UPDATE 2-U.S. sues Wells Fargo in civil mortgage fraud case

* Complaint brought by U.S. Attorney in Manhattan

* Alleges misconduct related to gov't-insured home loans

* Wells Fargo, the No. 4 U.S. bank, denies allegations

(Adds details from complaint, background)

By Rick Rothacker and Aruna Viswanatha

Oct 9 (Reuters) - The U.S. government filed a civil mortgagefraud lawsuit on Tuesday against Wells Fargo & Co , thelatest legal volley against big banks for their lending duringthe housing boom.

The complaint, brought by the U.S. Attorney in Manhattan,seeks damages and civil penalties from Wells Fargo for more than10 years of alleged misconduct related to government-insuredFederal Housing Administration loans.

The lawsuit alleges the FHA paid hundreds of millions ofdollars on insurance claims on thousands of defaulted mortgagesas a result of false certifications by Wells Fargo, thefourth-biggest U.S. bank as measured by assets.

"As the complaint alleges, yet another major bank hasengaged in a longstanding and reckless trifecta of deficienttraining, deficient underwriting and deficient disclosure, allwhile relying on the convenient backstop of governmentinsurance," said Manhattan U.S. Attorney Preet Bharara.

Wells, the largest U.S. mortgage lender, denied theallegations and said in a statement it believes it acted in goodfaith and in compliance with FHA and U.S. Department of Housingand Urban Development rules. The bank said many of theallegations have been previously addressed with HUD and addedthat its FHA delinquency rates have been as low as half theindustry average.

In a regulatory filing in August, the bank said it was beinginvestigated for possible violations of laws and regulationsrelating to mortgage origination practices, including FHA loans.Wells said it will vigorously defend itself against the suit.

Bharara's office has brought similar cases in the past fewyears, including one against Citigroup Inc unitCitiMortgage Inc, which settled the case for $158.3 million inFebruary, and against Deutsche Bank , which paid$202.3 million in May to resolve its case.

The U.S. Attorney's office in Brooklyn brought the biggestsuch case, against Bank of America Corp's Countrywideunit, which agreed in February to pay $1 billion to resolve theallegations.

The Wells Fargo case is brought under the False Claims Act,which provides penalties for fraud against the government, andunder the Financial Institutions Reform, Recovery, andEnforcement Act, or FIRREA for short, a little-used statute thathas grown in popularity in the past year.

The law requires a lower burden of proof than criminalcharges, has a longer statute of limitations than otherfinancial laws and potentially could bring big fines.

A civil fraud unit that Bharara created in March 2010 filedits first lawsuit under FIRREA in December of that year.


At issue In Tuesday's suit are loans Wells Fargo madethrough a program that allows banks to originate, underwrite andcertify mortgages for FHA insurance, according to the complaint.Under the so-called Direct Endorsement Lender program, neitherthe FHA nor HUD reviews a loan before it is approved for FHAinsurance, but lenders are supposed to follow program rules.

Between May 2001 and October 2005, according to thecomplaint, Wells certified more than 100,000 loans for FHAinsurance, even though the bank knew its underwriters had failedto verify information that was directly related to theborrower's ability to make payments.

"The extreme poor quality of Wells Fargo's loans was afunction of management's singular focus on increasing the volumeof FHA originations (and the bank's profits), rather than thequality of the loans being originated," the complaint said.

The bank also failed to properly train its staff, hiredtemporary workers and paid improper bonuses to its underwritersto encourage them to approve as many loans as possible, thecomplaint said.

During a 7-month stretch in 2002, at least 42 percent of thebank's FHA loans failed to actual qualify for the insurance theywere submitted for, even though the bank's internal benchmarkfor such violations was set at 5 percent.

Wells also kept its defective loans secret from HUD, thecomplaint said. From January 2002 to December 2010, the bankinternally identified more than 6,000 "materially deficient"loans, including 3,000 that had defaulted in the first sixmonths, but did not comply with its self-reporting obligations,the complaint said.

Prior to October 2005, the bank did not self-report a singlebad loan, and the inadequate reporting continued even after aHUD inquiry that year, the suit states. All told, from 2002through 2010 the bank self-reported only 238 loans, according tothe complaint.

Some of the mortgages Wells Fargo suspected of fraud butdeclined to report to HUD include loans it separately reportedas suspicious activity to the U.S. Treasury Department,according to the suit.

The complaint seeks treble damages and penalties forhundreds of millions of dollars in insurance claims already paidto Wells Fargo, as well as penalties on claims HUD may pay inthe future.

Citi, in its settlement, paid $158 million to resolveallegations that a "substantial percentage" of around $200million in insurance claims failed to meet FHA requirements.

The Wells Fargo complaint also includes specific allegationsthat the lender failed to report another $190 million in loansit should have flagged as potentially problematic to HUD, whichpotentially adds to any eventual payout from the bank.

The lawsuit adds to the growing number of civil cases thegovernment has filed targeting conduct that allegedlycontributed to the financial crisis.

The Justice Department has indicted few individuals andinstitutions on criminal charges for roles in the collapse, andofficials have said prosecutors determined much of the conductamounted to greed but not crimes.

A joint federal-state task force set up earlier this year tocontinue to probe conduct tied to the 2007-2009 crisis has alsoacknowledged the bulk of its inquiries are under civil law.

(Reporting by Rick Rothacker in Charlotte, N.C. and ArunaViswanatha in Washington; Editing by Matthew Lewis and TimDobbyn)

((rick.rothacker@thomsonreuters.com)(+1 704 998 2504)(ReutersMessaging: rick.rothacker.reuters.com@reuters.net))