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On January 15, the SEC filed a brief in a pending U.S. Supreme Court action, Liu v. SEC. The question presented to the Court asks whether the SEC, in a civil enforcement action in federal court, is authorized to seek disgorgement of money acquired through fraud. The petitioners were ordered by a California federal court to disgorge the money that they collected from investors for a cancer treatment center that was never built. The SEC charged the petitioners with funneling much of the investor money into their own personal accounts and sending the rest of the funds to marketing companies in China, in violation of the Securities Act’s prohibitions against using omissions or false statements to secure money when selling or offering securities. The district court granted the SEC’s motion for summary judgment, and ordered the petitioners to pay a civil penalty in addition to the $26.7 million the court ordered them to repay to the investors. The petitioners appealed to the Supreme Court and in November, the Court granted certiorari.
The petitioners argued that Congress has never authorized the SEC to seek disgorgement in civil suits for securities fraud. They point to the court’s 2017 decision in Kokesh v. SEC, in which the Court reversed the ruling of the U.S. Court of Appeals for the Tenth Circuit when it unanimously held that disgorgement is a penalty and not an equitable remedy. Under 28 U.S.C. § 2462, this makes disgorgement subject to the same five year statute of limitations as are civil fines, penalties and forfeitures (see previous InfoBytes coverage here). The petitioners also suggested that the SEC has enforcement remedies other than disgorgement, such as injunctive relief and civil money penalties, so loss of disgorgement authority will not hinder the agency’s enforcement efforts.
According to the SEC’s brief, historically, courts have used disgorgement to prevent unjust enrichment as an equitable remedy for depriving a defendant of ill-gotten gains. More recently, five statutes enacted by Congress since 1988 “show that Congress was aware of, relied on, and ratified the preexisting view that disgorgement was a permissible remedy in civil actions brought by the [SEC] to enforce the federal securities laws.” The agency notes that the Court has recognized disgorgement as both an equitable remedy and a penalty, suggesting, however, that “the punitive features of disgorgement do not remove it from the scope of [the Exchange Act’s] Section 21(d)(5).” Regarding the petitioner’s reliance on Kokesh, the brief explains that “the consequence of the Court’s decision was not to preclude or even to place special restrictions on SEC claims for disgorgement, but simply to ensure that such claims—like virtually all claims for retrospective monetary relief—must be brought within a period of time defined by statute.”
In addition to the brief submitted by the SEC, several amicus briefs have been filed in support of the SEC, including a brief from several members of Congress, and a brief from the attorneys general of 23 states and the District of Columbia.
On September 9, the Department of Justice (DOJ), issued a policy memorandum concerning DOJ’s goal of holding individuals accountable for corporate fraud or other misconduct. While some of the guidelines set forth in the memorandum are statements of practices already being followed by DOJ, or by specific U.S. Attorney’s Offices, some of the measures are new and reflect an enhanced focus on DOJ’s goal of holding individuals criminally or civilly liable for corporate wrongdoing. The memo sets forth “six key steps” to accomplish this goal and further DOJ’s underlying policies of deterring future illegal activity, incentivizing change in corporate behavior, holding proper parties responsible for their actions, and promoting public confidence in the justice system.
First, the memo provides that, to be eligible to receive any credit for cooperating with the government in a civil or criminal investigation, a company must completely disclose to DOJ all relevant facts about individual misconduct, regardless of the individual’s position, status or seniority at the company. If a company provides incomplete information about individual employees’ misconduct, then the company’s cooperation will not be considered a mitigating factor in a criminal investigation and will not support, in the case of a prosecution, a cooperation-related reduction at sentencing. Likewise, where the company is not completely forthcoming about individual wrongdoing in a civil investigation, DOJ will not consider the company’s cooperation in negotiating a settlement agreement.
Second, the memo provides that both criminal and civil investigations should focus on individuals from the outset of the investigation, in order to discern the full extent of alleged misconduct, increase the likelihood of cooperation by individuals with knowledge of the misconduct, and maximize the chances that resolution of the investigation will include civil or criminal charges against both the company and culpable individuals.
Third, the memo emphasizes that DOJ criminal and civil attorneys should be in routine communication with one another, so that the DOJ can consider the full range of potential remedies to address alleged misconduct by individuals.
