BofA ‘Hustle’ appeal tests Justice’s novel use of old S&L statute

April 23, 2015

(Reuters) – In successive rulings in 2013, three well-regarded federal judges in Manhattan endorsed the Justice Department’s creative adaptation of an old law from the savings and loan crisis of the 1980s to cases against banks involved in the financial crisis of the 2000s. That April, U.S. District Judge Lewis Kaplan refused to dismiss the government’s civil suit against Bank of New York Mellon. Similar rulings followed in August from U.S. District Judge Jed Rakoff in the so-called “Hustle” case against Bank of America and in September from U.S. District Judge Jesse Furman in a Justice Department civil suit against Wells Fargo.

All three banks had argued that the statute at the heart of the government suits, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, was intended to protect financial institutions from self-dealing insiders – and not to enable the government to bring suits against the banks themselves. FIRREA permits Justice to bring civil cases against defendants that engage in mail or wire fraud “affecting a federally insured financial institution.” The government said in the BNY Mellon, BofA and Wells Fargo cases that the banks had affected themselves by committing fraud. The banks, as you can imagine, said that was a perverse way to read the statute.

The judges all agreed with the government’s “self-affecting” theory. As Charles Michael of Brune & Richard (and the indispensable S.D.N.Y. Blog) wrote for Columbia’s securities litigation blog, “The upshot is that the government will likely be able to pursue civil charges against federally insured financial institutions (whose misconduct in most cases would affect themselves) for conduct going back 10 years (the limitations period. Conduct leading into or during the financial crisis could be the subject of FIRREA claims for several more years to come.”

BofA went on to lose a jury trial in the case before Rakoff, which involved allegations that Countrywide defrauded Fannie Mae and Freddie Mac when it sold them mortgages underwritten with a fast-track automated system. Rakoff hit the bank with $1.2 billion in damages, along the way rejected BofA’s “self-affecting” defenses in summary judgment and post-trial motions. BNY Mellon settled the government’s FIRREA case (as well as related New York attorney general claims) last month for $714 million. In the case before Judge Furman, Wells Fargo and the government are still in discovery, according to the docket.

The Justice Department still has a couple of years under FIRREA’s 10-year statute of limitations to bring claims for crisis-era misconduct – but only if the 2nd U.S. Circuit Court of Appeals agrees with the government and Judges Kaplan, Rakoff and Furman.

The government’s self-affecting theory is now before the 2nd Circuit – and, for that matter, any federal circuit – for the first time, courtesy of Bank of America’s appeal in the Hustle case. In a 105-page (!) brief, BofA lawyers at Williams & Connolly and Countrywide counsel at Goodwin Procter argued that Judge Rakoff made all kinds of mistaken evidentiary decisions at trial and awarded absurdly outsized damages under a theory that not even the government espoused. As my astute Reuters colleagues Jon Stempel and Nate Raymond noticed and reported yesterday when the brief was filed, the bank wants Rakoff replaced if the 2nd Circuit remands the case because, according to BofA, his impartiality is in doubt. The bank also raised a technical argument that the supposed “fraud” in the government’s case was actually an alleged breach of contract, which can’t give rise to liability under FIRREA.

But the primary substantive argument in BofA’s brief, and the reason other financial institutions should be watching this appeal, is that it cannot be liable under FIRREA when it is the only federally insured institution affected by its supposed wrongdoing. According to BofA, Judge Rakoff’s reading of the government’s self-affecting theory would automatically subject banks to FIRREA penalties for any mail or wire fraud.

“That interpretation cannot readily be reconciled with the statutory text or with its underlying purpose,” BofA said in its brief. “If allowed to stand, the district court’s interpretation would convert a statute designed to protect federally insured financial institutions from fraud by others into a mechanism for imposing punitive fines against those institutions. The statutory language, purpose, history, and context uniformly support the conclusion that (FIRREA) does not reach conduct by a federally insured financial institution that ‘affects’ only the institution itself.”

Can BofA convince a 2nd Circuit panel to buy an argument that judges in the district have roundly rejected? It will be an industry hero if it does.

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