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Judge endorses US use of fraud law against Bank of America

Monday, 19 Aug 2013 | 10:10 PM ET
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A federal judge has endorsed a broad interpretation of a savings-and-loan era law that the U.S. Justice Department is trying to use in cases against Wall Street banks.

U.S. District Judge Jed Rakoff in Manhattan said Monday that a "straightforward application of the plain words" of the Financial Institutional Reform, Recovery and Enforcement Act (FIRREA) allowed the interpretation sought by the government.

The law has a low burden of proof, strong subpoena power and a 10-year statute of limitations, twice as long as the typical limit for fraud cases.

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Rarely asserted until recently, it has become the basis of three lawsuits by lawyers under Manhattan U.S. Attorney Preet Bharara against banks including Bank of America Corp, Wells Fargo & Co and Bank of New York Mellon Corp.

The latest decision came in a case the Justice Department brought last October against Bank of America over toxic mortgages that its Countrywide Financial mortgage unit sold to Fannie Mae and Freddie Mac in the financial crisis.

The government's case, which is set for trial on Sept. 23, focuses on a program instituted in 2007 by Countrywide called "High Speed Swim Lane" and also known as "HSSL" or "Hustle."

The government contends the program speeded up some home loan processing by removing quality checkpoints, resulting in thousands of fraudulent and defective mortgages being sold to Fannie and Freddie.

Rakoff issued a brief order in May dismissing some claims but largely allowing the case to move forward.

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His ruling on Monday explained his reasoning, particularly why the government could proceed with claims brought under a law adopted in the wake of the savings and loan scandals of the 1980s.

The FIRREA law allows the government to pursue civil penalties against those who commit frauds "affecting a federally insured financial institution."

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Under the government's position, claims under FIRREA can be asserted against a bank when the affected financial institution is the bank itself.

Banks have objected to this so-called "affect yourself" theory, saying it ignores the statute's original purpose.

Rakoff agreed with the government. Citing a dictionary definition of "affect," he said Bank of America paid billions of dollars to resolve demands by Fannie and Freddie to buy back defective mortgages.

"The fraud here in question had a huge effect on BofA itself (not to mention its shareholders)," Rakoff wrote.

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The ruling followed a similar decision in April by U.S. District Judge Lewis Kaplan, also in Manhattan, who allowed the advancement of a FIRREA lawsuit that accused Bank of New York Mellon of overcharging clients for trading currencies.

The rulings mean the Justice Department can now use FIRREA to not just go after bank fraud but the banks themselves for defrauding others, said Andrew Schilling, a former head of the civil division in the Manhattan U.S. Attorney's Office.

The rulings will encourage the government to tackle "a wider range of targets in the financial services industry, and a much broader range of alleged misconduct, including potentially consumer fraud," said Schilling, a partner at law firm BuckleySandler.

In his ruling on Monday, Rakoff said there were limits to the government's reach under FIRREA.

In an alternative argument, the Justice Department said it could also use FIRREA against Bank of America because the alleged fraud affected a small bank that invested in Fannie and Freddie.

Rakoff did not rule on that alternative argument because he had already allowed the case to proceed based on the effects on Bank of America.

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But he said Bank of America's response - that Congress had not intended the law to cover indirect impacts on a bank - "is not without some force."

A spokeswoman for Manhattan U.S. Attorney Bharara, whose office has been pursuing the Bank of America case, declined to comment.

Lawrence Grayson, a spokesman for the bank, said the bank continues to believe "neither Bank of America nor Countrywide defrauded Fannie Mae or Freddie

Mac, and we look forward to addressing the remaining allegations as this matter proceeds."

The case is U.S. ex rel. O'Donnell v. Bank of America Corp et al, U.S. District Court, Southern District of New York, No. 12-01422.

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