Mortgage lenders have been the target of a new series of investigations by the U.S. Department of Justice to determine whether lenders acted improperly in mortgage practices involving federal guarantees. Investigations fall under the False Claims Act, a law that has been used in the past to fight health care fraud. See the following article from The Street for more on this.
The U.S. Department of Justice has been aggressively investigating whether mortgage lenders defrauded the government by improperly accessing federal guarantees on mortgage debt, according to attorneys and other banking professionals with knowledge of the investigation.
It’s unclear how far the Justice Department has gone in its probes, or which lenders it is targeting, because the investigations often remain under seal for several years. Also, because of the complexity of the mortgage market and how the investigation falls under the False Claims Act (FCA), the scope of lender liability also remains uncertain, industry watchers say.
This new front in the government’s push on mortgage fraud may be more successful than previous efforts since it has been a useful tool in other industry investigations. Since 1986, the Justice Department has recouped $27 billion in False Claims Act settlements. The health care industry, which has been the main target of False Claims Act investigations in recent years, has contributed the lion’s share.
Attorneys who have been involved in such cases say that if targets are publicly traded, they are required to mention related subpoenas in regulatory filings. Mentions of government subpoenas have been popping up in bank regulatory filings recently.
Bank of America (BAC) said in its most recent 10-K filing that its Countrywide division received a subpoena from the Justice Department. A spokesman did not respond to a request for comment.
Citigroup (C) also said that government agencies had issued subpoenas concerning its "subprime mortgage-related conduct and business activities." A spokesman did not immediately have a response regarding the nature of those subpoenas. The most recent annual reports for Wells Fargo (WFC) and JPMorgan Chase (JPM) do not mention subpoenas.
Those top four mortgage players, as well as Ally Financial and a host of other large banks, have already been targeted by state attorneys general and federal regulators that are probing foreclosure practices.
Justice Department spokesman Charles Miller said he couldn’t confirm or deny that there are active False Claims Act cases related to mortgage fraud, but wouldn’t rule it out.
"I can’t tell you whether anything’s percolating," said Miller, later adding, "that’s not to say things can’t change in a week, a month or a year."
Lawyers on either side of the litigation table were less circumspect.
"It’s something that the federal government is very interested in," says Brian P. Kenney, a partner at the law firm Kenney & McCafferty, which represents plaintiffs in False Claims Act cases. Kenney wouldn’t comment on anything he’s directly involved in, but said mortgage fraud is "being actively investigated" by the Justice Department.
"They’re always under seal when the government investigates them, so there will be a period of time before cases come to light," says Kenney. "But I do believe there’s a lot of government interest in using the False Claims Act in order to try to recover funds from banks that have defrauded the federal government out of moneys."
Another attorney who works closely with the Justice Department on False Claims Act health care cases says, "I would be shocked if there weren’t already dozens of cases filed against banks that the government is working on that we just haven’t heard about."
Adam Feinberg, a defense attorney who chairs the litigation department at Washington, D.C.-based law firm Miller & Chevalier Chartered, says banks have been scrambling to prepare for potential claims.
"We’re about to see a slew of this," says Feinberg. "Twenty years ago, health care fraud was not that big a deal. Now it is the single biggest use of the False Claims Act. Mortgage fraud is going to be the next big wave."
Congress passed the False Claims Act, also known as the "Lincoln Law," in 1863 to recoup money from grifters who cheated the government on supplies during the Civil War. The law has been altered and expanded a few times since then, but still protects federal dollars that are distributed under false pretenses — from defense companies that receive military contracts to health-care providers that receive funds from programs like Medicare and Medicaid.
Cases originate in two ways: The Justice Department can start investigating a company of its own accord, or, more often, it’s tipped off by whistleblowers. Those individuals, known as "relaters" in DOJ parlance, can sue a company on the government’s behalf under what’s known as a "qui tam" provision. They are eligible to receive as much as 30% of a recovery, if and when monetary settlements are reached.
In theory, the False Claims Act protects not just federal grants, but money that has gone to support affordable housing or cover defaults on mortgage debt guaranteed by Fannie Mae (FNMA.OB), Freddie Mac (FMCC.OB) and other government-backed entities. Such subsidies represent the biggest cost to taxpayers stemming from the financial crisis. The Federal Housing Finance Agency estimates Fannie and Freddie will cost taxpayers $142 billion to $363 billion through 2013.
Partly as a result, the Justice Department has focused its attention on mortgage fraud and other types of misdeeds within the financial industry. Those investigations are being spearheaded by two career government attorneys, Tony West, who heads the Justice Department’s civil division, and Renée Brooker, an assistant director. Before being nominated to lead the division, West had spent 15 years as a prosecutor in the Northern District of California. Brooker built her reputation in Washington, having helped orchestrate a $280 billion racketeering case against the tobacco industry — the largest in U.S. history.
As it happens, the new DOJ lawyers have already used the False Claims Act successfully in the mortgage industry, albeit not against a bank. Just after West took the reins in 2009, the False Claims Act was expanded to include federal funds granted through stimulus and bailout programs. Less than two months after the president signed the Fraud Enforcement and Recovery Act of 2009 into law, the Justice Department announced a mortgage-related settlement with Beazer Homes (BZH) for $5 million, along with contingent payments of up to $48 million that would be shared with homeowners.
