Tag Archives: Department of Justice

Judge Rakoff Is All FIRREA-ed Up

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Law360 quoted me in a story, Rakoff Gives DOJ License To Be Bold In Bank Crackdown (behind a paywall), that reads in part,

U.S. District Judge Jed S. Rakoff’s expansive Monday opinion backing the federal government’s $1 billion mortgage fraud suit against Bank of America Corp. leaves the U.S. Department of Justice wide latitude to use its favorite financial fraud tools in cases linked to the recent financial crisis.

Judge Rakoff’s opinion expanded his May decision allowing the Justice Department’s October suit against Bank of America over lending practices during the housing bubble and financial crisis to move forward under the Financial Institutions Reform Recovery Enforcement Act, while also explaining why portions of its case using the False Claims Act failed.

The ruling, which accepted the government’s broad view of which federally insured financial institutions can be sued under FIRREA and on what grounds, gives the government further ammunition to bring such cases in the future, said Brooklyn Law School professor David Reiss.

“The federal government has taken an expansive view of this phrase, and Judge Rakoff agrees that it can be read broadly in certain circumstances, such as when the affected federally insured financial institution is the alleged wrongdoer itself,” he said.

* * *

[T]he Second Circuit will look closely at other appellate rulings related to interpreting congressional intent, as well as any rulings dealing specifically with FIRREA should an appeal come its way, as many observers expect.

However, it is likely to look closely at Judge Rakoff’s opinion when rendering an ultimate decision, which is why he considered those issues, Reiss said.

“Judge Rakoff stated that this result clearly flowed from the plain language of FIRREA, so the defendants may have a hard time on appeal,” he said.

What Was S&P Puffing?

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I have been closely following DoJ’s suit against S&P since the complaint was filed in February (and see here, here and here).  DoJ alleges that S&P “issued or confirmed ratings that did not accurately reflect true credit risks” and seeks to obtain civil penalties pursuant to FIRREA. (4) Yesterday, Judge Carter issued a doozy of an order, denying S&P’s motion to dismiss the case.

Let’s remember that for the purposes of a motion to dismiss, the judge takes as true all of the facts alleged in the plaintiff’s complaint.  So, if a complaint survives a motion to dismiss, it means that the legal theory of the case is sound and that the plaintiff can win if the facts are as it alleges.

This should be the scariest passage in the order, as far as S&P is concerned:

Defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications.  They claim that, out of all the public statements that S&P made to investors, issuers, regulators, and legislators regarding the company’s procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings. (7-8)

This is repudiation of S&P’s “puffery” defense: their statements about their objectivity and rigorous methodology were merely “non-actionable puffery” along the lines of Charmin’s claim that it is the softest of all toilet papers. (8)

The Court follows this line of thought through to its logical conclusion:

if no investor believed in S&P’s objectivity, and every bank had access to the same information and models as S&P, is S&P asserting that, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness? (12)

One wonders how S&P executives responded to their lawyers when they proposed this argument — were they thinking about anything else other than winning this motion?  Did they consider how regulators might react to this argument?

And, while this goes beyond the matter at hand, the Court’s reaction to S&P’s argument is an implicit indictment of the business model of the major rating agencies: they are really in the business of selling licenses to access the capital markets more than they are in the business of issuing mini-editorials about the creditworthiness of securities, as they have successfully argued in previous cases challenging their ratings.

S&P Myth #1: No One Could Have Known

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S&P filed its Memorandum in Support of Defendants’ Motion To Dismiss the DoJ lawsuit filed back in February. The memorandum states that S&P’s inability, along with other market participants, “to predict the extent of the most catastrophic meltdown since the Great Depression reveals” only “a lack of prescience” and “not fraud.” (1) This short phrase requires some serious unpacking.

First, it ignores the fact that many of the analysts who engaged in fact-based investigations of the rated securities were sounding warnings but were overruled by higher ups who demanded that market share be maintained.  So if S&P and “other market participants” is defined to exclude all of those analysts, risk officers, underwriters and due diligence providers that worked for all of those market participants, then S&P is certainly right.  But if plaintiffs can demonstrate that facts were ignored to the extent that short term profits would be hurt by them, then S&P’s characterization is less compelling.

A second related point is that S&P’s argument that “its views were consistent with those of virtually every other market participant” is not compelling if plaintiffs can demonstrate that it ignored the facts before it and the findings of its own models.

Finally, its characterization of the Subprime Bust as “the most catastrophic meltdown since the Great Depression” fails to acknowledge that an S&P AAA rating offers quite the stamp of approval:  “An issuer or obligation rated ‘AAA’ should be able to withstand an extreme level of stress and still meet its financial obligations. A historical example of such a scenario is the Great Depression in the U.S.”  (The quote is from S&P’s website and can be accessed here on page 58.) But mortgage-backed securities with that S&P triple A did not quite live up to their promise.

This is not to say that S&P has not raised serious legal issues with Justice’s complaint in its motion to dismiss, but just that its rationalizations of its own behavior (which echo those of Dick Fuld and many others at the helm of various “market participants”) don’t stand up against the record.

Reiss on Booming Structured Finance Litigation

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Law360 interviewed me about the boom in structured finance litigation arising from the Financial Crisis (here, behind a paywall):

banks will not be able to let their guard down anytime soon, thanks to the U.S. Department of Justice’s rediscovery of a statute developed in response to the late 1980s savings and loan crisis and the increasing ability of plaintiffs attorneys to expand claims first brought in mortgage cases to other consumer finance products, according to Brooklyn Law School professor David Reiss.

“I would still be worrying if I were the [general counsel] of a large financial institution about the cases that might still be filed,” Reiss said.

Most of the fraud claims available under federal securities law have a statute of limitations that expires after five years. Because most of the securities that failed did so in 2007 and 2008, 2013 looked like the end of the line for many of the government’s claims.

That was until the DOJ sued Standard & Poor’s Financial Services LLC in February, claiming it was rife with conflicts of interest and that it ignored evidence that mortgage-backed securities were stuffed with subprime mortgages that were likely to fail. In bringing its suit, the DOJ dusted off the 1989 Financial Institutions Reform, Recovery and Enforcement Act, a federal response to the savings and loan crisis of the late 1980s that allows the government to bring claims against defendants that adversely affect federally insured financial institutions.

Using that statute was a game-changer, Reiss said.

Among a host of other measures provided in the law, FIRREA extended the statute of limitations on those claims from five to 10 years, giving prosecutors more time to bring claims. It also gave the government the chance to bring civil versions of mail, wire and other fraud claims that normally would be brought in a criminal context, meaning the government will now only have to prove its allegations to a jury by a preponderance of evidence, rather than beyond a reasonable doubt.

“If courts favor DOJ’s expansive reading of FIRREA, all bets are off as to how much financial institutions may still be on the hook for suits arising from the financial crisis brought by the government,” Reiss said.

Prosecutors are also looking to bring more cases as pressure from lawmakers mounts.

After Attorney General Eric Holder admitted Wednesday that some banks were “too big to jail,” the spotlight has been turned anew on whether regulators have been tough enough on banks. Critics say that prosecutors and bank regulators have been too timid in their pursuit of crimes allegedly committed by banks.

That could also push the DOJ and the other regulators to find new theories to bring cases, Reiss said.

“It does seem that there is a bit more of a populist bent to prosecutions now that we are past the worst of the crisis,” he said.