Fourth, the memo provides that, absent “extraordinary circumstances,” no corporate resolution will provide protection for criminal or civil liability for any individuals. Fifth, the memo states that DOJ attorneys should not resolve civil or criminal investigations of a corporation without a “clear plan” to resolve related individual cases. In addition, if a decision is made not to prosecute or proceed civilly against individuals who committed the misconduct, DOJ attorneys must memorialize and submit for approval the reasons for that decision.
Finally, the memo provides that civil prosecutors should consistently focus on individuals as well as the company, and evaluate the decision whether to sue an individual based on considerations beyond the individual’s ability to pay. The memo notes that, while DOJ attorneys may validly consider an individual corporate wrongdoer’s ability to satisfy a judgment in determining whether to pursue an action against that person, DOJ attorneys also should consider other goals and concerns in making this determination, including such things as the seriousness of a person’s misconduct, the person’ s past history, the ability to obtain and sustain a judgment, and the long-term deterrent effects of holding an individual accountable.
On July 30, the U.S. District Court for the Southern District of New York ordered a bank to pay a nearly $1.3 billion civil penalty after a jury found the bank liable in October 2013 on one civil mortgage fraud charge arising out of a program operated by a mortgage lender the bank had acquired. The case was the first in which the government alleged violations of FIRREA in connection with loans sold to Fannie Mae and Freddie Mac. The government originally sought damages of $1 billion based on alleged losses incurred by Fannie Mae and Freddie Mac. Subsequently the government argued the penalty should be calculated not based on loss to the GSEs, but rather based on gross gain to the lender, in order to accomplish “FIRREA’s central purpose of punishment and deterrence.” The government calculated a gross gain of $2.1 billion, and requested that the court impose a penalty in that amount.
In its order on civil penalties, the court noted that FIRREA provides no guidance on how to calculate a gain or loss or how to choose a penalty within the broad range permitted. To quantify the gain or loss on the 17,611 loans at issue, the court focused on the general principle that the “civil penalty provisions of FIRREA are designed to serve punitive and deterrent purposes and should be construed in favor of those purposes.” The court determined that both gain and loss should be viewed in terms of how much money the lender “fraudulently induced” the GSEs to pay. Even though many of the loans were in fact high quality, the Court included all of the loans in the gain and loss analysis because the jury found that the lender engaged in an intentional scheme to defraud the GSEs and that the lender intended to represent loans as being materially higher quality than they actually were. The court reasoned that the “happenstance that some of the loans may still have been of high quality should not relieve the defendants of bearing responsibility for the full payments they received from the scheme, at least not if the purposes of the penalty are punishment and deterrence.” As a result, the Court found the proper measure of both gain and loss to be the amount Fannie and Freddie paid for all loans at issue, and set $2,960,737,608 as the statutory maximum for the penalty. As a compensating factor, the court considered that 57.19 percent of the loans were not materially defective and reduced the penalty to 42.81 percent of the statutory maximum, or $1,267,491,770.
On July 14, the DOJ, the FDIC, and state authorities in California, Delaware, Illinois, Massachusetts, and New York, announced a $7 billion settlement of federal and state RMBS civil claims against a large financial institution, which was obtained by the RMBS Working Group, a division of the Obama Administration’s Financial Fraud Enforcement Task Force. Federal and state law enforcement authorities and financial regulators alleged that the institution misled investors in connection with the packaging, marketing, sale, and issuance of certain RMBS. They claimed, among other things, that the institution received information indicating that, for certain loan pools, significant percentages of the loans reviewed as part of the institution’s due diligence did not conform to the representations provided to investors about the pools of loans to be securitized, yet the institution allowed the loans to be securitized and sold without disclosing the alleged failures to investors. The agreement includes a $4 billion civil penalty, described by the DOJ as the largest ever obtained under FIRREA. In addition, the institution will pay a combined $500 million to settle existing and potential claims by the FDIC and the five states. The institution also agreed to provide an additional $2.5 billion in borrower relief through a variety of means, including financing affordable rental housing developments for low-income families in high-cost areas. Finally, the institution was required to acknowledge certain facts related to the alleged activities.
