BofA Fails to Win Dismissal of U.S. Mortgage Fraud Suit

bloomberg.com | June 22, 2014

Bank of America Corp. failed to win dismissal of a U.S. Justice Department lawsuit in which it’s accused of misleading investors about the quality of loans tied to $850 million in residential mortgage-backed securities.

U.S. District Judge Max O. Cogburn Jr. in Charlotte, North Carolina, gave the Justice Department 30 days to revise the suit after a magistrate judge earlier found the government’s complaint was deficient and recommended it be dismissed.

The case is part of a U.S. bid to punish companies for actions it says helped trigger the financial crisis. The Bank of America case and others like it rely on a law dating to the savings-and-loan crisis of the 1980s that allows the government to punish actions taken too long ago to be covered by other laws. It also lets the U.S. seek larger damages awards.

“The court need not reach far outside the complaint or be an expert in economics to take notice that it was the trading of toxic RMBS between financial institutions that nearly brought down the banking system in 2008,” Cogburn said in his ruling today.

Bank of America will still have a chance to challenge the amended complaint and could appeal any ruling against it.

Lawrence Grayson, a spokesman for the Charlotte-based bank, declined to comment on the ruling.

In a parallel fraud lawsuit by the U.S. Securities and Exchange Commission over the same securities, the same magistrate judge recommended on March 31 that Bank of America’s motion to dismiss the case be denied, saying the regulator had properly laid out its claims. Bank of America objected to that recommendation, and a ruling by Cogburn could come at any time.

‘Sophisticated’ Institutions

The bank in December 2007 told Wachovia Corp. and the Federal Home Loan Bank of San Francisco, which bought about 98 percent of the securities, that most of the mortgages were acquired wholesale, according to court papers. That wasn’t disclosed in the securities prospectus, the government claims.

In its bid to dismiss the case, Charlotte-based Bank of America argued the disputed securities were sold to two “sophisticated” financial institutions around 2007 and 2008, a few months before the U.S. real estate market collapsed. Those institutions never sued, the bank said.

The U.S. seeks to “fundamentally rewrite the securities laws by criminalizing immaterial misstatements,” the bank said its filing. “With the benefit of hindsight, the government alleges that the bank should have provided these investors with more information about the risk of their investment.”

Targeted Companies

If the case had been dismissed, it would have been a first for about a dozen companies that have been targeted under the Financial Institution Reform, Recovery and Enforcement Act of 1989, or FIRREA, which lets the government sue people or groups, rather than charge them with a crime, for fraud that affects a federally insured financial institution.

A magistrate judge on March 27 recommended that the case be dismissed without giving the government the option to fix any defects. The Justice Department countered that the recommendation ignored legal standards for bringing a lawsuit and relied on incorrect factual findings.

The rarely used law has advantages: It imposes a lower burden of proof than a criminal prosecution and threatens penalties of more than $1 million for each fraudulent statement or act. FIRREA also gives prosecutors 10 years to file, rather than the five years under some criminal and civil statutes. Banks fighting to get FIRREA cases dismissed have yet to succeed.

Fannie Mae Case

In a New York case, Bank of America was found liable by a federal jury last year after a trial over claims that its Countrywide unit defrauded Fannie Mae (FNMA) and Freddie Mac (FMCC) by selling them billions of dollars in bad mortgages. U.S. District Judge Jed Rakoff is now weighing a penalty, with prosecutors seeking the maximum of $863 million.

In the North Carolina case, the Justice Department said the lender portrayed its bonds as being backed by prime loans vetted by its staff, even though most were riskier wholesale mortgages originated by outside brokers. Some were “PaperSaver” loans that didn’t require proof of borrowers’ income, the U.S. said.

The case is U.S. v. Bank of America Corp. (BAC), 13-cv-00446, U.S. District Court, Western District of North Carolina (Charlotte).