NEW YORK—The Justice Department and whistleblowers are increasingly making use of a Civil War-era law to target financial services firms for allegedly defrauding the federal government, litigation lawyers told BNA in May.
The False Claims Act, enacted in 1863, was materially strengthened in the 1980s and again in the early 21st century to combat government losses incurred when entities present a false claim to the government for payment.
While the statute to date has largely been used to combat fraud involving payments to military contractors, federally funded health care entities such as Medicare, and pharmaceutical firms, plaintiff and defense bar lawyers said they expect an uptick in cases alleging False Claims Act violations by financial services firms. Indeed, the Justice Department in May launched cases involving several large financial firms in New York and California.
Practitioners said two events will spark the increase in financial services firm cases: the government’s massive injection of taxpayer dollars into the financial services sector during the 2007-2009 financial crisis and a lingering public perception that a degree of abuse occurred in the sector during the crisis and indeed may continue to persist.
U.S. Attorney for the Southern District of New York Preet Bharara told reporters May 3 after announcing the assertion of a False Claims Act case against a financial institution that it would not be “fantastical” to imagine his team of prosecutors is currently developing additional lawsuits against banks using the False Claims Act.
Origins of Statute.
Congress originally approved the law during the Civil War in response to unscrupulous vendors defrauding the armed forces, including providing the U.S. Army with deficient armaments. After that period, the law was used infrequently, in part because of what some plaintiffs’ bar lawyers said were statutory limitations contained in the law’s original language.
Passage of the False Claims Act Amendments statute (
The 1986 law expanded the statute’s reach, revised procedures for civil actions, trebled damages, increased penalties to a range from $5,000 to $10,000 per civil liability claim, and potentially increased financial payouts to individuals known under the law as “relators”—whistleblowers—who launch cases on their own, cases which later could be joined by federal prosecutors.
The act was further amended by the Fraud Enforcement and Recovery Act (
‘Immensely Powerful Tool.’
The law creates liability for any person who knowingly submits a false claim to the government, causes another to submit a false claim to the government, or knowingly makes a false record or statement to get a false claim paid by the government.
Knowledge of a false claim is the statutory threshold for a successful claim; intent is not required. The statute’s definition of knowledge includes reckless disregard of the truth.
The statute as amended “is an immensely powerful tool” for the government, Kelley Drye & Warren LLP partner Sarah L. Reid told BNA May 5. “I think that they will, and are, seeing the value of moving it into the financial services area,” she said.
Indeed, Phillips & Cohen LLP founding partner Mary Louise Cohen told BNA May 18 that casual conversations with DOJ officials inform her that the government fully expects an increase in FCA cases involving financial services firms.
“In conversations with people at the Justice Department—we frequently have conversations among members of our bar at conferences—it became clear that they anticipate seeing these cases, … they expect to see TARP cases, they expect to see financial cases,” said Cohen, whose firm specializes in representing whistleblowers.
‘Relator’ Provisions.
False Claims Act cases may launched against an entity by the Justice Department. Relators, or whistleblowers, may also file qui tam lawsuits on behalf of the government. Whistleblower-generated cases are sealed while the government investigates merits of the cases. Cases may be sealed for years.
In cases the government joins, the whistleblower may receive between 15 to 25 percent of the settlement. In cases where the government does not join but the individual presses on alone and wins, the whistleblower is awarded between 25 and 30 percent of the judgment. Reasonable expenses and attorneys’ fees in either case structure are available to prevailing plaintiffs.
“What is clear and what government officials are talking about, now more than even when I was working in the department, is that the statute has become all about paid informants,” HoganLovells LLP partner Jonathan Diesenhaus told BNA May 16.
“It’s all about bringing fresh information from inside an organization to the government in contexts where you just wouldn’t find out about it otherwise,” said Diesenhaus, who worked with whistleblowers to develop cases during 1998-2005, when he worked at the Justice Department.
Number of Cases Increasing.
The Justice Department recorded a total of $27 billion in settlements and judgments between 1987 and Sept. 30, 2010 and paid out $2.9 billion in whistleblower awards, department data said. The Justice Department as of Sept. 30, 2010 was investigating 1,246 False Claims Act cases, the data said.
Diesenhaus said a Justice Department official attending a May 2011 seminar in Miami told seminar attendees government-filed FCA cases nearly doubled since the beginning of FY 2011 compared with FY 2010, cases Diesenhaus said likely relate to the financial services industry.
“The number of cases [involving financial services firms] is trending up….We are going to see more cases in that area, we are starting to see signs of it,” Diesenhaus said. The 2007-2009 financial crisis, he added, will “induce whistleblower attorneys to see if there are real cases out there and that the government is also interested in it, in financial services.”
“A lot of people will say this type of litigation goes in waves: it starts in the defense industry and then it winds up in the health-care industry and now we’re financial fraud. I think that’s one way to think about it,” Vinson & Elkins LLP partner John Faust told BNA May 10.
Delay in Cases Being Filed.
The actual number of cases currently being developed by the government against financial firms is necessarily not known because prosecutors are currently working on them. “To the extent these are going to come to fruition, you should be seeing them in the next year or so,” Reid said.
But the combination of significant amounts of government spending and once-again profitable banks will likely encourage potential whistleblowers to launch cases, the lawyers said. “You’ll see a large increase in cases wherever you see a large increase in government spending,” Motley Rice LLC partner and former prosecutor Mark Labaton told BNA May 12.
