In recent years, the U.S. Department of Justice
("DOJ") has begun using the civil money penalty provision
of the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA") to investigate and prosecute persons
suspected of financial fraud. Although FIRREA was enacted more than
20 years ago in the wake of the savings and loan crisis, its civil
money penalty provision generally lay dormant until its recent
resurrection by the DOJ as a tool to combat financial fraud,
particularly residential mortgage fraud. As a result, there was
until recently a scarcity of case law interpreting the civil
penalty provision. Two recent decisions, however, address important
issues of first impression regarding the scope of liability and
calculation of civil penalties under FIRREA. On April 24, 2013, a
New York federal district court ruled that a federally insured
financial institution may incur FIRREA liability for engaging in
fraudulent conduct "affecting" itself (as opposed to
frauds by third parties that victimized the bank). See
United States v. The Bank of New York Mellon, No. 11 Civ.
06969 (S.D.N.Y). This case followed on the heels of a March 6, 2013
ruling by a California federal district court that set forth an
eight-factor analysis to be used in assessing civil money penalties
under FIRREA. See United States v. Menendez, No.
11 Civ. 06313 (C.D. Cal.).
What Is the FIRREA Civil Penalty Provision?
Section 951 of FIRREA, codified at 12 U.S.C. § 1833a,
authorizes the DOJ to bring a complaint seeking civil money
penalties against persons who violate one or more of 14 enumerated
criminal statutes (or predicate offenses) that involve or affect
financial institutions and government agencies. For nine of the
predicate offenses, which deal specifically with banks or other
financial institutions in one way or another (such as bank fraud,
18 U.S.C. § 1344), the government does not have to prove
any additional element beyond violation of the predicate offense
itself. For the five others, which are more general offenses such
as false claims on the U.S. government (18 U.S.C. § 287),
false statements within federal jurisdiction (18 U.S.C.
§ 1001), fraud on federal receivers and conservators (18
U.S.C. § 1032), and mail and wire fraud (18 U.S.C.
§§ 1341, 1343), the government must additionally
prove that the violation of the underlying criminal statute was one
"affecting a federally insured financial institution"
(such as an FDIC-insured bank or thrift). FIRREA does not define
the term "affecting" and, until recently, there were no
reported decisions interpreting that term.
Recently, the DOJ has invoked FIRREA, often in conjunction with the
False Claims Act (31 U.S.C. § 3729 et seq.), to seek
multimillion- or multibillion-dollar penalties against some of the
largest financial institutions in the United States. Earlier this
year, the DOJ filed its largest-ever lawsuit under FIRREA against
the world's largest credit rating agency, Standard &
Poor's ("S&P"), seeking more than $5 billion in
civil money penalties based on allegations that S&P engaged in
a scheme to defraud investors who purchased residential mortgage
backed securities and collateralized debt obligations.
What Are the Benefits of FIRREA from the DOJ's Perspective?
FIRREA provides the DOJ with a number of key advantages in
conducting investigations and bringing civil penalty suits against
persons suspected of financial fraud.
Scope. FIRREA is broader in scope than the False
Claims Act, which is generally limited to circumstances in which
the United States suffers a pecuniary loss as a result of a fraud.
By comparison, FIRREA allows the DOJ to pursue civil money
penalties for any frauds involving or affecting certain types of
financial institutions. 12 U.S.C. § 1833a(c). FIRREA's
broad scope is principally derived from the inclusion of the mail
fraud and wire fraud statutes (18 U.S.C. §§ 1341 and
1343) among FIRREA's predicate offenses, provided that the
fraud "affects" a federally insured financial
institution. The mail fraud and wire fraud statutes encompass
virtually any fraud where interstate mail, email, telephone, faxes,
or other electronic communications are used in furtherance of the
fraud.
Burden of Proof. Unlike in a criminal prosecution,
where the government must prove the defendant's guilt
"beyond a reasonable doubt," in a FIRREA civil case, the
DOJ must prove only that a defendant committed one of FIRREA's
predicate offenses by a "preponderance of the evidence."
12 U.S.C. § 1833a(f). This lower standard of proof makes
FIRREA a useful alternative or supplement to criminal prosecutions,
because it allows the DOJ to seek substantial civil money penalties
even when it lacks evidence to prove the defendant's guilt
beyond a reasonable doubt.
