DOJ Takes Aim at Individuals: A quest to uncover violations of criminal law that purportedly occurred during the 2007-2008 financial crisis

Notwithstanding the recent series of record-breaking settlements between the Department of Justice (DOJ) and many of the world’s largest financial institutions[1], the DOJ has now set its sights on investigating individuals – pursuant to a civil statute – in a quest to uncover violations of criminal law that purportedly occurred at or around the time of the 2007–2008 financial crisis. Specifically, the DOJ is relying on the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA)[2], a broadly drafted law enacted as a result of the savings and loans crisis in the 1980s, in order to pursue fraud charges related to the mortgage-backed securities industry that it previously concluded were not viable as a criminal prosecution. In light of the substantial elapse of time since the underlying events, the significant amounts of money that have already been paid to the government in relation to such conduct, and the overall purpose of FIRREA, one is left struggling to understand how these actions are a fair and worthwhile expenditure of government resources.

A Brief History of FIRREA

Enacted in 1989, FIRREA was part of a comprehensive legislation plan formed in response to the savings and loan crisis, which was believed to have been caused, at least in part, by the fraudulent conduct of individuals and third parties against financial institutions that seemingly could not protect themselves from unscrupulous fraudsters. The FIRREA statute not only restructured the federal depository insurance systems but also authorized the DOJ to investigate and “prosecute” financial-institution related offenses, as well as impose civil monetary penalties for such offenses.[3]

The statute is often described as a “hybrid” because it predicates civil liability on the government’s ability to prove a criminal violation of at least one of 14 statutes by a preponderance of the evidence – i.e., under a civil liability standard.[4] For certain of these violations, including mail and wire fraud, the government must also prove that such violation affected a financial institution.[5] And recently, as a result of the DOJ’s extensive use of this statute to “prosecute” financial institutions for conduct that allegedly caused the 2007–2008 financial crisis, courts have held that “affecting” under FIRREA does not exclude “self-affecting” conduct, such that banks and other financial institutions can be prosecuted for conduct that violated the statute by “affecting” themselves.[6]

Undoubtedly because FIRREA was drafted as a civil statute, with neither the threat of imprisonment nor the stigma traditionally associated with a criminal charge, it was broadly written to include four defining characteristics: (1) an extended statute of limitations; (2) a requirement of proof only by a preponderance of the evidence; (3) extensive DOJ subpoena power; and (4) hefty fines.

First, under 12 USC § 1833a(h), the statute of limitations for violations of FIRREA is an exceptional 10 years. This is considerably longer than in most civil and criminal cases. By way of comparison, the statue of limitations for securities fraud in civil cases brought by the Securities Exchange Commission (SEC) is five years from the time the fraud occurred,[7] and in criminal cases brought by the DOJ, it is six years.[8] Thus, although both the SEC and the Criminal Division of the DOJ have likely passed the outer limits of relevant statutes when it comes to events contributing to the 2007–2008 financial crisis, the Civil Division of the DOJ – regardless of whether the alleged conduct is of the type that FIRREA was originally intended to prevent – may still have considerable slack left in its line.

Second, as noted earlier, notwithstanding the fact that FIRREA requires a criminal violation, the DOJ only needs to prove that violation by a preponderance of the evidence – i.e., under a civil burden of proof.[9] Thus, a wide array of cases that are criminal in essence can be brought without having to meet the beyond-a-reasonable-doubt standard, an undeniably appealing option for a complicated, fact-intensive prosecution that involves multiple actors, as is typical of many financial-crisis-era cases.

Third, FIRREA empowers the government to issue subpoenas for documents from any place in the United States and testimony at any place in the United States, so long as it is done “for the purpose of conducting a civil investigation in contemplation of a civil proceeding under FIRREA.”[10] These subpoenas therefore enable the DOJ to conduct wide-ranging discovery even before filing a civil complaint, thereby providing fodder for extensive and prolonged investigations. Moreover, materials produced and testimony given pursuant to such administrative subpoenas are not subject to Federal Rule of Criminal Procedure 6, which governs grand jury proceedings and provides in subsection (e) for the secrecy of such proceedings. Such information may therefore be shared with other government agencies, which in turn may conduct their own sprawling investigations.

