On October 28, 2019, HUD and the DOJ released a Memorandum of Understanding (MOU) announcing their new joint approach to a gentler form of FCA enforcement against FHA mortgage lenders. The stiff FCA penalties levied against FHA lenders in the years following the financial crisis led directly to declining participation among depository institutions in the FHA guaranteed loan market. HUD Secretary Ben Carson decried those penalties as “outsized liability from immaterial errors.”1 Upon releasing the MOU, which followed related regulatory action and several years of declining FCA recoveries in the financial services sector, Carson encouraged banks to return to FHA lending, announcing that “our intention is to make it crystal clear to all responsible lenders that this is a program you should be participating in.”2
Indeed, FCA recoveries from the financial services industry fell sharply in FY 2019 – consistent with Secretary Carson’s agenda to ease FCA pain for FHA lenders. Recoveries in FHA mortgage-based claims totaled only $68.12 million in FY 2019 – a dramatic decline from the recent past: $365 million (2015), $1.6 billion (2016 – largely comprised of a single outsized $1.2 billion settlement), $543 million (2017), and $161 million (2018). 2019’s Quicken Loans settlement (against a non-bank lender that is one of the largest currently participating in the FHA lending program) pales by comparison with past recoveries; the company agreed to pay $32.5 million without admitting any wrongdoing or agreeing to tweak any of its practices.
First-of-its-kind HUD-DOJ MOU
The HUD-DOJ MOU reflects the intention to raise the bar for initiating FCA enforcement proceedings against FHA lenders and stresses that allegations of regulatory non-compliance should be resolved principally through HUD administrative proceedings. According to the MOU, when HUD detects noteworthy violations of FHA lending requirements, it will first refer them to HUD’s Mortgage Review Board (MRB), through which HUD oversees FHA-approved lenders. Emphasizing that FCA enforcement should only be pursued when it is “the most appropriate method to protect the interests of FHA’s mortgage insurance program,” the MOU states that the MRB will refer cases to the DOJ for potential FCA litigation only when two “FCA Evaluation Standards” are met: (1) a minimum threshold number of loans (or loans with an aggregate minimum value) are impacted by detected defects; and (2) there are aggravating factors such as systemic violations. Cases not referred to the DOJ for FCA enforcement may still result in administrative action, indemnification, or monetary penalties.
The MOU also explains that the DOJ will confer with HUD when an FCA action is initiated by a party other than HUD. HUD can provide its support or opposition to FCA litigation and advise whether HUD believes the matter would have met HUD’s FCA Evaluation Standards. Because the Supreme Court has stated that the FCA’s materiality requirement turns on the “effect on the likely or actual behavior of the recipient of the alleged misrepresentation,”3 the MOU notes that “HUD will make known to the DOJ whether and to what extent any alleged defects or violations regarding the relevant FHA requirements are material or not material to the agency so that DOJ can determine whether the elements of the FCA can be established.”4
Finally, following the DOJ’s adoption of standards for exercising its § 3730(c)(2)(A) authority to dismiss qui tam FCA actions, the MOU empowers HUD to recommend when the DOJ should exercise this authority. It enumerates specific criteria and examples of instances where HUD will seek the DOJ’s support for dismissal. These include when HUD determines the alleged violation was not material, that the allegations do not meet the MOU’s FCA Evaluation Standards, or that the litigation would otherwise interfere with HUD’s administration of the FHA lending program. This appears to be the first MOU between the DOJ and a client-agency announcing such program specific protocols. It comes as the United States Court of Appeals for the Ninth Circuit is considering the DOJ’s interlocutory appeal of a district court decision that denied the DOJ’s motion to dismiss a relator’s FCA suit against FHA lender Academy Mortgage Corporation.5
Complimentary regulatory changes
As part of its overall agenda to ease the burden on FHA lenders and lift the specter of future FCA enforcement actions, HUD has also been refining the language and streamlining the loan level and lender level certifications required by the FHA single family mortgage lending programs. These changes appear to address the materiality and culpability concerns raised in FCA enforcement actions, in part by effectively removing the certification requirement almost altogether.
The FHA is also refining its Defect Taxonomy6 for HUD loan reviews in an effort to connect it to relevant HUD remedies and violations. In the meantime, however, it remains uncertain what kind of violations identified in the Defect Taxonomy, and of which severity, will trigger consequences like HUD “administrative action, indemnification, or civil money penalties” referenced in the MOU.
The road ahead
The recent assurances from HUD, declining FCA recoveries, the HUD-DOJ MOU, and related regulatory reform efforts aim to assuage lenders’ fears regarding risks associated with FHA lending. None of these changes, however, mark the end of FCA enforcement against FHA lenders, nor do they curtail criminal enforcement by the DOJ. There is not yet any guidance as to how the MOU’s provisions related to the exercise of prosecutorial discretion in this area will be applied. And the impact of the scaled-back FHA certification requirements under the prevailing materiality standard is far from certain.