Investigative Powers. FIRREA authorizes the DOJ to
issue administrative subpoenas for the purpose of conducting a
civil investigation in contemplation of a civil proceeding. 12
U.S.C. § 1833a(g). Under this broad subpoena power, the DOJ
may engage in extensive pre-trial investigations, including taking
depositions of key witnesses and compelling the production of
documents and records, without obtaining prior judicial
authorization. For instance, FIRREA's subpoena power enabled
the DOJ to conduct a multiyear investigation of S&P prior to
filing its lawsuit early this year. During the course of that
investigation, the DOJ's attorneys reportedly served hundreds
of civil subpoenas, spent thousands of hours reviewing and
analyzing millions of pages of documents, and contacted and
interviewed more than 150 witnesses, including dozens of former
S&P analysts and executives.
Statute of Limitations. FIRREA has a 10-year
statute of limitations, which is far longer than the more typical
period of three to five years applicable to civil lawsuits. 12
U.S.C. § 1833a(h). This extended time period provides the DOJ
with additional time to conduct its pre-suit investigations and to
bring suits in connection with violations that would ordinarily be
time barred.
Civil Money Penalties. While FIRREA does not
authorize the imposition of criminal sanctions (such as
imprisonment), the civil money penalties available under FIRREA are
potentially crippling. FIRREA authorizes penalties of up to $1.1
million per violation. For continuing violations, the maximum
increases up to $1.1 million per day or $5.5 million per violation,
whichever is less. 12 U.S.C. § 1833a(b)(1) and (2) (as
adjusted pursuant to 28 C.F.R. § 85.3(a)(6) and (a)(7)).
Moreover, FIRREA allows the court to increase the penalty up to the
amount of the pecuniary gain that any person derives from the
violation, or the amount of pecuniary loss suffered by any person
as a result of the violation. 12 U.S.C. §1833a(b)(3). The DOJ
has invoked this special penalty rule to seek more than $5 billion
in civil money penalties from S&P in the current
litigation.
When Does a Fraud "Affect" a Federally Insured Financial Institution?
On April 24, 2013, the U.S. District Court for the Southern
District of New York issued the first judicial interpretation of
the phrase "affecting a federally insured financial
institution" as used in FIRREA. In United States v.
The Bank of New York Mellon, the DOJ brought suit against
The Bank of New York Mellon ("BNYM") and one of its
employees under FIRREA for alleged violations of the mail fraud and
wire fraud statutes. These charges were in connection with the
defendants' alleged scheme to defraud BNYM's custodial
clients by fraudulently misrepresenting that BNYM provided
"best execution" when pricing foreign exchange trades
under its "standing instructions" program.
In support of its claims, the DOJ contended that the
defendants' alleged fraudulent scheme "affected" a
federally insured financial institution—namely BNYM
itself—as well as a number of other federally insured
financial institutions that were BNYM foreign exchange clients.
BNYM moved to dismiss the complaint, contending that a federally
insured financial institution may be "affected" by a
fraud only if it were the victim of or an innocent bystander to the
alleged fraud, but not if it were the perpetrator.
After considering the text, statutory structure, and legislative
history and purpose of FIRREA, the court rejected the
defendants' narrow construction. The court held that Congress
intended the statute to apply in circumstances in which a federally
insured financial institution was "affected" by the
fraud, not just a "victim" of a fraud. The court viewed
the term "affecting" as a "singularly broad
term" meaning something closer to "involving" than
"victimizing." The court stated that the word
"affect" ordinarily means "to act upon" as in
"to produce an effect ... upon," "to produce a
material influence upon or alteration in," or possibly
"to have a detrimental influence on" and, in the
court's opinion, none of those definitions came close to
equating "affecting" with "victimizing."
The court considered that the essential purpose of FIRREA's
civil money penalties was to deter fraud that put federally insured
deposits at risk, in order to protect depositors and ultimately
U.S. federal taxpayers. It was entirely consistent with that
purpose to hold an institution liable for fraudulent conduct that
harmed itself. The court also noted that FIRREA's penalty
provision applied to "whoever" violated a predicate
offense, and that the statute could not be read to exclude the
affected financial institution itself from the meaning of the word
"whoever."
The court also concluded that a fraud may "affect" an
institution within the meaning of FIRREA if it exposes that
institution to a new or increased risk of loss, even
without a showing of any actual loss. As such, the court
held that the DOJ sufficiently alleged that BNYM was negatively
affected by its own fraud, even though BNYM may have profited from
that fraud. The DOJ's complaint alleged that BNYM had been
named as a defendant in numerous private lawsuits as a result of
its alleged fraud, which required it to incur litigation costs,
exposed it to billions of dollars in potential liability, and
damaged its business by causing a loss of clients, forcing BNYM to
adopt a less-profitable business model and harming its reputation.
Furthermore, the court held that these negative effects were of a
different character than any profits BNYM gained from the alleged
fraud, such that those profits could not be understood to offset
the negative losses and risks that affected BNYM. As the DOJ's
complaint had sufficiently alleged that the fraud had negatively
affected BNYM, the court declined to determine whether a direct but
positive effect alone would be sufficient to "affect" a
financial institution for the purposes of FIRREA.
