Two significant events in the last several weeks are forcing Federal Housing Administration (FHA) mortgage lenders to scratch their heads in assessing the Government's fraud enforcement intentions. First, in mid-September, a district judge imposed massive False Claims Act (FCA) and Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) damages and penalties against FHA mortgage lender defendants, in a worrisome display of the debilitating consequences that can befall businesses and individuals who find themselves the targets of civil fraud enforcement actions under both the FCA and FIRREA. See United States v. Americus Mortgage Corp., No. 4:12-CV-2676, 2017 WL 4117347 (S.D. Tex. Sept. 14, 2017) (Allied). Second, less than a month later, the Trump Administration signaled what sounded to many like a retreat when Department of Housing and Urban Development (HUD) Secretary Ben Carson told Congress and industry groups that HUD staff was working with the Department of Justice to address and resolve the “ridiculous” escalation in the Government's use of the FCA against mortgage lenders.

Where does that leave mortgage lenders who are contemplating remaining in or entering the federallyinsured mortgage business? The answer is that – for the moment – nothing has changed. In fact, Secretary Carson’s sentiments are not out of step with those of prior HUD Secretaries who have understood that post hoc attempts by the Justice Department and relators (as well as HUD-OIG) to slap “fraud” labels on routine loan origination and servicing disputes are counterproductive to HUD’s mission and unfair to lenders. The only unusual thing about Secretary Carson’s comments is that he expressed them in a very public manner. Until enforcement initiatives are changed at the Justice Department – or changes are mandated by Congress – the likelihood is that cases like Allied will continue. Nonetheless, from these mixed signals, there still are a few take-aways for FHA lenders.

The District Court’s Troubling Damages/Penalties Decision in Allied

In pursuing joint FCA and FIRREA cases against financial institutions and individuals, the Government has had varied success. In a number of cases, the Government and financial institutions have logged high-dollar, out-of-court settlements. Yet, in perhaps its highest profile litigated case to date, involving FCA and FIRREA causes of action against Bank of America and Countrywide, the Government had to abandon its FCA claims and then later had a jury verdict and $1.2 billion FIRREA penalty reversed by the Second Circuit due to the Government’s failure to carry its burden of proof. Since most of the cases settled or resolved on other issues, very few courts have been called upon to address the interplay of FCA damages/penalties and FIRREA penalties in the same case. That is what makes the Allied case so significant, even at the district court level. 

The Allied case was initiated by the U.S. Attorney’s Office for the Southern District of New York (SDNY) as an affirmative FCA and FIRREA complaint arising out of alleged FHA lending misconduct. The action was transferred to Texas, where it was tried, with SDNY prosecutors taking the lead. Following trial, the jury found Allied Capital, Allied Corporation, and Allied’s CEO liable. The district court then awarded a total of $291,898,325 (jointly and severally) in trebled damages and penalties under the FCA, and an additional $2,200,000 (per defendant) in FIRREA penalties. While trebling of the FCA damages is no surprise, since the statute requires it, other aspects of the court’s decision are concerning, as they appear to reflect fundamental misconceptions regarding the FCA, FIRREA, and the way FHA lending works.

First, even though the district court correctly endorsed, at least in name, the “proximate causation” standard for FCA claims, the court gave jury instructions that, as a practical matter, allowed the jury to apply the much more lenient “but for” analysis for causation. And, the court refused to further analyze whether the Government’s evidence actually supported a finding of proximate causation rather than the idea that, but for the original underwriting and endorsement, a claim for FHA insurance would not have been submitted months or years later, regardless of whether there were independent reasons for the loan’s default. The court’s refusal to consider the actual reasons for the loan’s default distorts damages and undermines the purpose of demanding that the Government prove that its damages were proximately caused by the alleged misconduct. Notably, the Seventh Circuit issued an important decision on this very topic after the Allied decision. In United States v. Luce, No. 16-4093, 2017 WL 4768864 (7th Cir. Oct. 23, 2017), the court overturned its own precedent (which had endorsed “but for” causation in FCA cases) and joined every other circuit to decide this issue in holding that proximate cause is the proper standard.

Second, the district court in Allied unnecessarily waded into the debate about “gross” versus “net” trebling under the FCA. Even though the Government’s own expert calculated the “net” losses to HUD from the defaulted loan, and even though the court apparently based its treble damage award on the “net” loss calculation, the court’s decision itself clearly rejects net trebling as the appropriate measure of damages in FCA cases. If it was the court’s intent to endorse a “gross” damages methodology in FCA cases, that too would distort damages and result in windfall recoveries (beyond mere trebling) to the Government. See FraudMail Alert No. 13-03-25.

