FIRREA and Bank Fraud

The U.S. District Court for the Southern District of New York, in U.S. ex rel. O’Donnell v. Bank of America Corp et al., No. 12-01422 (S.D.N.Y. 2013), has endorsed a broad interpretation of a savings-and-loan era law that the Justice Department is trying to use in cases against Wall Street banks. This ruling came as part of a federal case against Bank of America over allegations that it sold toxic mortgages to Fannie Mae and Freddie Mac under a program since 2007.

The Financial Institutional Reform, Recovery and Enforcement Act (“FIRREA”) allows the government to pursue civil penalties against those who commit frauds “affecting a federally insured financial institution.” The court held that the “straightforward application of the plain words” of the FIRREA allowed the interpretation sought by the Government. Citing a dictionary definition of “affect,” the court reasoned that Bank of America paid billions of dollars to resolve demands by Fannie and Freddie to buy back defective mortgages, and this fraud had a huge effect on the bank itself, as well as the shareholders.

This interpretation allows claims under FIRREA to be asserted against a bank when the affected financial institution is the bank itself. Wall Street has objected to this so-called “affect yourself” theory, arguing such interpretation would be contrary to the statute’s original purpose.

FIRREA was adopted in the 80s after hundreds of savings and loan institutions collapsed as a result of corruption. It has a relatively low burden of proof, strong subpoena power and a 10-year statute of limitations, twice as long as the typical limit for fraud cases. Although, rarely asserted in the past, it has recently become the basis of three lawsuits against banks, namely Bank of America, Wells Fargo and Bank of New York Mellon.

The ruling in O’Donnell followed a similar decision in April 2013 by another U.S. District Judge, also in New York, who allowed the advancement of a FIRREA lawsuit that accused Bank of New York Mellon of overcharging clients for trading currencies.

Similar cases and decisions will mean that the Justice Department can now use FIRREA, not only to pursue bank fraud, but also after the banks themselves for defrauding others. The rulings will likely encourage an increasing number of governmental actions challenging a wider range of targets in the financial services industry for a variety of alleged misconducts including potentially consumer fraud.