On July 14, Illinois Attorney General (AG) Lisa Madigan announced that her office filed separate civil lawsuits (here and here) in state court against two student debt relief firms and their principals. The lawsuits allege that the defendants violated several state consumer protection statutes relating to their deceptive student debt relief practices and collection of improper fees. The AG claims that the unlicensed companies and their sole principals improperly accepted upfront fees from student borrowers while claiming to have enrolled them in sham loan forgiveness programs or other legitimate loan relief programs that were available to borrowers free of charge. The lawsuits also allege that the defendants engaged in extensive false and misleading advertisements that misrepresented their expertise, affiliation with the U.S. Department of Education, and the debt relief programs available to borrowers.
The AG maintains that these practices violate several state consumer protection statues, including:
- The Illinois Consumer Fraud and Deceptive Business Practices Act, prohibiting unfair and deceptive business practices, including making false representations and failing to disclose material facts to consumers;
- The Credit Services Organizations Act, prohibiting unlicensed parties from acting as “debt settlement providers” or accepting illegal fees; and
- The Debt Settlement Consumer Protection Act, prohibiting parties from accepting upfront payment for debt relief services.
The lawsuits seek injunctive and non-monetary relief in the form of permanent injunctions against each defendant and a rescission of all contracts with Illinois residents. The AG is also pursuing a variety of monetary damages and penalties, including restitution, costs of prosecution and investigation, and civil penalties of $50,000 for each statutory violation with additional penalties for those conducted with the intent to defraud or perpetrated against elderly victims.
On February 4, the DOJ announced the filing and simultaneous settlement of a complaint by the U.S. Attorney for the Southern District of New York (SDNY) against a mortgage lender alleged to have violated the False Claims Act (FCA) by submitting false loan-level certifications to HUD that fraudulently induced HUD to insure ineligible mortgage loans. The complaint makes similar claims with respect to loans insured by the Department of Veterans Affairs (VA). This is the first FCA case brought by the SDNY to assert claims based on VA loans. Although the complaint was filed in a whistleblower qui tam case under seal in January 2013, it indicates the U.S. Attorney’s investigation of fraudulent lending practices has been on-going since 2011. In addition to allegations concerning reckless origination practices, the complaint also alleges that the lender’s underwriters manipulated the data entered into the AUS/TOTAL Scorecard system, repeatedly entering hypothetical data that lacked a factual basis with the goal of determining the lowest values that would generate an “accept/approve” recommendation. The U.S. Attorney claims this practice violated HUD guidance and encouraged fraud by both loan officers and borrowers, and also that the lender made false statements in its loan-level certifications when it falsely certified to the “integrity” of the data entered by underwriters into AUS/TOTAL. To resolve the matter, the lender agreed to pay a total of $614 million; $564.6 million to resolve the HUD claims and $49.4 million to resolve the VA claims. Consistent with the SDNY’s recent practice of requiring admissions in civil fraud cases, the settlement stipulation recites that the lender admits responsibility for certain specified allegations. The settlement also requires the lender to implement “an enhanced quality control program,” the terms of which are to be memorialized in a separate agreement still to be negotiated.
On January 30, the U.S. District Court for the Southern District of New York denied the SEC’s motion for an order authorizing alternative means of service for two Chinese nationals residing in the People’s Republic of China. SEC v. China Intelligent Lighting & Electronics, Inc., No. 13 CIV. 5079, 2014 WL 338817 (S.D.N.Y. Jan. 30, 2014). The SEC moved for the order after it was unable to serve two individual defendants in a securities fraud case by means of the Hague Convention on the Service Abroad of Judicial and Extra-Judicial Documents in Civil and Commercial Matters. The court agreed that alternative service would be appropriate, but rejected the SEC’s proposed method of alternative service: publication in the International New York Times and via email. The court held that alternative service is acceptable if it (i) is not prohibited by international agreement, and (ii) if it comports with constitutional notions of due process. Although no international agreement would prevent the SEC’s proposed methods of service, the court held the SEC failed to demonstrate such service was “reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.” The court held that the SEC failed to provide evidence that either method of service would actually reach the defendants—it did not provide any information about the distribution of the newspaper and failed to provide evidence the email addresses were accurate and in use by the defendants. The court denied the SEC’s motion without prejudice.
