United States: FIRREA: Expect Substantial Anti-Fraud Enforcement And Compliance Issues

Previously published in Compliance & Ethics Professional

• The Department of Justice has redoubled its efforts to pursue financial crisis matters.
• DOJ has increased its reliance on FIRREA as a means to prosecute financial fraud.
• FIRREA is powerful because it has a broad reach and the preponderance of the evidence standard applies to it.
• FIRREA can be used against any company that transacts with a financial institution.
• Companies should examine how FIRREA impacts their anti-fraud compliance efforts.

Since the financial crisis began, many banks and lenders have been shuttered, and dozens of major financial institutions have collapsed or merged out of existence, including household names like Bear Stearns and Lehman Brothers. The toll of the ongoing financial crisis on the American economy has been well documented. Many have questioned why the federal government has not punished a greater number of individuals and corporations that are perceived to have engaged in misconduct which allegedly contributed to or exacerbated the crisis.

As the crisis began to take hold, the Department of Justice (DOJ) acted aggressively. Indeed, in June 2008, two Bear Stearns fund managers were arrested, having been charged with a $1.6 billion securities fraud in connection with the collapse of the funds they managed. The funds had been heavily invested in residential mortgage-backed securities (RMBS), which lost substantial value during the crisis. In November 2009, following just six hours of deliberations after a three-week trial, a jury acquitted the fund managers on all charges. At trial, although numerous witnesses testified, the government did not present the testimony of a single cooperating witness. Instead, the government primarily relied upon e-mail exchanges between the defendants to prove their criminal intent. What many had assumed would be the first of many successful criminal prosecutions related to the financial crisis, instead demonstrated how difficult such criminal prosecutions can be for the government.

Whether or not the government has pursued alleged financial crisis wrongdoers with sufficient urgency will continue to be debated, but one thing is clear: the Department of Justice appears to be redoubling its efforts to pursue individuals and entities that it believes engaged in misconduct that contributed to the financial crisis.

On January 27, 2012, following the President's announcement in the State of the Union address regarding a renewed effort to pursue cases related to the financial crisis, the Attorney General announced the formation of the RMBS Working Group. Part of the Financial Fraud Enforcement Task Force, the RMBS Working Group is led by the Criminal and Civil Divisions at the DOJ, the United States Attorney's Office in Colorado, the Securities and Exchange Commission (SEC), and the New York State Attorney General's Office. According to the Attorney General, approximately 55 DOJ attorneys, analysts, agents, and investigators were initially assigned to the Working Group.

In the wake of that announcement, the Attorney General appeared at Columbia University to discuss the DOJ's resolve and commitment in this area. In doing so, the Attorney General explained: "We found that much of the conduct that led to the financial crisis was unethical and irresponsible. But we have also discovered that some of this behaviour - while morally reprehensible-may not necessarily have been criminal."

At the time, some may have interpreted the Attorney General's statement as an effort to explain the DOJ's perceived inaction. With the benefit of hindsight, however, it appears the Attorney General was signaling the Department's decision to reshape its approach to pursuing cases related to the financial crisis. As several financial institutions have observed in recent months, the DOJ has increased its reliance on a statute that has been at its disposal since 1989-a little-used provision of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA),¹ which authorizes the Attorney General to commence civil actions seeking civil monetary penalties against whoever violates various criminal statutes relating to or affecting financial institutions.

The DOJ's increased use of FIRREA in this manner is demonstrated by a number of actions filed in the past year, including:

• United States v. Bank of America Corp., et al.²Filed by the U.S. Attorney's Office, District of Columbia and the Attorneys General of 49 states and the District of Columbia, the complaint alleges FIRREA violations and violations of the consumer protection laws of each state for a range of conduct including residential loan origination, servicing, and foreclosure that affected the Federal Housing Administration (FHA) and other government programs. On March 12, 2012, DOJ announced a settlement under which the defendants agreed to pay, among other things, $20 billion to assist homeowners.
• United States v. The Bank of New York Mellon.³ The government is alleging a vast scheme to defraud in violation of FIRREA for mail and wire fraud based on the bank's foreign exchange business.
• United States v. Citigroup, Inc.⁴ Citigroup settled this FIRREA action for $158.3 million a day after the public filing of the government's complaint. This case began as a whistleblower lawsuit brought under the False Claims Act, entitling the relator to a portion of the settlement.
• United States v. Allied Home Mortgage Corp.⁵The complaint alleges that hundreds of millions in government insurance payouts resulted from the fraudulent conduct of the defendants in violation of FIRREA.
• Given the increased frequency with which the DOJ appears to be relying on FIRREA in the context of allegations of financial fraud, it is important for financial institutions and companies that deal with them to understand FIRREA and to shape their anti-fraud compliance initiatives accordingly.

