- Rakoff Decision Supports Expanded Use of FIRREA as an Enforcement Tool
- September 3, 2013 | Authors: Meg Bailey; Mary Gail Gearns
- Law Firms: Bingham McCutchen LLP - San Francisco Office ; Bingham McCutchen LLP - New York Office
On August 16, 2013, United States District Judge Jed Rakoff issued a 24-page opinion explaining an earlier two-page order in which he upheld claims against Countrywide Financial Corporation and certain of its affiliates under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) while dismissing claims under the False Claims Act.1 In allowing the FIRREA claims to stand, Judge Rakoff joined Judge Lewis Kaplan, also of the Southern District of New York, in endorsing an expansive reading of FIRREA that empowers the United States Attorney General to sue any federally insured financial institution to recover civil penalties for the institution’s own alleged fraud affecting itself.2 Judge Rakoff’s decision is expected to embolden the Government to make increased use of FIRREA as a civil enforcement tool, particularly in its prosecution of claims arising from the financial crisis, as well as other claims that could similarly benefit from FIRREA’s generous 10-year statute of limitations.
FIRREA’s Emergence From Obscurity
Enacted in 1989 in the wake of the savings and loan crisis, FIRREA established the Resolution Trust Company to manage failed savings associations, transferred federal oversight of savings associations to the Office of Thrift Supervision, and imposed various regulatory requirements and restrictions on depository institutions.3 FIRREA also created a powerful enforcement tool by authorizing the Attorney General to bring civil actions to recover civil penalties against persons and entities alleged to have committed, or to have conspired to commit, violations of certain enumerated criminal offenses “affecting a federally insured financial institution.” The offenses giving rise to FIRREA liability include, among others, mail fraud and wire fraud (18 U.S.C. §§ 1341, 1343), which the Attorney General may establish under the civil “preponderance of the evidence” standard.4 FIRREA has a 10-year statute of limitations, and it authorizes the Attorney General to issue subpoenas to obtain documents and testimony “[f]or the purpose of conducting a civil investigation in contemplation of a civil proceeding under this section.”5 There is no private right of action under FIRREA, and no other governmental body or regulator besides the Attorney General may bring a suit under the Act.
Despite its enactment more than two decades ago, FIRREA was rarely used as a civil enforcement tool until recently. Since 2011, however, the Civil Division of the Department of Justice has filed multiple actions against financial institutions and a rating agency for alleged violations of FIRREA. In two of those actions, the Government asserted that the federally insured financial institution affected by the alleged violations was the same institution being charged with the violations. In the first of those actions, currently pending before Judge Kaplan, the Government alleged that The Bank of New York Mellon engaged in mail and wire fraud in connection with foreign currency transactions for its custodial clients. In the second action, the Countrywide action pending before Judge Rakoff, the Government alleged that the defendants committed mail and wire fraud in connection with the sale of mortgage-backed securities to Fannie Mae and Freddie Mac. In both actions, the defendants moved to dismiss on the ground that the Government had not alleged (and could not allege) a direct effect of the claimed violations on a federally insured financial institution. Relying on FIRREA’s legislative history, policy considerations, and a common sense reading of the statute, the defendants asserted that FIRREA was never intended, and cannot be used, as an enforcement tool to address fraud allegedly committed by, but not directed to, a federally insured financial institution.