Fourth and finally, FIRREA provides for generous financial penalties, an instrument that, as discussed more fully below, the DOJ has not shied away from wielding in recent years. Specifically, although FIRREA initially provides for a civil penalty of not more than $1 million for a single violation and $5 million for a continuing violation, it alternatively provides, in the case of violations creating gain or loss, for the amount of the penalty to equal the greater of the amount of such gain or loss.[11] And despite not being defined under the statute, courts have read such language to refer to gross, as opposed to net, gain and loss.[12]

Recent Use of FIRREA

In light of the unusually expansive nature of this hybrid statute, it is unsurprising that the DOJ has substantially relied on FIRREA in recent years to investigate and charge some of its most complicated financial cases. Indeed, leveraging this considerable statutory power has enabled the DOJ to secure at least $18 billion from settlements with major financial institutions in relation to conduct that occurred largely in 2007 and 2008.[13] And this number – which reflects a record-breaking $5 billion settlement with Bank of America and an unprecedented $687.5 million settlement with financial services firm S&P – does not even include the additional monies paid in relation to the same conduct but for violations of state law.[14]

That being said, the DOJ’s use of this statute has not proceeded without any issues. Indeed, the Second Circuit recently dealt a blow to DOJ attorneys relying on this statute to pursue fraud claims that are premised on misrepresentations made in connection with a contract, as is the case in many investigations and prosecutions involving the sale of mortgage-backed securities. In U.S. ex rel. O’Donnell v. Countrywide Home Loans, Inc. et al.[15],the Second Circuit held that the evidence presented by the DOJ during trial, demonstrating that defendants knew mortgages sold to the Federal Home Loan Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) were not consistent with representations made in the contract governing the sale of such mortgages, was insufficient as a matter of law to prove a FIRREA violation. The court reached this decision because the DOJ did not – or chose not to – put on evidence showing that defendants had fraudulent intent at the time of entering into the underlying contracts with Fannie Mae and Freddie Mac. The court observed that, based on the evidence offered, the defendants had merely breached their contracts with those entities, and thus held that the jury had no legally sufficient basis on which to find the defendants liable for fraud.[16] Defendant Countrywide (acquired by Bank of America) had originally been ordered to pay a $1.27 billion penalty and defendant Rebecca Mairone a $1 million penalty, both on the basis of their liability for fraud, but the case has now been remanded for final judgment consistent with the Second Circuit’s holding.[17]

Notwithstanding the considerable recovery the DOJ has achieved in these recent investigations and civil charges, and unlikely to be deterred by the recent loss in U.S. ex rel. O’Donnell, the DOJ is most recently using this same statute to investigate individuals who are alleged to have contributed to the financial crisis, nearly 10 years after engaging in conduct while employed at these same institutions.[18] Although it appears that this recent effort was spurred, at least in part, by the DOJ’s well-intentioned September 2015 Yates Memo, which requires all components of the DOJ to run to ground any case against individuals (criminal or civil) before closing an investigation into illegal corporate activity, the DOJ’s deployment of FIRREA power is not an effective and efficient approach to punishing the criminal activity of individuals.

First, such investigations are fundamentally unfair because they enable the government to “prosecute” individuals where there is insufficient evidence to file, let alone prove, criminal charges. Indeed, it is widely reported that no individuals have thus far been criminally charged in connection with the conduct that, under the DOJ’s FIRREA investigation, purportedly contributed to the financial crisis. Although this is disappointing to Congress, watchdog groups and the public at large, and therefore a thorn in the side of the current administration, it is not a basis to invest additional resources in long-running investigations that were not fruitful even before the relevant evidence became stale.

Second, such investigations are costly for all of the parties involved, not least of which is the government, and they are unlikely to result in any worthwhile additional recoveries. As previously noted, the DOJ has recovered substantial sums of money – indeed more than $18 billion under FIRREA alone – from financial institutions in relation to financial-crisis-era conduct that occurred approximately eight years ago. Continuing these investigations requires cooperation not only from the banks and other financial institutions that have paid substantial sums to settle such cases but also from the individual witnesses to the allegedly criminal conduct, many of whom are no longer even in the industry under investigation (to the extent those industries even continue to exist). When the prospect of exacting meaningful financial settlements, given the relatively limited resources of the typical individual defendant, is but a pipe dream, spending additional government funds and compelling corporations to do the same strikes us as too aggressive a quest to be worth pursuing.

Third, such investigations will unlikely have a deterrent effect on current criminal activity. FIRREA was enacted in response to the savings and loan crisis, but really to protect financial institutions against fraud and insider abuse.[19] Given that individuals undeniably continue to commit fraud against, and probably within, banks today, it is readily apparent that there is still a role for FIRREA to play in today’s enforcement landscape. But perhaps the DOJ’s efforts investigating financial fraud would have a greater deterrent effect if it were to focus on fraud that is currently affecting today’s markets, as opposed to conduct that is by and large a distant memory for most people in the financial services industry. To the point, query how spending hundreds of thousands of dollars to collect documents that have already been produced in related but more timely cases, and dragging innocent witnesses – who are long gone from the financial services industry – clear across the country to testify as to events they do not recall from nearly 10 years ago, all in order to investigate a washed-up residential mortgage-backed securities banker, is going to deter mortgage fraud that is occurring today. We suspect that it will not. In fact, today’s fraudster may be emboldened by the DOJ’s continued distracted obsession with the previous decade.