"Mortgage fraud is a top priority for this Administration, especially when public dollars are at stake," West said in a statement at the time. "We will aggressively pursue fraud on federal mortgage insurance programs, which are so vitally important to this economy."
The Justice Department accused Beazer’s lending subsidiary of violating the False Claims Act in several ways: Pocketing upfront payments to reduce interest rates without ever providing the discounts; attempting to hide elevated default rates to qualify for federal programs; providing down payment assistance for federally backed loans, which is illegal under Federal Housing Administration guidelines; and fudging paperwork to make it appear as though borrowers qualified for federal assistance when they did not. (Beazer cooperated with the investigation and agreed to strengthen its "control and compliance culture" as a result.)
The case had a precedent in a $41 million settlement with ABN Amro in 2006, but generally speaking, housing-related cases under the False Claims Act were rare before the subprime-mortgage fallout. Now, with ample evidence of shoddy lending practices and inflated appraisal values, such cases appear much easier to prove.
"A lot of people had Budweiser incomes and champagne dreams," says Patrick Burns, of the advocacy group Taxpayers Against Fraud. "Banks wanted to sell them the most expensive thing they could buy, but banks have to be worried about all these whistleblower programs because they had a fiduciary responsibility that they didn’t live up to. Not doing your job — being oblivious to the obvious — is not a defense in a False Claims Act case."
Mass layoffs in mortgage divisions and mass foreclosures have created plenty of potential whistleblowers with first-hand knowledge of banks’ behavior — and an axe to grind. Plaintiffs’ attorneys have been aggressively courting potential plaintiffs.
"They have identified all of these fraudulent schemes and have Web sites out there saying, ‘Hey, if you know anything of this sort, you need to contact me right away,’" says Feinberg.
Kenney’s firm is one that’s set up such a site. "There are causes of action that would allow the federal government to go after banks and financial institutions that have lent money based on fraudulent mortgage applications, so long as the federal government has lost money somewhere in the process," he says.
Still, some are skeptical that False Claims Act cases against big banks’ mortgage divisions will gain significant traction. Besides the fact that the banks are already being targeted by all 50 state attorneys general, federal regulators, private litigants, Fannie Mae and Freddie Mac, the Justice Department would have to mount several legal hurdles, with limited resources to do so.
First, prosecutors would have to prove that whistleblower claims actually represent fraud. Prosecutors would have to prove that fraudulent practices were spread throughout the organization’s culture and enforced by management — not just related to a few rogue underwriters. And they’d have to determine beyond a reasonable doubt that banks are the ones to blame.
Burns, of Taxpayers Against Fraud, points out that there are many bad actors in most fraudulent mortgage cases: Borrowers who signed documents that misstated their income and home values, appraisers who determined those inflated values and intermediaries who rubber-stamped the documents before pushing it through to the bank.
"Let’s say a house was sold for $300,000 but it’s only worth $100,000," says Burns. "Well, is that the bank’s fault? Or is that the appraiser’s fault? Mind you, the appraiser doesn’t have any money. So, if you find that every appraisal done by Bank of America was bupkis — that all of the homes were appraised at $300,000 but only worth $100,000 — then you’ve got a pattern. But if it’s only these 15 houses in upstate Michigan, then you can argue that the problem is episodic, it’s not chronic."
Others point out that it’s unclear Fannie and Freddie guarantees are covered by the False Claims Act, even if their losses have been covered by federal funds. Joel Androphy, a partner at Berg & Androphy, doesn’t think passing federal funds through such a guarantor crosses the threshold for qui tam prosecution.
"It would have to be a large scale fraud," he adds, "since the DOJ cannot handle the current load of FCA health fraud and defense contractor cases."
Still, if the Justice Department does find evidence of wide-scale fraud and does decide to pursue cases at mortgage lenders, the stakes are high. In a successful False Claims Act prosecution, the government is entitled to so-called "treble" damages – meaning three times the funds used fraudulently. As an example: Say a bank is found to be complicit in a $100,000 fraudulent mortgage loan that was insured by the Federal Housing Administration. Even if the government recoups $70,000 by selling the property, the bank would be liable for $230,000 — three times the original loan, minus the recouped funds — even though the actual loss is $30,000.
"It’s quite a draconian statute," says Feinberg. "If a bank systematically did this with many, many homes – as we’re seeing now with the loans Fannie and Freddie are trying to push back – the damages could be astronomically high."
On the bright side, the Justice Department appears willing to work with lenders that comply with investigations and have taken steps to remedy problems. For instance, Tim McCormack, an attorney who works on False Claims Act cases at Phillips & Cohen in Washington, D.C, suspects the Justice Department wouldn’t peg prosecutions to banks‘ recent "robosigning" woes.
"Where’s the harm?" says McCormack. "Substantive harm vs. procedural harm, I think, would make a key difference. The Department of Justice doesn’t have enough resources — and I can’t imagine Congress allocating enough resources – to go after purely procedural flaws if the companies can show that they sort of mended their ways and have taken steps to fix them"
Miller, the Justice Department spokesman, says the agency has a history of working hard to consider the consequences of its prosecutions on defendants as well as plaintiffs. He says prosecutors have worked to forge affordable settlements with hospitals in small communities that committed "severe and serious fraud" — as long as they implement practices that protect federal funds in the future.
"That’s not a bank, but just an example of how we will work to try not to put a business under," he says.
This article has been republished from The Street. You can also view this article at The Street, a site covering financial news, commentary, analysis, ratings, business and investment content.