(Reuters) - The Justice Department’s long-running and extremely remunerative campaign to punish banks that packaged and sold allegedly misrepresented residential mortgage-backed securities culminated Thursday in a 302-page complaint in federal court in Brooklyn against the Swiss bank UBS. UBS, which stands accused of deceiving investors about the quality of more than $41 billion in mortgage loans underlying 40 MBS offerings in 2006 and 2007, is apparently the last bank in DOJ’s sites, after a string of settlements with more than a dozen U.S. and foreign banks that has netted the Justice Department tens of billions of dollars.
UBS’ lead lawyer, Robert Giuffra of Sullivan & Cromwell, told me Friday that the bank has no intention of settling anytime soon. UBS has been talking to the Justice Department about its MBS offerings for years and, according to my Reuters colleagues, turned down a government offer to settle the case for $2 billion. It’s not a coincidence that, as Giuffra puts it, “We are the last bank standing.”
Many of UBS’ anticipated defenses, which the bank outlined in an unusually detailed press release responding to the government’s complaint, are specific to this case. UBS contends, for instance, that it lost $45 billion in MBS investments, including $900 million in securities it purportedly misrepresented to investors, so it’s more accurately portrayed as a victim of the meltdown in mortgage-backed securities than a fraudster capitalizing on demand for the securities. The bank also points to its success against private investors who pursued securities fraud allegations that parallel the Justice Department’s case; the 2nd U.S. Circuit Court of Appeals concluded (752 F.3d 173) investors couldn’t show UBS intended to defraud them.
But for other banks and securities issuers, the important issue in the UBS case is the Justice Department’s expansive view of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. If UBS follows through with its vow to litigate this case vigorously, it will test the limits of a law that, depending on your perspective, has either permitted the government to hold banks accountable for widespread fraud that nearly brought down the entire economy or has cast a shadow of unwarranted liability over every securities offering in which a U.S. bank participates.
As you surely recall, in the wake of the 2008 financial crisis, the Justice Department dusted off and repurposed FIRREA, a law that arose from the 1980s savings-and-loan scandals in which S&L insiders looted their institutions. DOJ lawyers came up with a theory that FIRREA’s fraud provisions could be read to apply to banks’ representations about mortgage-backed securities. That theory allowed the government to take advantage of FIRREA’s 10-year statute of limitations – an important consideration since DOJ didn’t sue banks over MBS until 2013, after time ran out for ordinary securities claims - and steep penalties.
Banks protested that FIRREA was supposed to protect federally insured financial institutions from criminals in their ranks – not to be used as a weapon against those very institutions. The Justice Department countered with arguments that U.S. banks were liable under FIRREA because they hurt themselves when they engaged in fraud. Countrywide challenged that proposition at the 2nd Circuit in 2015, after it was hit with a billion-dollar FIRREA jury verdict for allegedly defrauding Fannie Mae. The 2nd Circuit didn’t end up reaching that issue, instead erasing the jury verdict because DOJ hadn’t proved Countrywide intended to defraud Fannie Mae at the time it sold the MBS (822 F.3d 650). The 2nd Circuit’s Countrywide ruling is the only appellate decision addressing DOJ’s use of FIRREA to police securities fraud.
UBS is a foreign bank uninsured by the U.S. government, so DOJ’s so-called self-affecting theory doesn’t apply. Instead, the government alleges that UBS is liable for selling allegedly misrepresented MBS to U.S. financial institutions that fall under FIRREA’s aegis.
That’s an extremely potent theory because the Justice Department alleges UBS is liable not just for purchases by U.S.-insured financial institutions but for the entire face value of offerings in which a U.S. bank participated. In other words, according to the government, if a U.S. financial institution invested $1,000 in a million-dollar offering, UBS is liable under FIRREA for the entire $1 million.
“I think the government is on thin ice with this issue,” said MBS litigation expert Donald Hawthorne of Axinn Veltrop & Harkrider, who is not involved in the UBS case. “If I were a judge, I’d be really concerned about the government’s theory. When you say it out loud, it sounds like overreaching.” (Hawthorne pointed out that another foreign bank, Barclays, argued against government overreaching in an October 2017 motion to dismiss a DOJ FIRREA case but ended up settling for $2 billion before a ruling on its motion.)
I have a strong suspicion that UBS’ arguments about FIRREA overreaching will track a November 2017 white paper that the Securities Industry and Financial Markets Association submitted to the Justice Department. SIFMA, citing comments by high-ranking Trump officials who said DOJ would no longer leverage criminal laws to extract big civil settlements from corporations, urged DOJ to curb its use of FIRREA. At a minimum, SIFMA said, the Justice Department should restrict FIRREA claims to losses incurred by U.S. banks that actually relied on the alleged misrepresentations.
SIFMA’s two strongest arguments were that DOJ’s “boundless interpretation of FIRREA” adds a big threat of liability to virtually all securities offerings and that the government’s use of the statute interferes with the Securities and Exchange Commission’s role as the enforcer of securities laws. “DOJ’s interpretation of FIRREA upends the civil securities fraud enforcement regime, displacing the SEC’s regulation of the capital markets and setting up FIRREA as a nuclear option for DOJ,” the white paper said. Nothing in FIRREA’s text or legislative history suggests that its purpose was to give DOJ the power to impose penalties on the basis of garden-variety securities claims against issuers and underwriters in registered securities offerings.”
Giuffra echoed those themes in our interview. “Before these cases, FIRREA was not used as thermonuclear securities law,” he said. “DOJ is upending the role of the SEC as primary civil securities enforcer.”
MBS expert Hawthorne said the government will probably dig in to defend its use of FIRREA, for the very reasons the SIFMA brief cites: The statute allows DOJ to claim bigger penalties, over a longer timeframe, than the SEC could seek under ordinary securities laws. “It’s an all-purpose fraud tool,” Hawthorne said.
Ten years after the MBS market imploded, the UBS case may shape the government’s weapons for the next big financial crisis. As Yogi Berra used to say, it ain’t over til it’s over.
The views expressed in this article are not those of Reuters News.