The Reach of FIRREA

Best known as the statutory scheme for dealing with failed financial institutions, FIRREA became law in the wake of the savings and loan crisis of the 1980s. To deter future fraudulent conduct and protect federally insured financial institutions regulated by the federal government, Congress included a provision in FIRREA that authorizes the DOJ to conduct quasi-criminal investigations and commence civil actions where alleged misconduct affects a financial institution.

Indeed, under FIRREA, the Attorney General may pursue a civil action seeking civil penalties for violations of numerous federal criminal laws, including:

• mail and wire fraud (18 U.S.C. §§ 1341 & 1343)
• false statements to the government (18 U.S.C. § 1001)
• bank fraud (18 U.S.C. § 1344)
• false claims (18 U.S.C. § 287)
• false statement to influence action of federal finance agencies or programs, including FHA (18 U.S.C. § 1014)
• false entries, reports and transactions affecting FDIC insured accounts (18 U.S.C. § 1006)
• false statement or document to FDIC (18 U.S.C. § 1007)
• unauthorized notes, false books, by employee of Federal Reserve bank or member institution (18 U.S.C. § 1005); and
• receipt of commissions or gifts for procuring loans (18 U.S.C. § 215).

FIRREA's broad application makes the statute a potentially powerful tool for the DOJ against financial institutions and against any company that engages in business with financial institutions. Numerous other aspects of FIRREA also make it particularly potent:

• Burden of proof: To prevail at trial and recover civil monetary penalties, the DOJ must prove its case by only a preponderance of the evidence, not by clear and convincing evidence or the familiar criminal standard-beyond a reasonable doubt.
• Pre-complaint discovery: Unlike many other civil statutes, FIRREA allows the DOJ to conduct quasi-criminal investigations through the issuance of administrative subpoenas for testimony and documents.
• Use of grand jury investigation materials: Also unlike other civil statutes, the DOJ is authorized to use materials acquired through criminal grand jury investigations to pursue civil actions under FIRREA.
• 10-year statute of limitations: FIRREA has a 10-year statute of limitations.
• Severe penalties: If found liable under FIRREA, a defendant can be required to pay up to $ 1 million per violation or, in the case of a continuing violation, the lesser of $1 million per day or $5 million. As a practical matter, the nature and number of discrete violations could be irrelevant. That is because, if a violation has caused a monetary gain or loss, FIRREA authorizes a civil penalty equal to the amount of such gain or loss. Thus, a civil monetary penalty imposed pursuant to FIRREA could be hundreds of millions of dollars in the context of matters arising from the financial crisis.
• Pairing with the False Claims Act: Using FIRREA in tandem with the False Claims Act,⁶ the DOJ may attempt to pursue treble damages. The DOJ appears to have done this in the Citigroup and Allied cases discussed above. If the DOJ is successful, the defendant could be required to pay three times the actual loss (or gain) to the government as a penalty, in addition to penalties that may be due under FIRREA.

Potential defenses

Depending on the facts and circumstances of a particular FIRREA case, there may be applicable defenses. As discussed below, FIRREA defendants have raised-without much success thus far-potential constitutional challenges, and statutory construction-based defenses. FIRREA defendants may also avail themselves of case-specific arguments and affirmative defenses based upon the facts of a given case.

Constitutional challenges

Defendants have raised Due Process and other constitutional challenges to FIRREA's penalty scheme. For example, they have argued that FIRREA is unconstitutional because a right to recovery only has to be established by a "preponderance of the evidence," even though, the defendants argue, the statute is punitive. To date, however, defendants have been unsuccessful in making this argument, largely because the government has convinced trial courts that FIRREA is remedial in nature.⁷ It remains to be seen whether this argument can prevail in different contexts where, for example, the remedial remedy theory is more attenuated.

