Tuesday, May 31, 2016

Bankster Dodges $1.3 Billion Judgment For Stuffing Crappy Home Mortgages Into Investor Portfolios; Federal Appeals Court Accepts BofA's 'We Didn't Mean To' Defense, Saying Racket Wasn't Really A Fraud - "At Most An Intentional Breach Of Contract", Ruling Gives White-Collar Wrongdoers "An All-Purpose Get-Out-Of-Jail-Free Card"

Financial columnist Michael Hiltzik writes in the Los Angeles Times:
  • If I'm ever dragged into court for a financial fraud, I want to throw myself on the mercy of Judge Richard C. Wesley.

    Wesley is the U.S. appeals court judge in New York who, with his colleagues Reena Raggi and Christopher F. Droney, found a loophole in federal fraud law big enough for the nation's second-largest bank to fit through without even scratching a fender. In a ruling written by Wesley and issued [last week], the three judges tossed out a $1.3-billion judgment against Bank of America for stuffing thousands of lousy mortgages into the portfolios of Fannie Mae and Freddie Mac in 2007 and 2008 by pretending they were high-quality loans. Their ruling turned on the curious question: "When is a fraud not a fraud, but just, sort of, a lie?"(1)

    Anyone concerned about white-collar crime should be find the appellate court's logic appalling. One who does is Dennis Kelleher, a former corporate lawyer who is now CEO of the financial watchdog group Better Markets.(2) "You wonder why the American people are so cynical," he told me after the decision came down. "It's because there's an endless reservoir of ways to figure out how to hold no one accountable for illegal conduct."

    In Monday's decision, the appellate judges didn't actually question that the mortgages sold to Fannie and Freddie by BofA (originally via Countrywide Financial, the subprime lender BofA acquired in 2007) weren't the quality they were claimed to be. Indeed, they didn't really address at all that question, which was analyzed in great detail by the trial court judge who imposed the $1.3-billion penalty, New York Federal Judge Jed S. Rakoff.
    ***
    The judges based their ruling on the contracts that Countrywide had reached with Fannie and Freddie, pledging to provide those government-sponsored firms with "investment quality" mortgages. There was no evidence, the appellate judges found, that the executives who signed those contracts intended at the time to stuff the pipeline with toxic junk. It just turned out that way.

    Because there was no intent to defraud when the contracts were signed, the judges ruled, this whole affair is merely a case of breach of contract, not fraud. The penalties for a breach are much lower than those for fraud--often, the guilty party has to give back the money it got from breaking the contract. According to the judges' analysis, a mere breach of contract can't be elevated into a case for fraud.
    ***
    The biggest danger with the court's exoneration of the bank, however, is that it provides a road map for white-collar wrongdoers to evade responsibility. Breach-of-contract damages, as Kelleher says, have "zero deterrent effect -- there's no downside for committing the fraud." You either get away with it and pocket the gains, or you get caught, and have to give back the money. The way to stamp out fraud, however, is to make punishment greater than the potential gains.

    That course was closed off by the appeals judges. Wrongdoing executive now know they only have to dredge up a preexisting contract "breached" by their behavior--since few businesses enter into contract plotting in advance to make it the vehicle for fraud, this becomes an all-purpose get-out-of-jail-free card.

    It's quite possible that the appeals court happened upon a loophole that had been lying around for years. If that's the case, Congress should close it, quick. On the other hand, Judge Rakoff anticipated and rejected that argument, and even pointed out that Congress closed the loophole by amending the mail fraud statute -- in 1909. It's also likely that the government will appeal the latest ruling to the full 2nd circuit court, and thence, if necessary, to the Supreme Court.

    The loophole Judges Wesley, Raggi, and Droney identified should hearten anyone motivated by pure greed in financial dealings. For the rest of us, it's a ticking time bomb, until Congress or the courts extinguish the fuse.
For the story, see The legal technicality that let BofA skate on an alleged billion-dollar mortgage fraud.

See also, ProPublica/The New Yorker: Bank of America’s Winning Excuse: We Didn’t Mean To (A federal appeals court overturned a $1.3 billion judgement against Bank of America, ruling that good intentions at the outset shield bankers from fines for subsequent fraud):
  • [T]he 2nd U.S. Circuit Court of Appeals looked at that judgment and asked this question: If a entity (in this case, a bank) enters into a contract pure of heart and only deceives its partners afterward, is that fraud?

    The three-judge panel’s answer was no. Bank of America is no longer required to pay the judgment.
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(1) See United States, ex rel. O'Donnell v. Countrywide Home Loans, Inc., Nos. 15-496, 15-499 (2d Cir. May 23, 2016):
  • On appeal, Defendants argue that the evidence at trial shows at most an intentional breach of contract—i.e. that they sold mortgages that they knew were not of the quality promised in their contracts—and is insufficient as a matter of law to find fraud.

    We agree, concluding that the trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises. Accordingly, we reverse with instructions to enter judgment in favor of Defendants.
(2) Mr. Kelleher, on behalf of Better Markets, Inc., submitted a "friend of the court" brief in this case in support of upholding the trial court's $1.3 billion judgment against Bank of America.

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