Indeed, the lawyers said because of the controversial nature of the government assistance to banks and others during the financial crisis plus the sheer amount of money involved in the assistance, it is highly likely a significant increase in cases will occur.
“[I]n whatever historical context you’re looking at, either defense or Medicare or whatever, in essence you follow the money. If there’s an awful lot of federal money being pumped into the [financial] system you can expect you’re going to see some increase in FCA litigation because federal money is the hook for that sort of litigation…. That’s the indicator that you’re going to see more action in this area,“ Faust said.
Recent Justice FCA Cases.
Two recent cases illustrate the trend. In a May 3 complaint, the Justice Department alleged a wholly owned Deutsche Bank AG subsidiary fraudulently misrepresented its mortgage lending and underwriting practices for years while participating in a federal mortgage-insurance program (United States v. Deutsche Bank AG, S.D.N.Y., No. 11-cv-2976, complaint filed 5/3/11).
The complaint asserted the subsidiary repeatedly lied to federal regulators in order to qualify for a Housing and Urban Development program, and once a program participant engaged in reckless mortgage lending practices that resulted in underwriting government-insured mortgages totaling more than $5 billion in underlying principal obligations; to date $386 million of the mortgages have defaulted and had to be repaid by the government (
The second case, brought by whistleblowers Derek and Nancy Casady and subsequently joined by the government, alleged the American International Group Inc. concealed its true financial condition and presented ineligible collateral in order to obtain $85 billion in emergency funds from the federal government in September 2008 (United States and Derek Casady v. American International Group Inc., S.D. Cal., No. 10-cv-0431, filed under seal 9/30/10, unsealed 4/28/11).
The complaint asserted AIG then used the $85 billion to meet collateral calls on collateralized debt obligations (CDOs) that were fraudulently constructed by AIG counterparties, including Goldman Sachs Group Inc. and some of its subsidiaries as well as Societe Generale SA—firms also named as defendants in the lawsuit.
A May 3 Deutsche Bank statement labeled the allegations “unreasonable and unfair” and said the bank intends to defend itself against the charges “vigorously.” And an AIG spokesman told BNA May 16 the AIG complaint’s claims are “devoid of merit.” Mark Herr, the spokesman, also said a similar case brought against by the same plaintiffs in state court was dismissed for failure to state a claim.
Case Development.
Those cases could instigate an interest in constructing new cases, the lawyers said.
“These two cases coming out when they did against very well known institutions with a lot of money at stake does, at least to me, give some indication that the government is looking to use the FCA and other antifraud statutes to, quote, do something, unquote, about the financial collapse,” Faust said.
“We know there is enormous public pressure to identify whoever was responsible for what’s happened to our economy and `do something’ about it. And we know, too, that there’s a great deal of federal money in the system right now that has been and will be spent to deal with the collapse of the housing market and securitization issues…. There is enormous public interest in recovering those federal dollars,” Faust said.
BuckleySandler LLP partner Benjamin B. Klubes told BNA May 12 he predicts that the number of cases involving financial services firms as a percentage of all FCA cases will increase as a percentage of all cases while the number of cases involving other industries will likely decrease as a percentage of all cases.
The False Claims Act “is a tool of the government that kind of moves with public perceptions of abuses as well as actual dollars spent. And I think what you’re going to see is a shift toward financial services,” Klubes said.
Types of Future Claims.
The lawyers said they could envision many types of FCA cases against financial services firms, and even more if the plaintiffs’ bar applies the law creatively.
Financial firms originating government-backed mortgages that ultimately defaulted, such as in the Deutsche Bank case, would be one area, they said. Firms purchasing and then securitizing government-backed loans into new securities that suffered default could be another possible area of asserting claims, they said.
Money lent to banks or other institutions under the Troubled Asset Relief Program (TARP) is another area. TARP money was allocated not only to banks but to AIG, domestic automobile firms, and others.
Other TARP programs aimed at assisting the housing market, including the Home Affordable Modification Program or HAMP, received approximately $50 billion; the programs in part paid mortgage servicers fees if they represented to the government they met certain goals. The lawyers said banks could face FCA exposure if they made false representations when applying for the fees.
Creative Theories.
The lawyers varied in their opinions regarding possible False Claims Act cases involving government financial support for domestic automobile manufacturers and the government-sponsored enterprises Fannie Mae and Freddie Mac.
But they also said plaintiffs could develop “creative” theories of how banks knowingly profited from government loans, grants, and other assistance during the 2007-2009 financial crisis that resulted in government losses. One lawyer, for instance, said bank losses guaranteed by the Federal Deposit Insurance Corp. may be able to be targeted.
“When you’re seeing this level of federal bailout and other money flowing into the system to deal with the near collapse of the housing market and the financial services industry, there’s enormous incentive for both the government and private relators to get creative in their theories,” Faust said.
Advice to Banks.
The Deutsche Bank complaint alleged in part the bank did not place adequate due diligence regimes in place to monitor for potentially fraudulent actions, an indication that government investigators may scrutinize banks’ due diligence practices during FCA cases, the lawyers said.
Banks, thus, should ensure their internal compliance plans established to combat fraudulent actions are current and bank employees are aware of those plans and have received any needed training to implement the plans, the lawyers said.
“A lot of lawyers are going to advise their clients about in the FCA context, to say, `Look, the government is focused not only what you do or say to actually get government funds, but if you’re in this arena they are going to be demanding due diligence from you and quality compliance programs if you’re doing business with the government,” Faust said.
“That’s one bit of advice I think a lot of companies are getting from their lawyers right now,” he said.
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