In a decision of first impression, Judge Kaplan held on April 24 that a federally insured financial institution may be charged under FIRREA for allegedly engaging in fraud that affects itself.6 Judge Kaplan concluded that it is not necessary for a financial institution to have been “victimized” by a fraud for the institution to have been “affected” by it, and he “decline[d] to conclude that an institution cannot be affected by a fraud solely because it participate[d] in it.”7
Five days later, Judge Rakoff stated during oral argument in the Countrywide case that he was “troubled, notwithstanding Judge Kaplan’s opinion,” by the Government’s self-affecting fraud theory under FIRREA.8 Despite this concern, however, he proceeded on May 8 to issue a summary order allowing the Government’s FIRREA claims to stand. In the August 16 opinion explaining the order, Judge Rakoff reasoned that the Government had stated a claim because the conduct underlying the FIRREA count harmed one of the defendants, Bank of America (a federally insured financial institution), as evidenced by the significant sums paid by the bank to settle repurchase claims made by Fannie Mae and Freddie Mac. Relying on Webster’s dictionary, Judge Rakoff stated that a proper interpretation of FIRREA “requires nothing more than straightforward application of the plain words of the statute. The key term, ‘affect,’ is a simple English word, defined in Webster’s as ‘to have an effect on.’ The fraud here in question had a huge effect on [Bank of America] itself.”9
Civil Penalties Available Under FIRREA
The civil penalties assessed for a FIRREA violation “shall not exceed” $1.1 million per violation with two important exceptions. First, in the case of a continuing violation, the penalty is capped at $1.1 million per day or $5.5 million per violation, whichever is less. Second, where there has been a pecuniary gain to the violator or a loss to someone else, a penalty can be imposed for the full amount of gain or loss even if it exceeds the $1.1 million and $5.5 million limitations.10
In its enforcement actions filed to date, the Government has used FIRREA’s open-ended use of the term “violation” to demand very large penalties, asserting that each use of the mails and wires constitutes a separate violation for which a penalty may be imposed. In a FIRREA action filed in February 2013 against S&P Financial Services LLC (S&P) and its parent, McGraw-Hill, for example, the Government alleged that S&P engaged in hundreds of acts of mail and wire fraud in connection with the issuance of allegedly fraudulent ratings. The complaint alleges that each act of mail or wire fraud constitutes a separate FIRREA violation, creating potential exposure for S&P in the billions of dollars.
It is uncertain, however, whether courts will award the maximum penalties available under FIRREA, even where the Government establishes the predicate statutory violations. In March 2013, a federal district court judge in Los Angeles issued what appears to be the first-ever decision identifying factors to be considered when imposing civil penalties under FIRREA.11 Drawing upon principles applied by courts in other civil penalty contexts, the court identified eight factors relevant to the assessment of FIRREA penalties:
- the good or bad faith of the defendant and the degree of scienter;
- the injury to the public and 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 the conduct;
- the amount of the defendant’s profit from the fraud; and
- the penalty range available under FIRREA.
The court in that action concluded that the first three factors weighed against the defendant while the next two weighed in the defendant’s favor. It then held that the civil penalty requested by the Government - nearly $1.1 million - was excessive considering that the criminal fine available under the sentencing guidelines would have been in the range of $20,000 to $30,000 and the defendant’s profit was only $40,000. After considering all eight factors, the court awarded a penalty of just $40,000, a necessarily disappointing outcome for the Government.
Judge Rakoff’s decision, although not binding on other courts, is expected to encourage the Government to make increasing use of FIRREA as a broad and potentially powerful enforcement tool. Given FIRREA’s generous statute of limitations, low burden of proof (when compared to criminal enforcement actions), pre-litigation subpoena power, and potentially significant penalties, FIRREA could soon become a mainstay of securities enforcement.
1 United States v. Countrywide Fin. Corp., 12 Civ. 1422 (JSR), 2013 WL 4437232 (S.D.N.Y. Aug. 16, 2013).
2 Judge Kaplan’s decision approving the “self-affecting” fraud theory under FIRREA was issued in United States v. Bank of New York Mellon, et al., No. 11 Civ. 6969 LAK, 2013 WL 1749418 (S.D.N.Y. Apr. 24, 2013).
3 FIRREA, Pub. L No. 101-73, 103 Stat. 183 (1989) (codified at various sections of 12 and 15 U.S.C.).
4 12 U.S.C. § 1833a(c)(2) and (f).
5 12 U.S.C. § 1833a(g).
6 Bank of New York Mellon, 2013 WL 1749418 at *9-11.
7 Id. at *11.
8 Transcript of Oral Argument (Apr. 29, 2013) at 20.
9 Countrywide, 2013 WL 4437232 at *5 (citations omitted). Although Judge Rakoff expressed skepticism about the Government’s alternative theory that harm caused to federal insured financial institutions as a result of their investments in Fannie Mae and Freddie Mac sufficed to state a claim under FIRREA, Judge Rakoff declined to decide the issue.
10 12 U.S.C. § 1833a(b)(1) and (2) (as adjusted pursuant to C.F.R. § 85.3(a)(6) and (a)(7)).
11 United States v. Menendez, No. CV 11-06313 MMM (JCGx), 2013 WL 828926, at *5 (C.D. Cal. Mar. 6, 2013).