The court did state one limiting principle on FIRREA liability,
holding that to "affect" an institution, the fraud must
be the proximate cause of the alleged negative effects on the
institution, and that the touchstone of proximate causation was
reasonable foreseeability. The court recognized that at "some
point" the effect of a defendant's fraud on a financial
institution may become "so attenuated, so remote, so
indirect" that it does not in any meaningful sense
"affect" the institution. In the case before it, however,
the court held that it was reasonably foreseeable that the alleged
scheme, if uncovered, would result in the kind of harms suffered by
BNYM.
The court's decision will be of immediate relevance in at least two other cases currently before the Southern District of New York, which present the same question of whether FIRREA recognizes an "affect yourself" theory of liability. Interestingly, according to recent public reports, a district court judge presiding over one of those cases commented that he was "troubled" by the DOJ's "affect yourself" theory of liability, although he stated that his comment was only a preliminary one. Arguably, the court's broad reading of FIRREA in The Bank of New York Mellon case appears to contradict the view of at least one other federal district court that "[p]unitive statutes, such as FIRREA, are to be narrowly construed." See United States v. Vanoosterhout, 898 F. Supp. 25, 30 (D.D.C. 1995). In any event, the court's conclusion that the term "affecting" is a "singularly broad term"—such that a financial institution is "affected" by a mere increased risk of loss—will encourage the DOJ to continue invoking FIRREA as it aggressively investigates and prosecutes financial institutions and others for financial fraud.
How Are Civil Money Penalties Calculated Under FIRREA?
As discussed above, FIRREA establishes maximum penalty limits
but otherwise leaves the precise award within the discretion of the
court. FIRREA does not set forth any factors that a court must
consider in calculating civil money penalties, and until recently,
there were no reported cases that discussed such factors. On March
6, 2013, the U.S. District Court for the Central District of
California issued the first judicial decision setting forth factors
relevant to assessing civil money penalties under FIRREA.
In United States v. Menendez, the DOJ brought a FIRREA
suit against a licensed real estate broker who had allegedly
committed bank fraud in violation of 18 U.S.C. § 1344(1) by
submitting a false certification to the U.S. Department of Housing
and Urban Development ("HUD") in connection with a short
sale of a residential property. After obtaining summary judgment on
the issue of the defendant's liability, the DOJ requested that
the court impose a penalty in the amount of approximately $1.1
million, which was the amount of the loss allegedly suffered by HUD
as a result of the defendant's fraudulent scheme. (The damages
claim included 27 other transactions, as to which the court struck
the DOJ's proof of damages for inadequate foundation.) The
defendant argued that the amount sought by the DOJ was excessive
and requested that the court either deny the DOJ's motion or
impose a substantially reduced penalty.
In its ruling on the issue, the court noted the absence of any
authority setting forth factors or criteria that the courts should
consider in assessing a civil penalty under FIRREA. In the absence
of such authority, the court looked to factors that courts have
applied in other contexts involving civil penalties. The court set
forth the following eight factors for determining the civil penalty
amount under FIRREA:
- The good or bad faith of the defendant and the degree of his/her scienter;
- The injury to the public, and whether the defendant's conduct created substantial loss or the risk of substantial loss to other persons;
- The egregiousness of the violation;
- The isolated or repeated nature of the violation;
- The defendant's financial condition and ability to pay;
- The criminal fine that could be levied for this conduct;
- The amount the defendant sought to profit through his fraud; and
- The penalty range available under FIRREA.
Applying these factors, the court
imposed a civil money penalty of $40,000, or the amount that the
defendant had profited from his alleged fraud. In determining that
the $1.1 million penalty sought by the DOJ was excessive, the court
noted that the maximum criminal fine for bank fraud was $1
million. The court also found that the likely fine under the
federal sentencing guidelines would be in the range of
$20,000–$30,000. The court also rejected the DOJ's
argument that a defendant's finances are irrelevant to
assessing a civil penalty under FIRREA, holding that a heavy
penalty was not warranted due to the fact that the defendant had
limited assets and income and had filed a petition for Chapter 7
bankruptcy.
Menendez establishes that the courts have flexibility in
determining the actual civil penalty awarded under FIRREA. Under
this framework, the courts are instructed to consider the
particular facts of the case and the defendant's unique
circumstances, and not to rigidly adhere to the statutory maximums.
The Menendez factors will likely be followed by other
courts adjudicating FIRREA claims. In the meantime, the decision
provides a general framework for defendants and their advisers to
evaluate the likely range of financial penalties that a court may
impose for FIRREA violations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.