FIRREA defendants also could challenge a FIRREA claim based on the Eighth Amendment, which prohibits excessive fines. Successfully making such a challenge is very difficult, however. Still, depending on the allegations and losses at issue, a defendant to a FIRREA claim could argue that the civil penalty is unconstitutionally excessive if it does not serve the remedial purpose identified by the government.⁸

Statutory construction defenses

There may be statutory construction defenses that should be explored further. For example, FIRREA's legislative history suggests that Congress's primary goal in passing FIRREA was to protect financial institutions from wrongdoing by insiders and other individuals, not necessarily to hold financial institutions accountable for alleged misconduct that impacts counterparties and customers. Financial institutions defending FIRREA claims should explore carefully this and other legislative history to determine whether their case is arguably inconsistent with FIRREA's purposes. Defendants may then raise arguments concerning the statute's failure to apply their alleged conduct.

Case-specific defenses

Although the government must prove its case only by a preponderance of the evidence, it must still prove fraudulent intent, if the underlying violation involves a criminal fraud statute. Thus, a corporate defendant also can raise case-specific defenses about its lack of criminal intent, including efforts to provide meaningful disclosure to the relevant financial institution or other conduct that demonstrates good faith, rather than an intent to defraud. As the DOJ saw in the acquittal of the two Bear Stearns fund managers, such defenses can be successful.

Other defenses may exist based on the underlying criminal acts alleged as part of a FIRREA claim. For instance, in the Allied case, the defense has argued that the Complaint is deficient because the criminal offense underlying the FIRREA claim, 18 U.S.C. § 1006, only applies to individuals, and because 18 U.S.C. § 1014 did not include conduct affecting the FHA prior to 2008. At the time this article went to press, the court had yet to rule on these issues.

Potential impact on anti-fraud compliance efforts

Although there may be defenses to FIRREA claims, the breadth of the statute will present challenges for defendants. Thus, financial institutions and other companies should consider how to avoid FIRREA liability in the first instance. To do so, they should examine how its use impacts their anti-fraud compliance efforts.

DOJ's current use of FIRREA is particularly relevant to financial institutions, but all companies are potentially at risk of violating its provisions. Indeed, any time a company engages in business with a financial institution, FIRREA liability is a potential risk. For example, FIRREA implications could arise whenever a company seeks a loan, issues securities, purchases securities, deposits or withdraws funds, or engages in other activities affecting a financial institution.

The risk of FIRREA liability is particularly acute because of the applicability of the preponderance of evidence standard to FIRREA violations. Because of this lower standard, the government may be more willing to pursue claims, even in the absence of direct evidence of fraud, such as direct evidence from a cooperating witness or a document explicitly setting forth criminal conduct. Moreover, even when there is ultimately no basis for a FIRREA claim, the government can pursue pre-complaint discovery, which can be burdensome and distracting to a corporation.

Because of FIRREA's broad reach, financial institutions and other companies should consider FIRREA's potential impact upon their anti-fraud compliance efforts. For instance, just as many companies focus compliance resources on interactions with the federal and state governments to avoid federal and state False Claims Act exposure, companies should also focus such efforts on their interactions with financial institutions. Similarly, financial institutions should focus compliance resources not only on their interactions with, among others, investors and governments, but also with other financial institutions.

Finally, if a corporation finds itself negotiating a settlement with the DOJ related to alleged misconduct that could arguably implicate FIRREA liability, the corporation should consider whether a resolution should also cover any FIRREA exposure.

Conclusion

Although the two Bear Stearns fund managers accused of misconduct during the financial crisis were able to avoid criminal convictions, the question remains whether a similar case brought under FIRREA's lower burden of proof would have been successful. Given the DOJ's efforts to use FIRREA to pursue alleged misconduct during the financial crisis, we may well find out.

Footnotes

1. 12 U.S.C. § 1833A

2. No. 1:12-cv-00361-RMC (D.D.C. filed March 12, 2012)

3. No. 1:11-cv-06969-LAK (S.D.N.Y. filed Feb. 16, 2012)

4. No. 11 Civ. 05473 (VM) (S.D.N.Y. filed Feb. 14, 2012)

5. No. 11 Civ. 05443 (VM) (S.D.N.Y. filed Nov. 1, 2011)

6. False Claims Act, 31 U.S.C. § 3729

7. See, e.g., U.S. v. Meisinger, No. EDCV 11-00896 VAP (OPx), 2011 WL 4526082 (C.D. Cal. Aug. 26, 2011); United States v. Mullins, Civ.A. No. 91-4331, 1992 WL 30472 (E.D. Pa. Feb. 12, 1992)

8. See United States v. Bajakajian, 524 U.S. 321, 329 (1998).

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