Department of Justice senior officials and state attorneys general are indicating they will continue to target financial institutions under the Financial Institutions Reform, Recovery and Enforcement Act in a move to recoup losses associated with the subprime crisis, according to regulatory officials who requested anonymity.
State and federal officials are expected to pursue civil lawsuits arising from allegedly falsified records and fraudulent activity. The law carries a 10-year statute of limitations, meaning some actions could be brought through 2017. The new legal moves would be aimed at quelling criticism from the public and some lawmakers that regulators and law enforcement officials did not deal harshly enough with banks at the center of the financial crisis. A DOJ insider said even banks that have reached settlements over their mortgage practices will likely face additional investigations under FIRREA.
Most notably, the DOJ, with the U.S. Attorney's Office for the Central District of California in Los Angeles, has brought a $5 billion civil complaint against S&P Financial Services LLC and its parent, McGraw-Hill Cos., under FIRREA in February 2013. The ambitious action, which has not been settled, arose from S&P's rating of residential mortgage-backed securities and collateralized debt obligations during the financial crisis. The complaint alleges that S&P defrauded investors by disseminating misleading statements to federally insured financial institutions during 2007 in connection with more than 20 securities. The suit is expected to go to trial in September.
The Justice Department declined to comment for this article.
Several lawyers with FIRREA experience agree that banks, small and large, should prepare for additional exposure. "There will be a proliferation of civil settlements and potential lawsuits under FIRREA to come," said Allyson Baker, partner at Venable LLP, in Washington. "The DOJ has demonstrated its willingness to use FIRREA to investigate financial institutions. We could see the Department of Justice broadening its use of FIRREA in the months and years to come."
John Richter, partner at King & Spalding LLP in Washington, said he also believes FIRREA-based civil cases will certainly continue in the year ahead.
"There has been a lot of criticism that the Department failed to hold the financial industry sufficiently accountable for the subprime crisis, Richter said. "Whether that criticism is fair or not, there is still the idea out there that 'somebody ought to hang' for the mortgage crisis."
FIRREA was enacted in 1989 as a response to the savings and loan crisis. The law dramatically reshaped financial regulation in the company, but its use as a tool to recover civil damages is a relatively recent development. Under Section 951 of the act, the Justice Department can seek civil penalties against persons who violate any of 14 criminal statutes, or predicates. The predicate offenses include such acts as mail fraud, wire fraud, bribery, making false entries, making false statement to the Federal Deposit Insurance Corporation and/or a bank agency, making false claims, concealing assets from the FDIC, and making false statements to small business administration.
As long as pressure to get tough on banks remains, the DOJ and state attorneys general will continue to aggressively use FIRREA, Richter said. The law is an attractive tool for the government for a couple of reasons. First, courts have interpreted its language broadly — particularly the law's application to fraud "affecting" financial institutions. The rulings allow the government to pursue damages in a wide variety of circumstances — that is, whether the banks are victims, perpetrators or innocent bystanders. Second, FIRREA allows the government to rely on a lower civil burden of proof for the predicate offenses.
Given the courts' rulings, legal experts said that financial institutions should look to Congress for relief. In the most recent Congress, Rep. Blaine Luetkemeyer, R-Mo., introduced legislation that would have curtailed FIRREA actions by tightening the "affecting" language. Luetkemeyer could not be reached for comment.
No matter what happens in Washington, industry observers expect significant changes in the composition of big financial institutions. "Mark my words, big banks are heading toward another repeated crisis if they don't consider corporate change," said Ryan Mendy, COO at the Edge Consulting Group in London. "A new legacy multibillion-dollar fine is being presented by regulators every other week nowadays, affecting wider market confidence and truly harming investor wealth." Mendy suggested that keeping too many businesses under one roof creates too many management issues every day.
FIRREA suits could play into that dynamic, but one investment banker following the activity said it's difficult to determine exactly how the law would affect transactions within the financial services industry. "It's too premature to say, if amended or not amended, how it may motivate banks to separate from its mortgage units at this time," the banker said.
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