Third, and perhaps most notably, the court’s damages/penalties award is alarming because it imposed both FCA and FIRREA penalties for arguably the same underlying conduct. While the court attempted to avoid such criticisms and Eighth Amendment “excessive fines” concerns by accepting the Government’s argument that the FIRREA penalties arose out of Allied’s false annual certifications of FHA compliance whereas the FCA violations arose from loan underwriting behavior, that distinction has no meaning in the FHA loan context where any injury or damage relates back to one thing: a defaulted FHA loan.

Thus, the damages and penalties holdings in the district court’s opinion will only serve to embolden Justice Department attorneys and relators alike.

Secretary Carson’s Congressional Testimony and MBA Statement

On October 12, 2017, HUD Secretary Carson testified in a hearing before the House Financial Services Committee on “The Future of Housing in America: Oversight of the Department of Housing and Urban Development.” Well into the hearing, Congressman Trott (R-Mich.) turned to the topic of FCA enforcement in the FHA arena:

So, let’s talk about the FHA program. There’s a great article from the “Housing Wire” from July of this year written by David Stevens from the [Mortgage Bankers Association (MBA)], and it talks about the unprecedented use of the False Claims Act by HUD and the Department of Justice starting around 2011 under President Obama. … [A]re you familiar at all with how it’s been used in the context of FHA lending and some of the ramifications of that? So, I believe you and Attorney General [Jeff] Sessions could easily solve that problem and the consequence of the improper use of the False Claims Act to impose outrageous penalties against lenders for immaterial defects in loan origination files on FHA loans. The consequences are many lenders have left the FHA program and those that have stayed in the program, it’s more costly for the borrowers who can least afford it. So, do you have any plan once [FHA] Commissioner [Brian Montgomery] is in place to quickly address that problem?

After confirming that he was “very much” familiar with the issue, Secretary Carson responded:

Yeah, well, we are already addressing that problem – our staff, along with the DOJ staff. And we’re committed to getting that resolved because it’s ridiculous, quite frankly. And I’m not exactly sure why there had been such an escalation previously, but the long-term effects of that escalation is obviously providing fewer appropriate choices for consumers, and that’s exactly the opposite of what we should be doing.

Congressman Trott replied to Secretary Carson’s answer by commending to him an “easy solution that could be put in place without congressional action” developed by the MBA and involving revisions to FHA certification language.

On October 23, 2017, Secretary Carson repeated similar sentiments at the MBA Annual Conference, noting:

We have heard concerns on the part of some in the lender community about participating fully in our programs because of the undue risks they perceive from a lack of clarity in what we expect and exposure to outsized liability from immaterial errors. … We have heard these concerns, and today I am very pleased to announce that HUD, in consultation with the Justice Department, is committed to reviewing and addressing these issues.

Secretary Carson pointed to regulatory reform, review of FHA lender certifications, and implementation of a “defect taxonomy” as parts of this effort. However, he also was quick to underscore that there was no room for “bad actors” or “fraudsters” in the FHA program, which he characterized as “those without proper controls, or those who do not take their obligations in our market seriously” and which would be “found out and held accountable.”

What to Make of the Mixed Signals

While no moratorium on FCA cases against FHA lenders (as urged by the MBA in June 2017) has been announced, time will tell whether Secretary Carson’s statements are the harbinger of an ebb in FCA and/or FIRREA actions against mortgage lenders. The Justice Department’s position on civil fraud actions against FHA lenders remains unclear, especially in light of Secretary Carson’s reference to “bad actors” – which is a label the Justice Department has slapped on most FHA lenders at one time or another. Moreover, the Justice Department’s history of pursuing enforcement actions against FHA lenders even where there is clear evidence of contemporaneous HUD knowledge and endorsement of those lenders’ practices and performance suggests that an alignment of views between the Justice Department and HUD may not be easy to achieve. Lenders should not have to rely on after-the-fact legal defenses (such as those provided by the Supreme Court’s decision in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016)) to clear their names. Indeed, if HUD truly wants to encourage lenders to engage in the federally-insured mortgage market and serve borrowers who otherwise may not qualify for conventional loans, lenders will need clear and express Justice Department agreement on any new approach to lender certifications and defect taxonomies. 

In the meantime, the Allied damages decision (even though not yet reviewed, much less endorsed, by an appellate court) can be expected to encourage more FCA and FIRREA allegations and litigation.