Implications of FCA Legal Developments for the Financial Services Industry

After the financial sector’s enormous FCA recoveries in FY 2014 – surpassing the healthcare industry that year with $3.1 billion in recoveries – the recoveries slowed significantly in FY 2015, creating uncertainty with respect to future government enforcement in the sector. FY 2016 recoveries still did not match FY 2014, but increased from $365 million in FY 2015 to $1.7 billion in FY 2016, largely due to the $1.2 billion settlement with Wells Fargo.

The major mortgage industry FCA settlements of the past fiscal year all involved allegations that mortgage lenders had originated and then falsely endorsed residential mortgages as eligible for Federal Housing Administration (FHA) insurance, even though the loans did not meet Department of Housing and Urban Development (HUD) underwriting requirements. Unsurprisingly, following several years of relentless government pursuit of FHA insurance related claims resulting in large payouts by mortgage companies, larger banks have heavily curtailed their participation in FHA-backed lending programs, instead creating their own versions of FHA-like loans (which are designed for borrowers with weaker credit profiles). With this past year’s gargantuan $1.2 billion settlement with Wells Fargo, that trend is likely to continue. As a result, non-bank lenders that have moved into the FHA-lending space in the banks’ stead may increasingly become targets of both government and qui tam initiated FCA suits. Case in point, in May DOJ filed suit against Guild Mortgage Company, a non-bank lender, alleging FHA insurance related FCA violations. 

Though the federal Making Home Affordable (MHA) mortgage relief program – which was established under the Troubled Asset Relief Program (TARP) as part of the Emergency Economic Stabilization Act of 2008 in response to the subprime mortgage crisis – just expired on December 31, 2016, FCA suits premised on claims for government incentive payments submitted by mortgage servicers that participated in MHA programs are still alive and kicking. In July of 2016, Ocwen Loan Servicing LLC and whistleblowers Michael Fisher and Brian Bullock informed the Eastern District of Texas that they had reached a settlement in principal, pending approval by DOJ, of a FCA suit alleging violations stemming from implied false certifications made in connection with MHA’s Home Affordable Modification (HAMP) loan modification program.  Universal Health Services, Inc. v. U.S. ex rel. Escobar’s  endorsement of the implied certification theory could lead to an uptick in these types of claims.

A strand of mortgage-related FCA claims that received both a boost and a setback this year are those that stem from residential mortgage loan sales to the Government-Sponsored Enterprises (GSEs) Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation). The gist of these sorts of claims is that mortgage lenders, who had promised to sell “investment quality” mortgage loans to the GSEs, in fact sold them poor-quality mortgages. A Ninth Circuit case and a Second Circuit case decided in 2016 provide guidance as to how fraud or false claims made to GSEs might (or might not) be considered fraud on the government. The issue on appeal in the Ninth Circuit case, U.S. ex rel. Adams v. Aurora Loan Services, Inc., was whether the GSEs – which are private corporations, but government-chartered, and currently under government conservatorship – could nevertheless be considered “officers, employees, or agents of the federal government” under the FCA’s definition of “claim” as set out in 31 U.S.C. § 3729(b)(2)(A)(i).  The Ninth Circuit – affirming the Nevada district court – held that the GSEs could not be. However, the Ninth Circuit also specifically left open the possibility – as urged by an amicus brief filed by the United States – that FCA liability could in certain circumstances attach to mortgage loan sales made to GSEs under the second definition of “claim,” which was added to the FCA in 2009 as part of FERA (the Fraud Enforcement and Recovery Act).  Specifically, § 3729(b)(2)(A)(ii) expands the definition of “claim” to include a request for payment made to a third party “other recipient” of government monies provided “to advance a Government program or interest.”

The Second Circuit case, U.S. ex rel. O’Donnell v. Countrywide Home Loans, Inc., actually threw out a $1.2 billion jury verdict for civil penalties against Countrywide Home Loans, Bank of America, and Rebecca Mairone (chief operating officer of the targeted Countrywide lending division) stemming from loans sold to GSEs. The basis for the verdict was FIRREA (the Financial Institutions Reform, Recovery, and Enforcement Act), not the FCA. The FCA components of the claims were dismissed by the District Court in 2013 because – though the District Court reasoned that FCA liability could attach to claims made to GSEs under § 3729(b)(2)(A)(ii) – such liability could not attach to loans sold to the GSEs before FERA amended the FCA in 2009 (and pre-2009 claims formed the crux of the complaint against Countrywide).

The reasoning the Second Circuit applied in reversing liability on the FIRREA claims, however, could potentially be used to undercut FCA claims arising from loans sold to GSEs even after the 2009 FERA amendments to the FCA. Grounding its decision in common law fraud principals, the Second Circuit held that because the evidence at trial showed “at most an intentional breach of contract – i.e., that [Countrywide] sold mortgages that they knew were not of the quality promised in their contracts” with the GSEs, the government has not proved “the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises,” that is, the government had not shown that “at the time the contracts were executed Countrywide never intended to perform its promise of investment quality.”  FCA claims based on similar intentional breaches of loan sale contracts with GSEs may find themselves subject to the same reasoning. On the other hand, actual fraud is a predicate requirement for FIRREA claims, but not for FCA claims: FCA claims may be premised on false or fraudulent claims. Thus – the Second Circuit’s blow to FIRREA-based claims stemming from loan sales to GSEs may in fact shift claims that otherwise would have been brought under FIRREA back to FCA-based theories. 

We’ll continue to be on the lookout for these and other emerging FCA enforcement and qui tam trends in the financial services industry.