Few can ignite a legal firestorm like U.S. District Judge Jed Rakoff of the Southern District of New York. Last week, in a mortgage fraud suit against Bank of America and Countrywide, Judge Rakoff refused to dismiss a novel claim for civil penalties under the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). The ruling will surely encourage civil prosecutors to make wider use of FIRREA, which provides a generous ten-year statute of limitations and low burden of proof, in pursuing financial fraud cases.
FIRREA was enacted in response to the Savings and Loan debacle of the 1980s, as well as the fraud scandals that emerged during that era. The statute includes a clause imposing a civil penalty for mail and wire fraud and other violations “affecting a federally insured financial institution.” Until recently the civil penalty provision has been ignored by prosecutors, leaving courts without occasion to decide what exactly the statute means by “affecting” a financial institution.
In United States v. Countrywide Financial Corporation, civil division prosecutors argued that Bank of America and Countrywide’s allegedly fraudulent sale of mortgage-backed securities to Fannie Mae and Freddie Mac “affected” themselves by exposing the banks to risk of loss due to repurchase requirements. Prosecutors also claimed that other federally insured financial institutions were indirectly “affected” because they invested in Fannie Mae and Freddie Mac, which purportedly lost money on the mortgage-backed securities that they purchased from Bank of America and Countrywide. Judge Rakoff apparently accepted at least one of these arguments, as he denied the motion to dismiss in his summary order, promising to explain his rationale in a future written opinion.
Judge Rakoff’s full opinion will be eagerly awaited by lawyers and financial industry professionals alike, as it will shed greater light on the scope of a civil penalty clause that was rarely in use until now. The decision could very well fuel a new series of mortgage banking and other fraud claims against financial institutions, as a broad interpretation of FIRREA will enhance prosecutors’ ability to succeed on these allegations. This is because FIRREA carries a ten-year statute of limitations, which will allow prosecutors to raise allegations that would otherwise have been barred by the shorter statute of limitations applicable to fraud claims. And, under FIRREA, prosecutors need only establish their allegations “by a preponderance of the evidence.” This latter provision will enable prosecutors to prevail on claims too weak for success under a criminal statute.
Bottom line: The story of FIRREA is just beginning to heat up. Stay tuned.