Recent Developments Affecting the Financial Services Industry's Exposure to Liability Under the FCA and FIRREA
In the wake of the 2008 financial crisis, the financial services industry has faced an increased risk of exposure to civil liability premised on new theories of fraud pursued under two statutes: the False Claims Act (FCA), 31 U.S.C. § 3729 et seq., and the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), 12 U.S.C. § 1833a. Using these old tools in new ways, the U.S. Department of Justice (DOJ) has extracted historically high settlements of fraud-related claims over the past several years.
For those facing potential exposure to liability under the FCA and FIRREA, understanding these statutes—including recent developments in their application and interpretation—is essential. Perhaps the most significant event of the year so far has been the Supreme Court’s decision in Universal Health Services, Inc. v. United States ex rel. Escobar, 579 U.S. –, 136 S. Ct. 1989 (2016), in which the Court upheld the validity of the implied false certification theory of FCA liability, an oft-used but hotly-contested hook for liability that has been expanding the universe of FCA claims. At the same time, however, the Court clarified the theory in ways that may narrow its reach in future cases. This advisory examines how the FCA and FIRREA have been used to pursue new theories of fraud against the financial services industry and how Escobar and other developments in this area in recent years may affect the industry’s exposure to such claims going forward.
The False Claims Act
A. Overview of the FCA
B. The FCA and the Financial Services Industry
C. Proving a "False or Fraudulent Claim" and the Impact of Escobar
Given the broad range of statutory, regulatory, and contractual requirements that industries which submit claims to the federal Government are subject to, the implied certification theory has the continuing potential to dramatically expand the scope of FCA liability. For this reason, the theory had been the subject of repeated challenges, generating a split in the U.S. Courts of Appeals over its validity.17 Further complicating matters, certain courts added even greater nuance to the theory’s application. For example, the U.S. Court of Appeals for the Second Circuit held that the implied certification theory was only applicable when the relevant statutory or regulatory requirement "expressly state[d] the provider must comply in order to be paid."18 The Second Circuit also drew a distinction between certifying compliance with "conditions of payment" (i.e., "prerequisites to receiving reimbursement"), which could support an FCA claim, and certifying compliance with "conditions of participation" (i.e., requirements to participate in the Government programs that provided reimbursement), which could not.19
In Escobar, the Supreme Court upheld the validity of the implied certification theory and shed light on all of the above issues. Although the Court declined to go so far as to hold that "all claims for payment implicitly represent that the billing party is legally entitled to payment,"20 it held that where "a defendant makes representations in submitting a claim but omits its violations of statutory, regulatory, or contractual requirements, those omissions can be a basis for liability if they render the defendant’s representations misleading with respect to the goods or services provided."21 Thus, "the implied false certification theory can, at least in some circumstances, provide a basis for liability."22
In upholding the theory, however, the Court also provided clarification regarding its application. First, the Court rejected the position that failing to disclose a violation of a contractual, statutory, or regulatory requirement could only give rise to liability if the Government had expressly designated the requirement as a condition of payment.23 On the other hand, the Government’s "decision to expressly identify a provision as a condition of payment is relevant, but not automatically dispositive."24 Instead, the Court held that the applicability of the implied certification theory turns on "whether the defendant knowingly violated a requirement that the defendant kn[ew] [was] material to the Government’s payment decision."25
The Court emphasized the "demanding" nature of the implied certification theory’s materiality requirement.26 Specifically, the Court explained that noncompliance must be more than "minor or insubstantial," and that it is not enough for the Government to show that it would have had "the option to decline to pay if it knew of the defendant’s noncompliance."27 The Government had taken the position in Escobar that the test for materiality is whether the defendant knew the Government "could lawfully withhold payment."28 In response to questioning at oral argument, the Government took this position to the extreme, arguing that a defendant who contracts with the Government to provide health services, while also agreeing to buy American-made staplers, violates the False Claims Act if it submits a claim for the health services "but fails to disclose its use of foreign staplers"—"irrespective of whether the Government routinely pays claims despite knowing that foreign staplers were used."29 "Likewise," the Court noted, "if the Government required contractors to aver their compliance with the entire U.S. Code and Code of Federal Regulations," then under the Government’s view "failing to mention noncompliance with any of those requirements would always be material."30 The Court emphatically rejected the Government’s position, stating that the False Claims Act "does not adopt such an extraordinarily expansive view of liability."31 As to what type of evidence would be probative of materiality, the Court explained that if the Government "regularly pays a particular type of claim in full despite actual knowledge that certain requirements were violated, and has signaled no change in position, that is strong evidence that the requirements are not material."32
While the full impact of Escobar remains to be seen as the case law develops in the lower courts, the decision undoubtedly has significant implications for the financial services industry. As the Second Circuit recently noted—in a pre-Escobar decision in which the court found a bank’s certification of compliance (that it had not violated "any laws or regulations") too broad to support FCA liability—the "universe of potentially applicable laws or regulations is vast . . . . [B]anks are subject to thousands of laws and regulations[.]"33 With the viability of the implied false certification theory no longer in question, the financial services industry is likely to face continued (and perhaps increased) exposure to FCA claims based on alleged noncompliance with statutory, regulatory, and contractual requirements. At the same time, the Supreme Court’s refusal to adopt a blanket rule regarding the applicability of the theory, as well as its emphasis on a "demanding" materiality requirement, may provide financial institutions with stronger defenses against such claims.
