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Special Alert: Second Circuit Reverses SDNY Judgment; Rules Fraud Claim Based on Contractual Promise Cannot Support FIRREA Violation Without Proof of Fraudulent Intent at the Time of Contract Execution
On May 23, in an opinion delivered by Circuit Judge Richard Wesley, the Second Circuit Court of Appeals reversed the District Court for the Southern District of New York’s (SDNY) July 30, 2014 judgment ordering a bank and its lender subsidiary to pay penalties in excess of $1.2 billion for alleged violations of section 951 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), 12 U.S.C. § 1833a. U.S. v. Countrywide Home Loans, Inc., Nos. 15-469, 15-499 (2d Cir. May 23, 2016). In relevant part, FIRREA imposes civil penalties for violations of the federal mail and wire fraud statutes that affect a federally insured financial institution. The Government had alleged in the case that the lender subsidiary had defrauded Fannie Mae and Freddie Mac (collectively, the GSEs), by originating mortgage loans through its High Speed Swim Lane (HSSL) loan origination process that it allegedly knew to be of poor quality, and subsequently selling those loans to the GSEs despite representations in the contracts between the GSEs and lender subsidiary that the loans were of investment quality. At trial, the Government presented evidence that high-level employees of the lender subsidiary “knew of the pre-existing contractual representations, knew that the loans originated through HSSL were not consistent with those representations, and nonetheless sold HSSL Loans to the GSEs pursuant to those contracts.” The defendants argued on appeal that, under common-law principles of fraud the Government’s trial evidence proved, at most, a series of intentional breaches of contract which did not suffice as a matter of law to establish fraud.
The Second Circuit agreed with defendants and reversed the judgment of the district court. The court held that:
a contractual promise can only support a claim for fraud upon proof of fraudulent intent not to perform the promise at the time of contract execution. Absent such proof, a subsequent breach of that promise—even where willful and intentional—cannot in itself transform the promise into a fraud.
Thus, the Second Circuit concluded that under common law principles, which were incorporated into the mail and wire fraud statutes, “the proper time for identifying fraudulent intent is contemporaneous with the making of the promise, not when a victim relies on the promise or is injured by it.” The Second Circuit further held that “where allegedly fraudulent misrepresentations are promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim.”
Click here to view the full Special Alert.
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Questions regarding the matters discussed in this Alert may be directed to any of our lawyers listed below, or to any other BuckleySandler attorney with whom you have consulted in the past.
- Amanda Raines Lawrence, (202) 349-8089
DOJ Settles with New Jersey Mortgage Lender Over False Claims Act Violations
On April 15, the DOJ announced a $113 million settlement with a New Jersey-based mortgage company to resolve allegations that the mortgage lender violated the False Claims Act. According to the DOJ, the mortgage company – acting as a direct endorsement lender in HUD’s Federal Housing Administration (FHA) program – knowingly originated and accepted FHA-insured mortgage loans that did not properly comply with HUD origination, underwriting, and quality control requirements. As part of the settlement agreement, the mortgage company agreed that it failed to (i) meet HUD underwriting requirements from January 1, 2006 through December 31, 2011; (ii) adhere to FHA’s quality control requirements between 2006 and 2008 by not sharing with production and underwriting management its early payment default quality control review; (iii) perform timely quality control reviews or perform audits of early payment defaults between 2008 and 2010; and (iv) report improperly originated loans between 2006 and 2011. The DOJ’s investigation further found that, after conducting a review of FHA loans underwritten between 2007 and 2012, the mortgage company self-reported to HUD only one of hundreds of loans that the company identified as not meeting FHA mortgage insurance requirements. Per the settlement agreement, the mortgage company must make an initial payment of $26 million by May 2, 2016.
Ninth Circuit: Fannie and Freddie Are Not Government Agents for FCA Purposes
Recently, the U.S. Court of Appeals for the Ninth Circuit affirmed the District Court of Nevada’s ruling that, for the purposes of the False Claims Act (FCA), 31 U.S.C § 3729(b)(2)(A)(i), Fannie Mae and Freddie Mac are not instrumentalities or officers, employees, or agents of the federal government. U.S. ex rel. Adams v. Aurora Loan Servs., Inc., No. 14-15031 (9th Cir. Feb. 22, 2016). In this case, the plaintiffs alleged that several lenders and loan servicers (collectively, defendants) made certain false certifications to Fannie and Freddie in connection with the purchase and sale of loans. Plaintiffs argued that the False Claims Act applies to claims made to Fannie and Freddie because they are agencies or instrumentalities of the federal government under one of the two definitions of a “claim” in the Act. The Ninth Circuit held that Fannie and Freddie are not federal instrumentalities for FCA purposes of the first definition of a “claim,” notwithstanding the government’s conservatorship. Likewise, the court confirmed that because Fannie Mae and Freddie Mac are private companies, albeit subject to the government’s conservatorship, claims made to the companies were not made to an officer, employee or agent of the federal government. The court observed that plaintiffs did not make an argument under the second definition of claim under the FCA, which defines a claim as a request or demand made upon non-government third parties under certain conditions, and therefore expressed no opinion on whether such a claim could have been brought.
