Tag Archives: High Speed Swim Lane

FIRREA Blanks

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photo by Mike Cumpston

The Court of Appeals for the Second Circuit reversed the District Court’s judgment (SDNY, Rakoff, J.) against Bank of America defendants for actions arising from Countrywide’s infamous “Hustle” mortgage origination program. The case has a lot of interesting aspects to it, not the least of which is that it does away with more than one billion dollar in civil penalties levied against the defendants.

The opinion itself answers the narrow question, when “can a breach of contract also support a claim for fraud?” (2) The Court concluded that “the trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises.” (3)

I think the most important aspect of the opinion is how it limits the reach of the Financial Institutions Reform, Recover, and Enforcement Act of 1989 (FIRREA). Courts have have been reading FIRREA very broadly to give the federal government immense power to go after financial institutions accused of wrongdoing.

FIRREA provides for civil penalties for violations of federal mail or wire fraud statutes, but the Court found that there was no fraud at all. It made its point with a hypothetical:

Imagine that two parties—A and B—execute a contract, in which A agrees to provide widgets periodically to B during the five-year term of the agreement. A represents that each delivery of widgets, “as of” the date of delivery, complies with a set of standards identified as “widget specifications” in the contract. At the time of contracting, A intends to fulfill the bargain and provide conforming widgets. Later, after several successful and conforming deliveries to B, A’s production process experiences difficulties, and the quality of A’s widgets falls below the specified standards. Despite knowing the widgets are subpar, A decides to ship these nonconforming widgets to B without saying anything about their quality. When these widgets begin to break down, B complains, alleging that A has not only breached its agreement but also has committed a fraud. B’s fraud theory is that A knowingly and intentionally provided substandard widgets in violation of the contractual promise—a promise A made at the time of contract execution about the quality of widgets at the time of future delivery. Is A’s willful but silent noncompliance a fraud—a knowingly false statement, made with intent to defraud—or is it simply an intentional breach of contract? (10)

This case emphasizes that “a representation is fraudulent only if made with the contemporaneous intent to defraud . . .” (14) While this is not really new law, it is a clear statement as to the limits of FIRREA. This will act as a limit on how the government can deploy this powerful tool as new cases crop up. Unless, of course, the Supreme Court were to reverse it on appeal.

Reiss on Big BoA FIRREA Penalty

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Bloomberg BNA quoted me in FIRREA-Fueled Penalty Against BofA Signals More Risk for Large Institutions (behind a paywall). It reads in part,

A federal judge in New York ordered Bank of America to pay $1.26 billion in civil penalties to the U.S. government in connection with a Countrywide lending program, setting up a likely appeal in one of the most closely watched cases in the financial services arena (United States v. Bank of Am. Corp., S.D.N.Y., No. 12-cv-01422, 7/30/14).

The ruling by Judge Jed Rakoff of the U.S. District Court for the Southern District of New York, which also said former Countrywide official Rebecca Mairone must pay $1 million in installments, followed an October jury verdict that found Bank of America liable for Countrywide’s sale of bad loans to Fannie Mae and Freddie Mac, some of which were securitized.

Countrywide sold those loans under its “High-Speed Swim Lane” program—an initiative aimed at speeding the loan approval process and one launched before Bank of America acquired Countrywide in 2008.

Rakoff called the nine-month HSSL program “from start to finish the vehicle for a brazen fraud,” and imposed a $1,267,491,770 penalty on Bank of America.

The amount was less than the $2.1 billion sought by the government, but well above what Bank of America argued was appropriate, which was $1.1 million at the most .

“We believe that this figure simply bears no relation to a limited Countrywide program that lasted several months and ended before Bank of America’s acquisition of the company,” Bank of America spokesman Lawrence Grayson told Bloomberg BNA July 30. “We are reviewing the ruling and assessing our appellate options,” he said.

*     *      *

According to Rakoff, Firrea could have allowed a penalty in this case that would have equaled the value of the loan transaction itself, which totaled $2.96 billion.

Rakoff, citing the discretion granted to judges in such cases, reduced the penalty to $1.267 billion, saying not all of the loans were flawed.

Brooklyn Law School Professor David Reiss called Rakoff’s ruling significant and a new turn in an important area of case law for businesses.

“We’re beginning to see a jurisprudence of Firrea penalties and a penalty regime that is very pro-government,” Reiss told Bloomberg BNA. “This shows that the penalty can be as high as the nominal amount of the transaction. It’s good guidance in the sense that it helps businesses know the outer boundaries of their risk, but it’s a generous view of deterrence,” he said.

FIRREA Does the Hustle

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Judge Rakoff has issued another Opinion in U.S. v. Countrywide Fin. Corp. et al., 12 Civ. 1422 (Feb. 17, 2014).  Rakoff reconfirms his broad reading of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which covers fraudulent behavior that is self-affecting; that is, where the perpetrator and victim of the fraud are one and the same financial institution. This Opinion goes further, however, based on on developments in the litigation since that earlier opinion.

The Opinion notes that the defendants were found liable at trial and finds that

Based on the charge as given to the jury, the jury, by finding liability, necessarily found that the defendants intentionally induced two government-sponsored entities, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), to purchase from the Bank Defendants thousands of loans that Fannie Mae and Freddie Mac would not otherwise have purchased. The defendants did so, the jury necessarily found, by misrepresenting that the loans they were selling were “investment quality” and that they knew of nothing that might cause investors to regard the mortgages as poor investments, when in fact the defendants knew that their underwriting process, known as the “High Speed Swim Lane,” “HSSL,” or “Hustle,” was calculated to produce loans that were not of investment quality. (3)

The Court had previously found that “the fraud here in question, perpetrated by the Countrywide defendants and Ms. Mairone, had a huge effect on Bank of America defendants, which, as a result of Bank of America’s purchase of Countrywide, paid, directly or through affiliates, billions of dollars to settle repurchase claims brought by Fannie Mae and Freddie Mac.” (4) The opinion concludes that

It is highly improbable that Congress would have intended to place beyond the reach of FIRREA those defendants whose misconduct “affects” federally insured banks that have the great fortune to be fully insured [by their affiliates] for such losses. Even less so can it be imagined that the device of having BAC [the BoA parent holding company] indemnify BANA [the BoA federally insured bank] for losses that otherwise would result from Countrywide’s fraud immunizes Countrywide from liability under FIRREA. Indeed, defendants’ labeling of this theory of liability as the “self-affecting” theory is something of a misnomer; Countrywide’s fraud, which culminated before the merger with BANA, directly affected, not just Countrywide, but its merger partner, BANA, as well. While the effect on Countrywide might be “self-affecting,” the effect on BANA was not. (5)

This Opinion seems to bolster Rakoff’s broad reading of FIRREA.  As of now, FIRREA gives the federal government a powerful tool to pursue alleged wrongdoing affecting federally insured financial institutions.  The caselaw reads FIRREA broadly and the statute’s ten-year statute of limitations means that additional suits may still be coming down the pike.