Trends in FCA enforcement tend to be cyclical; there is no guarantee that current lending practices will not become the focus of future policy shifts and FCA enforcement priorities. FHA lenders should continue to tread with caution.
Indeed, a month before issuing the MOU, the government filed a different kind of FHA-lending suit against the developers of a hospital (Lakeway Regional Medical Center). The suit alleged that the developers participated in a scheme to improperly obtain an FHA-insured loan by delaying refunds to investors who had cancelled their investments, so as to make it appear that the project satisfied mortgage covenants regarding the cash on hand required to close the loan.7
Moreover, the Fifth Circuit recently affirmed a district court decision that denied defendants’ motion for judgment as a matter of law and left in place a jury verdict that resulted in nearly $300 million in damages and penalties against Allied Home Mortgage and its owner and CEO.8 That decision turned in part on the Fifth Circuit’s rejection of a strict nexus approach to proximate causation, which would require proof that a particular false statement – in this case, a certification that the loans at issue were originated by registered mortgage offices when they were, in fact, allegedly originated by unregistered offices – precipitated a specific loan default.
At trial, the government had relied on a sample of loan files and extrapolation to establish higher rates of default for loans from unregistered mortgage offices. The Fifth Circuit held that the government had adequately linked the alleged misrepresentation to a higher risk of default for loans originated by the unregistered offices “and that the expert evidence showed those loans, as predicted, defaulted at higher rates.”9 The court explained, “[i]t then follows that the false statements distorted the risk perceived by HUD, which caused it to insure more loans and incur more losses than it would have otherwise.”10 This decision is a marked departure from Fifth Circuit precedent and appears to ease the burden of proving causation in FCA sample and extrapolation cases. It stands in stark contrast to HUD’s efforts to raise the bar for FCA enforcement of FHA lending violations.
The mortgage industry has reason to be optimistic that the risk of mammoth FCA penalties for imperfect compliance with HUD regulations has peaked. However, FCA risk related to the FHA guaranteed loan market remains. Moreover, even absent FCA litigation, non-compliance with HUD regulations can trigger substantial administrative and civil penalties. Importantly, banks also face FCA risk unrelated to HUD-backed mortgages. In fact, the Second Circuit recently held that misrepresentations made in the course of securing loans from the Federal Reserve can support a FCA claim.
1. U.S. DEP’T HOUS. & URBAN DEV., DR. BEN CARSON’S REMARKS AT THE NATIONAL ASSOCIATION OF HOME BUILDERS EXECUTIVE BOARD MEETING (May 23, 2018).
2. U.S. DEP’T HOUS. & URBAN DEV., DR. BEN CARSON’S REMARKS AT MBA ANNUAL CONVENTION & EXPO 2019 (Oct. 28, 2019).
3. Universal Health Servs., Inc. v. U.S. ex rel. Escobar, 136 S. Ct. 1989, 2002(2016).
4. The DOJ recently updated the Justice Manual to include a reference to the MOU between DOJ and HUD. Most notably, the update appears to broaden the key principles embodied in the HUD MOU to extend to all “relevant agenc[ies].” The update establishes a requirement that the DOJ “solicit the agency’s views” on falsity and materiality in all cases, and provides a mechanism for the agency to recommend that DOJ seek dismissal. 4-4.110 Civil Fraud Litigation.
5. See U.S. v. US ex rel. Thrower, No. 18-16408 (9th Cir. filed July 27, 2018) (Oral argument was held on November 14. 2019); United States v. Acad. Mortg. Corp., No. 16-CV-02120-EMC, 2018 WL 3208157 (N.D. Cal. June 29, 2018).
6. “Defect Taxonomy” refers to the “Single Family Housing Loan Quality Assessment Methodology,” HUD’s standardized system for identifying FHA-insured loan defects at the single loan level when performing loan reviews of FHA-approved lenders. The Defect Taxonomy incorporates four severity tiers for identified defects. See HUD guidance here.
7. Press Release, U.S. Dep’t of Justice, United States Files False Claims Act Complaint against Participants in Hospital Development Project for Improperly Obtaining Government-Insured Loan and Misusing Loan Funds (Sept. 25, 2019), available here.
8. United States v. Hodge, 933 F.3d 468, 473 (5th Cir. 2019), as revised (Aug. 9, 2019). The Fifth Circuit also denied a petition to rehear the case en banc. See Nov. 12, 2019 order filed in United States v. Hodge, No.17-20720 (5th Cir.).
9. Id. at 475.