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'Hustle' Mortgage Fraud Case Falls Into Crevice of the Law

nytimes.com | June 1, 2016

By Peter J. Henning

Proving fraud usually starts with finding a lie made to mislead someone into pursuing a transaction or spending money when they would not have done so if they knew the truth.

Figuring out exactly what constitutes the type of deception that can support a case remains a challenge, however, as shown by a federal appeals court decision last week. The United States Court of Appeals for the Second Circuit in Manhattan threw out one of the few verdicts finding fraud in how banks handled mortgages before the meltdown in the housing market.

When the story of the lack of prosecutions from the financial crisis is finally written, the most important issue will be how difficult it turned out to be to prove fraud. The courts have held the government to a high standard, refusing to uphold cases in which the conduct came close to the line but never quite crossed over into a violation.

The appeals court overturned a jury verdict finding that Bank of America’s Countrywide mortgage unit and a former executive, Rebecca Mairone, violated the federal mail and wire fraud statutes for selling poor-quality mortgages to Fannie Mae and Freddie Mac in 2007 and 2008. Judge Jed S. Rakoff of the United States District Court in Manhattan presided over the trial and imposed a civil penalty of $1.27 billion on the bank and a separate $1 million penalty for Ms. Mairone.

The Justice Department filed the case under a provision of the Financial Institutions Reform, Recovery, and Enforcement Act, known as Firrea, which authorizes civil penalties for violations of the federal fraud laws that affect a financial institution. That law led to substantial settlements with banks for their subprime mortgage practices, including a record $16.65 billion settlement by Bank of America in 2014 for other mortgage-related violations.

This was the only case to go to trial under the statute, setting what seemed to be a benchmark for proving fraud in connection with questionable mortgage practices. The government introduced evidence that a Countrywide program called the High-Speed Swim Lane, or “hustle,” resulted in providing mortgages that did not meet the requirements set forth in contracts permitting them to be sold to Fannie and Freddie. Ms. Mairone oversaw the program that the government claimed caused more than $1 billion in losses to the two housing finance companies.

Judge Rakoff wrote that the hustle program was “the vehicle for a brazen fraud,” but the appeals court focused on the much narrower question of when a breach of contract can amount to a violation. Countrywide may well have known it was spewing bad loans that fell short of its contractual obligations for selling them, but the appellate judges concluded there was no affirmative misstatement about the quality of its mortgages at the time they were sold.

According to the appeals court, the key question is whether “willful but silent noncompliance” constituted “a fraud — a knowingly false statement, made with intent to defraud — or is it simply an intentional breach of contract?” There was no evidence that Countrywide made a false statement when it signed the contracts with Fannie and Freddie, only that it later decided to breach the agreement by selling bad mortgages without alerting the companies to that fact. Therefore, the Justice Department failed to “prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim.”

In the criminal law, which this case involved even though it was brought as a civil Firrea lawsuit, there must be what is known as a “concurrence of the elements.” For fraud, the misstatement and the intent to defraud must be present at the same time, so that a subsequent decision to intentionally violate an agreement by supplying a shoddy product does not establish that a misstatement took place with the requisite intent at the time the contract was signed.

Is this just a legal technicality that allows Bank of America to avoid liability? The answer is “yes and no” — what else do you expect from an academic?

It is a technicality because the bank knew its mortgages did not meet the terms of the contracts but never alerted Fannie and Freddie that it was selling them bad loans that would cause significant losses. A buyer expects the seller to adhere to the terms of the contract, or to try to withdraw from it otherwise, so normally one can assume that silence on Countrywide’s part meant it was meeting its legal obligations for the loans it sold.

Bank of America avoided the penalty because it found a loophole that meant it did not lie when it sold the bad mortgages, only that it breached the agreement in a way that fell short of being a fraud.

But the answer is also “no” because a basic requirement for proving fraud is that the government show there was an affirmative misstatement, or that the party that remained silent had a duty to speak. A contractual relationship does not impose such a duty unless it is an explicit term of the agreement.

Fannie and Freddie could have easily avoided the problem by including a requirement that the seller of mortgage loans certify that they were in compliance with the contract. That simple step that would have alerted the companies to problems in what Countrywide was selling — or been the basis for a fraud claim if the company said nothing about meeting the mortgage standards.

So the hustle case falls into a crevice in the law. Fraud requires a deception, and that those accused of a violation knew that their statement or silence was in fact misleading. Just breaching a contract, standing alone, will not be enough to prove fraud.

The case’s greatest impact may be on private civil suits brought under the Racketeer Influenced and Corrupt Organizations Act, better known as RICO. Those cases often involve contractual disputes that are alleged to have been violations of the mail and wire fraud statutes, a claim that will be harder to prove after the Bank of America case.

The appeals court’s decision fits a pattern in recent appellate cases in which misleading statements were found not to rise to the level of fraud, or at least raised a sufficient question about a violation that a conviction had to be overturned.

In United States v. Weimert, the United States Court of Appeals for the Seventh Circuit in Chicago in April overturned the wire fraud conviction of a former bank officer who misled both sides in a deal by his employer to sell its share of a commercial real estate development. Because the misstatements took place during the negotiations for the transaction, the appellate judges found there was not a fraud because each side expects their counterpart will be less than forthcoming about their position.

“To state the obvious, they will often try to mislead the other party about the prices and terms they are willing to accept. Such deceptions are not criminal,” the appeals court stated.

In December, the United States Court of Appeals for the Second Circuit overturned the securities fraud conviction of Jesse C. Litvak, a former Jefferies & Company trader, for misleading buyers about the prices the firm paid for residential mortgage-backed securities. Mr. Litvak wanted to introduce evidence to support his defense that institutional investors like those he dealt with did not care about what Jefferies paid for the securities.

In finding that the evidence should have been admitted, the appeals court said that “a jury could reasonably have found that misrepresentations by a dealer as to the price paid for certain R.M.B.S. would be immaterial to a counterparty that relies not on a ‘market’ price or the price at which prior trades took place, but instead on its own sophisticated valuation methods and computer model.”

There is an intuitive sense that deception resulting in losses must be fraudulent. But the appeals courts have taken a stricter view, making it more difficult to prove fraud in cases involving ordinary business transactions, even in some instances when it can be shown a statement was false.




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CFLA was founded by the Nation's Leading Foreclosure Defense Attorneys back in 2007 to serve the Foreclosure Defense Industry and fight pervasive Bank Fraud. Since opening our virtual doors, CFLA has rapidly expanded to become the premier online legal destination for small businesses and consumers. But as the company continues to grow, we're careful to hold true to our original vision. For us, putting the law within reach of millions of people is more than just a novel idea—it's the founding principle, just ask Andrew P. Lehman, J.D.. With convenient locations in Houston and Los Angeles, you can contact Our National Account Specialist and General Manager / Member Damion W. Emholtz at 888-758-2352 for a free Mortgage Fraud Analysis or to obtain samples of work product, including cutting edge Bloomberg Securitization Audits, Litigation Support, Quiet Title Packages, and for more information about our Nationally Accredited and U.S. Department of Education Approved "Mortgage Securitization Analyst Training Certification" Classes (3 days) 24 hours for approved CLE & MCLE Credit (Now Available Online).

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