Mortgage Company Resolves DOJ Allegations of False Claims Act Violations
On December 2, a Tennessee mortgage company agreed to pay the United States $70 million to resolve allegations that it violated the False Claims Act. According to the DOJ, the company, acting as a direct endorsement lender, knowingly originated and accepted FHA-insured mortgage loans that did not meet applicable HUD underwriting and quality control requirements. As part of the settlement agreement, the company admitted to engaging in the following conduct between January 1, 2006 and March 31, 2012: (i) employing unqualified junior underwriters to complete important underwriting tasks; (ii) setting high quotas for underwriters and disciplining them if the quotas were not met; and (iii) offering underwriters bonuses based in part on the number of loan files reviewed as incentive to increase loan production. Even though deficiencies in the loan underwriting process were identified in post-close audits, the company did not make any self-reports until 2009 and, even then, “[v]ery few of these self-reported loans were reported for containing serious underwriting deficiencies.” As a result of the company’s conduct, the FHA insured loans that were not eligible, purportedly suffering “substantial losses when it later paid insurance claims on those loans.”
DOJ Settles with For-Profit Education Company Over Alleged FCA Violations
On November 16, the DOJ announced a $95.5 million settlement with the country’s second-largest for-profit education company to resolve alleged federal and state violations of the False Claims Act (FCA). According to the DOJ’s complaint, the company’s admissions personnel received payment based on the number of students they enrolled, a violation of Title IV of the Higher Education Act’s (HEA) Incentive Compensation Ban (ICB) and the Regulatory Safe Harbor. The DOJ alleges that the company misrepresented its compliance with Title IV of the HEA to the Department of Education by certifying in Program Participation Agreements that it had not “paid to any persons or entities any commission, bonus, or other incentive payment based directly or indirectly on success in securing enrollments, financial aid to students, or student retention.” The Department of Education calculated that, from July 1, 2003 through June 30, 2011, the company, having submitted “a variety of claims to the government for Title IV funding that it [knew] to be false based upon its non-compliance” with the ICB, received more than $11 billion in government funding. Under the terms of the settlement, the $95.5 million will be divided among the United States, the co-plaintiff states, and the whistleblowers and their counsel in the FCA cases filed separately in federal court in Pittsburgh, Pennsylvania and Nashville, Tennessee.
HUD, FDIC, and U.S. Attorney File Suit Against Mortgage Lending Companies
On September 28, HUD, the FDIC, and the U.S. Attorney for the Eastern District of New York filed suit against a non-profit housing counseling corporation and certain mortgage lenders for allegedly running a scheme to defraud the United States and various banks out of over $5,000,000 in false claims. Filed in the Eastern District of New York, the complaint alleges that, in order to remain in HUD’s Direct Endorsement Program, a federal program that insures mortgage loans through the FHA, the mortgage lenders sought to fraudulently conceal the high default rates of their loans by funneling money through the corporation to pay their borrowers’ payments, in direct violation of FHA regulations. The mortgage lenders would then sell the federally-insured loans to FDIC-insured banks. Once either a bank’s indemnification or repurchase rights, or the period during which HUD monitored loans for early payment defaults, lapsed, the mortgage lenders would stop making payments, resulting in the ultimate default of the borrowers. The complaint seeks treble damages under the FCA, the FIRREA, and under common law theories of gross negligence, breach of fiduciary trust, and unjust enrichment.
Ninth Circuit Bars Qui Tam Relator's Whistleblower Recovery in False Claims Act Suit Over Conviction
On July 16, the U.S. Court of Appeals for the Ninth Circuit affirmed a district court’s dismissal of a qui tam relator from a False Claims Act suit, holding that the False Claims Act requires dismissal of a relator convicted of any conduct giving rise to the fraud at issue, however minor, and prevents the relator from collecting any share of a whistleblower award. United States ex rel. Schroeder v. CH2M Hill, No. 13-35479 (9th Cir. July 16, 2015). The relator submitted false time cards while working for a contractor who engaged in fraudulent billing practices. The Ninth Circuit held that the False Claims Act permits reducing relator awards for planners and initiators of the subject fraud, but dismisses and does not permit collection by all “relators convicted of criminal conduct arising from the fraudulent conduct at issue in the qui tam suit,” even those that did not plan or initiate the fraud. Congress’s hierarchy for relator awards, reasoned the court, “may satisfy other values, such as the deterrent effect of preventing criminally culpable individuals from gaining from their conduct, and the investigatory benefits of actions brought by planners and initiators who often have greater knowledge about co-conspirators and the scope of a fraudulent scheme.” The court rejected the idea that the statute “contain[s] an exception for minor participants” who were nonetheless convicted of the subject criminal conduct.