The Financial Institutions Reform, Recovery, and Enforcement Act
A. Overview of FIRREA
B. FIRREA and the Financial Services Industry
While RMBS-related FIRREA claims are becoming less frequent, the financial services industry has likely not seen the end of Government enforcement under this statute. Last year, for example, federal and state governments settled a multi-year suit against a bank alleging that the bank had represented that it was providing "best rates" and "best execution" when pricing foreign exchange trades, while instead giving its clients the worst reported interbank rates of the trading day.48 Other examples include the Government’s "payment processing" cases, in which the Government alleged that financial institutions violated FIRREA by permitting third-party merchants through payment processors to illegally withdraw funds from their customers’ bank accounts.49 Given the broad reach of the statute and the Government’s aggressive use of it in recent years, one can assume that DOJ will continue to look for ways to take full advantage of its enforcement powers in the days ahead.
Conclusion
The Government’s pursuit of fraud-related claims under the FCA and FIRREA has had a significant impact on the financial services industry. The Supreme Court’s Escobar decision may fuel a continuing surge of FCA claims, now that the validity of the implied false certification theory has been established. Whether those claims will, in fact, be reined in by the Supreme Court’s articulation of a demanding materiality standard remains to be seen. In addition, although FIRREA claims against many major industry members related to RMBS have been resolved, FIRREA remains a powerful tool applicable to a wide range of allegedly fraudulent conduct. Understanding the FCA, FIRREA, and recent developments in their interpretation and application therefore remains essential to members of the financial services industry, who may find themselves caught in the cross-hairs of these statutes in the future.
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See 28 C.F.R. § 85.5; Civil Monetary Penalties Inflation Adjustment, 81 Fed. Reg. 42,491, 42,501 (June 30, 2016).
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See, e.g., Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, M&T Bank Agrees to Pay $64 Million to Resolve Alleged False Claims Act Liability Arising from FHA-Insured Mortgage Lending (May 13, 2016),; Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Wells Fargo Bank Agrees to Pay $1.2 Billion for Improper Mortgage Lending Practices (Apr. 8, 2016).
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See, e.g., Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Walter Investment Management Corp. Pays More than $29 Million for the Alleged Submission of False Claims Related to Servicing Reverse Mortgage Loans (Sept. 4, 2015); Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, JPMorgan Chase to Pay $614 Million for Submitting False Claims for FHA-Insured and VA-Guaranteed Mortgage Loans (Feb. 4, 2014).
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See, e.g., Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Miami-Based Lender Pays $3.8 Million to Resolve Liability Relating to U.S. Export-Import Bank Loans (Mar. 12, 2015).
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See Bishop v. Wells Fargo & Co., 823 F.3d 35, 38-39, 41 (2d Cir. 2016).
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Mikes v. Straus, 274 F.3d 687, 697 (2d Cir. 2001), abrogated on other grounds by Escobar, 136 S. Ct. 1989.
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Id. at 696; see also United States ex rel. Conner v. Salina Reg’l Health Ctr., Inc., 543 F.3d 1211, 1217 (10th Cir. 2008).
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See Mikes, 274 F.3d at 697-99.
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See Escobar, 136 S. Ct. at 1998-99 (discussing Circuit split).
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Escobar, 136 S. Ct. at 2000 (emphasis added).
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Id. at 2004 (quoting Transcript of Oral Argument at 43).
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See, e.g., United States v. Wells Fargo Bank, N.A., 972 F. Supp. 2d 593, 599 (S.D.N.Y. 2013).
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See United States v. Bank of N.Y. Mellon, 941 F. Supp. 2d 438, 443 (S.D.N.Y. 2013) (emphasis added).
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See Wells Fargo Bank, 972 F. Supp. 2d at 629-31; United States v. Countrywide Fin. Corp., 961 F. Supp. 2d 598, 605-06 (S.D.N.Y. 2013); Bank of N.Y. Mellon, 941 F. Supp. 2d at 451-57; see also United States ex rel. O’Donnell v. Countrywide Home Loans, Inc., 822 F.3d 650, 655-56 (2d Cir. 2016) (observing lack of authority from other circuits, but declining to address the theory’s validity).
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See, e.g., Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Goldman Sachs Agrees to Pay More than $5 Billion in Connection with Its Sale of Residential Mortgage Backed Securities (Apr. 11, 2016); Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Morgan Stanley Agrees to Pay $2.6 Billion Penalty in Connection with Its Sale of Residential Mortgage Backed Securities (Feb. 11, 2016); Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Bank of America to Pay $16.65 Billion in Historic Justice Department Settlement for Financial Fraud Leading Up To and During the Financial Crisis (Aug. 21, 2014); Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Justice Department, Federal and State Partners Secure Record $7 Billion Global Settlement with Citigroup for Misleading Investors About Securities Containing Toxic Mortgages (July 14, 2014).
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United States ex rel. O’Donnell v. Countrywide Home Loans, Inc., No. 15-496(L), Dkt. No. 203 (Aug. 4, 2016); id., Dkt. No. 206 (Aug. 22, 2016).
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See, e.g., Wells Fargo Bank, 972 F. Supp. 2d at 599-603; Wells Fargo Bank Agrees to Pay $1.2 Billion for Improper Mortgage Lending Practices, supra note 7.
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See Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Manhattan U.S. Attorney and New York State Attorney General Announce $714 Million Proposed Settlement with The Bank of New York Mellon Over Fraudulent Foreign Exchange Trading Practices (Mar. 19, 2015); see also Bank of N.Y. Mellon, 941 F. Supp. 2d at 442-43.
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See, e.g., Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Justice Department Announces Settlement with California Bank for Knowingly Facilitating Consumer Fraud (Mar. 12, 2015) (settlement with Plaza Bank of Irvine, California); Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, CommerceWest Bank Admits Bank Secrecy Act Violation and Reaches $4.9 Million Settlement with Justice Department (Mar. 10, 2015),.