A recent U.S. court decision in a mortgage fraud case gives U.S. authorities more leverage in their pursuit of cases against banks, says Moody’s Investors Service in a new report.
The credit rating agency says that a judgment rendered last week in favour of the U.S. Justice Department (DOJ) is credit negative for banks facing government probes, “because it may encourage the DOJ to take more cases to trial or extract heftier penalties as part of a settlement.”
Moody’s notes that a federal jury in New York found Bank of America Corp. guilty of fraud related to mortgages that Countrywide Financial Corp. (which BAC acquired in 2008) sold to Fannie Mae and Freddie Mac under a novel interpretation of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The FIRREA enables the government to seek civil penalties for violations of certain criminal statutes, if the violation affects a federally insured financial institution, it notes.
“Last August, BAC tried to get the lawsuit dismissed by arguing that FIRREA was not applicable in this case because it was enacted to protect banks victimized by the fraudulent acts of third parties, not to prosecute them when they are damaged by their own fraudulent conduct. However, the district court disagreed,” it notes, adding that this is “the second ruling in the Southern District of New York to hold that an affected institution could also be the alleged perpetrator of a fraud.”
“The judgment is significant because FIRREA gives the government a number of tactical advantages that significantly increase the likelihood of conviction compared with traditional fraud prosecutions,” Moody’s says.
For one, it says that the act, “gives the DOJ a civil hook to investigate and prosecute mortgage fraud.” Additionally, the civil standard of proof, which is lower than the criminal standard, applies in these case, Moody’s says.
And, it says that FIRREA is one of the few federal statutes that authorizes the DOJ to issue subpoenas without court approval. “The DOJ can therefore engage in extensive discovery before it files a lawsuit,” it says.
The FIRREA also has a 10-year statute of limitations, which is far longer than the typical three to five years for civil lawsuits, so, Moody’s says, “these pre-suit investigations can last a long time and uncover numerous violations that would ordinarily be outside the timeframe of a typical civil lawsuit.”
“Pending a reversal, last Wednesday’s verdict may embolden the DOJ to take more cases to trial. In any event, the DOJ now has more leverage to extract heftier fines as part of any settlement,” Moody’s concludes.