Regional Bank Agrees to Pay Over $200 Million for Alleged Violations of the False Claims Act
On June 1, a regional bank agreed to pay the United States $212.5 million to resolve allegations that it knowingly violated the False Claims Act by originating and underwriting FHA-insured mortgage loans that did not meet applicable requirements. The bank – through its subsidiary and as a Direct Endorsement Lender in the FHA insurance program – had the authority to approve mortgage loans for FHA insurance without having FHA or HUD review the loan application first. The DOJ Civil Division’s investigation concluded that, from January 2006 through October 2008, the bank, even though it was aware of material deficiencies in its loan origination process, “failed to report even a single deficient mortgage to FHA.” DOJ further concluded that, while the bank profited from its loan process, taxpayers suffered significant losses when the loans defaulted and FHA incurred “substantial losses when it later paid insurance claims on these loans.” The bank admitted to failing to comply with FHA origination, underwriting, and quality control regulations.
DOJ and International Investment Bank Enter Into Plea Agreement to Resolve LIBOR Manipulation Claims, Bank Agrees to Pay $2.5 Billion Penalty
On April 23, the DOJ announced that an international investment bank and its subsidiary agreed to plead guilty to wire fraud for its alleged conduct, spanning from 2003 through 2011, in manipulating the London Interbank Offered Rate (LIBOR), which is used to set interest rates on various financial products. In addition, the DOJ announced that the bank entered into a deferred prosecution agreement to resolve wire fraud and antitrust claims for manipulating both the U.S. Dollar LIBOR and Yen LIBOR. Under terms of the agreement, the $2.5 billion in penalties will be divided among U.S. and U.K. authorities - $800 million to the Commodity Futures Trading Commission, $775 million to the DOJ, $600 million to the New York Department Financial Services, and roughly $340 million to the U.K.’s Financial Conduct Authority. The authorities also ordered the bank to install an independent compliance monitor.
U.S. Files Complaint Against Leading Non-Bank Mortgage Lender For Alleged Improper Underwriting Practices on FHA-Insured Loans After Lender Files Suit Against U.S. Alleging Arbitrary and Capricious Investigation Practices
On April 17, Quicken Loans filed a preemptive lawsuit against the DOJ and HUD in the Eastern District of Michigan against HUD, the HUD-IG, and DOJ, asserting that it “appears to be one of the targets (due to its large size) of a political agenda under which the DOJ is “investigating” and pressuring large, high-profile lenders into paying nine- and ten-figure sums and publicly ‘admitting’ wrongdoing, including conceding that the lenders had made ‘false claims’ and violated the False Claims Act.” Specifically, the complaint alleged that HUD, the HUD-IG, and DOJ retroactively changed the process for evaluating FHA loans, from an individual assessment of a loan’s compliance, taking into account a borrower’s individual situation, the unique nature of each property, and the specific underwriting guidelines in effect, to a sampling method which extrapolates any defects found in a small subset of loans across the entire loan population, contrary to HUD’s prior guidance and in violation of the Administrative Procedures Act. The complaint further alleged that the sampling method used by the government was flawed, and asked for declaratory and injunctive relief against the government’s use of sampling. Quicken also asked the court to rule that the FHA loans it made between 2007-2011 in fact were “originated properly in accordance with the applicable FHA guidelines and program requirements, and pose no undue risk to the FHA insurance fund,” asserting that “HUD reviewed a number of these loans and, except in a few rare instances, either concluded the loans met all FHA guidelines or that any issues were immaterial or had been cured.”
Six days later, the government filed its own lawsuit against Quicken in the District of Columbia seeking damages and civil penalties under the False Claim Act. U.S. v. Quicken Loans Inc, No. 15-0613, (D.D.C. April 23, 2015). The government’s complaint alleges that from September 2007 through December 2011, Quicken knowingly approved loans that violated FHA rules while falsely certifying compliance with those rules. The complaint alleged that Quicken encouraged practices that “allow ‘exceptions’ to HUD’s underwriting requirements, requesting inflated appraisals, manipulating key data, pressuring underwriters to approve loans faster, paying prohibited commission to its underwriters for approved loans, and encouraging underwriters to disregard risks that were evident in the loan files.” The complaint also criticized Quicken’s quality control process, alleging that the lender “underreported the magnitude of underwriting deficiencies, failed to adequately assess compliance with FHA requirements, and failed to disclose Quicken’s underwriting failures to HUD.”