 Each of these entities has disclosed receipt of such a subpoena in a public filing. See, e.g., Consumer Portfolio Services, Inc., Annual Report (Form 10-K) (Feb. 25, 2015), available at http://files.shareholder.com/downloads/CPSS/4030006967x0xS 1019687-15-711/889609/filing.pdf. KEY TAKEAWAYS REGARDING FIRREA The DOJ’s recent triumphs with FIRREA have transformed that statute from a little-used historical footnote to a powerful fraud enforcement tool. That success means more enforcement activity by the DOJ against financial institutions, as well as entities that engage in business that can “affect” financial institutions. And given the DOJ’s recently announced enforcement priorities with respect to individuals, corporate officers and employees should increasingly expect to be targets of FIRREA investigations and suits as well.34 As a result, financial institutions and other potential FIRREA defendants are on notice of a new and potentially very costly era in federal fraud enforcement. ■ ———————————————————— 34 Memorandum from Sally Quillian Yates, Deputy Attorney Gen., U.S. Dep’t of Justice, to Assistant Attorney Gen., Antitrust Div., et al., regarding Individual Accountability for Corporate Wrongdoing (Sept. 9, 2015), available at http://www.justice.gov/dag/file/769036/download.