The government is likely unimpeded in its effort to use a 25-year-old law to bring civil claims against big banks, even after being dealt a blow in one of its cases against Bank of America, according to legal experts.
B of A lawyers revealed cracks in the Department of Justice's use of the Financial Institutions Reform, Recovery, and Enforcement Act to punish banks when a magistrate judge last week recommended dismissal of a case alleging the bank grossly overstated the quality of over $850 million in mortgage securities sold to investors.
The Justice Department has so far been successful bringing claims under FIRREA, beating back other challenges to cases relying on the thrift crisis-era law, which also helped authorities ink their unprecedented $13 billion settlement with JPMorgan Chase. Known more for overhauling regulation of savings and loans, the 1989 law also allows the Justice Department to seek civil damages against banks for alleged crimes, rather than have to face the higher burden of proof in criminal prosecution.
"It's a warning shot," Arthur Wilmarth, a George Washington University law professor, said of the B of A decision. "A number of these have been challenged. But this is the first time I've heard that anyone in the decision-making chain is sympathetic to the challenge."
But several legal experts say the effect of the ruling is likely to be limited. The civil claims provisions in FIRREA may give DOJ other avenues to fight the case, and some note that a district court judge can ultimately ignore the magistrate's recommendation.
"It appears to be based on the unique facts of the claims they sought against Bank of America," said Charles Michael, an attorney at Brune & Richard LLP. "Even if the district court ultimately agrees with the magistrate and dismisses the case, there may be other predicate offenses the government can allege."
Rather than question the DOJ's FIRREA authority, U.S. Magistrate Judge David Cayer raised objections to specific arguments in the B of A case, which alleges the bank lied to Wachovia Bank—now owned by Wells Fargo—and the Federal Home Loan Bank of San Francisco. (Wachovia and the San Francisco FHLB together bought 98% of the securities.)
"The magistrate judge said, and appropriately so, that the attorney general has the right to bring these claims under FIRREA but he has to prove…the predicate offense," Wilmarth said.
The suit cites two of the 14 "predicate" criminal offenses that FIRREA allows the government to allege in civil court. One is making a false statement to a government agency that is "material to a matter within the jurisdiction of the agency." The other is making a false statement related to an application for credit or insurance.
But Cayer, a magistrate judge for the U.S. District Court in the Western District of North Carolina, said both allegations were thin. He rejected the government's argument that the fact that the FHLB is regulated by a federal agency, the Federal Housing Finance Board (which is now the Federal Housing Finance Agency), proved the first offense. He also said the second yardstick applies only for actual loans or insurance products, not securities backed by mortgages.
"The complaint contains no factual allegations that the defendants' statements occurred within the jurisdiction of FHFB or affected its decisions," Cayer wrote in the March 27 ruling. (Ironically, Cayer issued a ruling just days later recommending against a B of A motion to dismiss a separate Securities and Exchange Commission lawsuit over the same mortgage securities.)
Some say the ruling could pose a significant hurdle to the government's litigation efforts stemming from the 2008 crisis.
"If the judge's recommendation is accepted by the Federal District Court judge then this development will represent a significant setback for the government's legal efforts and likely mark the beginning of the end for crisis-era litigation," Isaac Boltansky, a policy analyst for Compass Point Research & Trading, said in a research summary following the ruling.
Yet the Justice Department does not appear to be backing down.
"The magistrate's ruling is a recommendation that will be reviewed by the District Court," an official with the department said on the condition of anonymity. "We believe the District Court will reject the magistrate's legal interpretations, and allow the case to be decided on the merits."
Observers noted that the DOJ can choose alternative predicate offenses authorized under FIRREA as it continues to plead its case. Those include more general crimes for committing mail and wire fraud that experts say have a lower bar to clear. Federal authorities have used those more general criminal statutes in FIRREA cases fought in the Southern District of New York, in which banks' attempts to get the cases dropped have been less successful.
"It really says nothing about FIRREA," Richard Scheff, the chairman of Montgomery McCracken based in Philadelphia, said of the magistrate's recommendation in the B of A case. "To me, they just used the wrong statute."
Scheff added that the mail and wire fraud "statutes are incredibly broad."
"It doesn't matter who the victim is," he said. "It doesn't make a difference as to what the nature of the transaction is."