On October 23, a jury found a bank liable on one civil mortgage fraud charge arising out of a program operated by a lender the bank had acquired. The jury also found against a former executive of the acquired lender. The verdict followed a four week trial in the first DOJ case alleging violations of the FCA and FIRREA in connection with loans sold to Fannie Mae and Freddie Mac. Judge Jed Rakoff of the Southern District of New York will consider briefing on the penalty—the DOJ originally had sought damages close to $1 billion. The bank stated that it will evaluate its options for an appeal. For more information about the government’s expanding FCA/FIRREA civil fraud initiative, please visit our resource center.
On August 16, the U.S. District Court for the Southern District of New York issued a written opinion in support of its May 8, 2013 dismissal of claims for damages and civil penalties under the False Claims Act (FCA) brought by the federal government against a mortgage lender alleged to have sold defective loans to Freddie Mac and Fannie Mae while representing that the loans complied with the enterprises’ requirements. U.S. v. Countrywide Fin. Corp., No. 12-1422, 2013 WL 4437232 (S.D.N.Y. Aug. 16, 2013). Although it dismissed the FCA claims, the court did not dismiss the government’s claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) that the lender’s conduct “affected” a federally insured financial institution – the lender itself. In its opinion, the court rejected the lender’s arguments that FIRREA’s legislative history and policy considerations contradict the government’s position, and instead applied a plain meaning analysis and held that the lender allegedly has paid billions of dollars to settle repurchase claims by Fannie Mae and Freddie Mac as a result of the alleged fraud, which “affected” the lender itself and as such is sufficient to sustain the FIRREA counts. The court also rejected the lender’s argument that the government failed to adequately allege the FIRREA predicate offenses of mail fraud and wire fraud because the alleged misrepresentations were “mere breaches of contract that cannot separately support an action for fraud,” holding that the argument is premised on the “fundamental error” that “mail fraud and wire fraud are subject to the same arcane limitations as common law fraud.” Notably, the court dismissed the government’s FCA claims “with prejudice” because the government failed to plead fraud with particularity with respect to loans sold after the enactment of the Fraud Enforcement and Recovery Act of 2009, which extended the FCA to cover indirect recipients of federal funds.
On August 6, the DOJ and the SEC announced parallel civil fraud actions filed in the U.S. District Court for the Western District of North Carolina. The DOJ alleged that a national bank and related entities misled investors about the residential jumbo prime mortgage loans backing an $850 million RMBS the bank offered for sale, made false statements after failing to perform proper due diligence, and filled the securitization with a disproportionate amount of risky mortgages originated through third party mortgage brokers. The DOJ action represents the enforcement agency’s latest effort to employ the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) to seek civil penalties. The SEC is seeking an order requiring disgorgement and civil penalties under the Securities Act. The complaints were announced as part of the Financial Fraud Enforcement Task Force’s RMBS Working Group, and Task Force participants Attorney General Eric Holder, Associate Attorney General Tony West, and New York Attorney General Eric Schneiderman all promised additional investigations and actions, using every tool and resource available to the group.
- Kathryn L. Ryan to host the affiliate members meeting at AARMR’s 2022 Annual Regulatory Conference & Training
- Kathryn L. Ryan and Jedd R. Bellman to discuss “Risk and compliance management: Are you covered?” at a Mortgage Bankers Association webinar
- Melissa Klimkiewicz and Daniel A. Bellovin to discuss “Things to know about flood insurance” at a NAFCU webinar
- Hank Asbill to discuss “Ethical issues at sentencing” at the 31st Annual National Seminar on Federal Sentencing
- Max Bonici will moderate a panel on “Enforcement risk and other regulatory and compliance issues related to crypto and digital assets” at the American Bar Association’s 2022 Annual Meeting
- John R. Coleman to provide a “CFPB Update” at MBA’s 2022 Regulatory Compliance Conference
- Amanda R. Lawrence to discuss “The shifting data privacy and data protection landscape” at MBA’s 2022 Regulatory Compliance Conference
- Benjamin W. Hutten to discuss “Fundamentals of financial crime compliance” at the Practicing Law Institute
- Benjamin W. Hutten to discuss “Ongoing CDD: Operational considerations” at NAFCU’s Regulatory Compliance & BSA Seminar