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United States v. Countrywide Financial Corporation

United States District Court, Second Circuit

August 16, 2013



JED S. RAKOFF, District Judge.

The Government, having intervened in what began as a "qui tam" case, brings this civil fraud action against defendants Countrywide Financial Corporation, Countrywide Home Loans, Inc., and Countrywide Bank, FSB (collectively, "Countrywide"), Bank of America Corporation, and Bank of America, NA (collectively, "BofA"), and individual defendant Rebecca Mairone, the Chief Operating Officer of Countrywide's Full Spectrum Lending division during the period relevant to this case. The Government alleges that the defendants engaged in fraud and made false representations in connection with the sale of loans by Countrywide and BofA to the Government-sponsored entities Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac"), all in violation of the False Claims Act, 31 U.S.C. §§ 3729(a)(1)(A) & (B), and the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA"), 12 U.S.C. § 1833a(c)(2). The FIRREA violations, in turn, are predicated on civil violations of the mail fraud and wire fraud criminal statutes, 18 U.S.C. §§ 1341 and 1343. See Amended Complaint ("Am. Compl.") ¶¶ 218-27.

On December 21, 2013, the defendants moved to dismiss the Government's then-operative complaint on three grounds: first, that the complaint failed to state a claim under FIRREA because the sale of loans to Fannie Mae and Freddie Mac did not directly "affect" a federally insured financial institution as required by the statute; second, that the complaint also failed to state a claim under FIRREA because the predicate mail and wire fraud violations were premised on statements that did not, as a matter of law, constitute fraudulent misrepresentations; and third, that the complaint failed to state a cause of action under the False Claims Act for false claims made after May 20, 2009, the date on which liability under the False Claims Act was broadened to reach false claims made to entities like Fannie Mae and Freddie Mac.[1] In addition, individual defendant Mairone moved to dismiss the FIRREA counts against her on the ground that the complaint failed to adequately plead facts that would support an inference that she acted with the requisite intent.

In response to defendants' motion, the Government, with leave of Court, amended its complaint on January 11, 2013, after which the Court permitted the defendants to renew their motions and to supplement their moving papers. There followed additional briefing by both parties, after which the Court heard oral argument on April 29, 2013. On May 8, 2013, the Court issued a "bottom-line" Order granting the defendants' motions to dismiss the False Claims Act counts but denying their motions to dismiss the FIRREA counts. This Opinion explains those rulings.

On a motion to dismiss under Federal Rule of Procedure 12(b)(6), the Court takes all well-pleaded allegations as true. Since, however, the claims here sound in fraud, the circumstances constituting fraud must be pleaded with particularity. See Fed.R.Civ.P. 9(b). For purposes of the instant motions, the well-pleaded factual allegations include the following:

Government-sponsored entities such as Fannie Mae and Freddie Mac purchase single-family mortgages from lenders like the defendants based on the lenders' representations and warranties that the loans comply with the standards outlined in applicable "guides" and "master" agreements. These guides and agreements set forth, among other things, underwriting, documentation, quality control, and self-reporting requirements. See Am. Compl. ¶ 36. The relevant requirements include, for example, the lenders' representations that they employ prudent underwriting and quality assurance checks and that the lenders will self-report loans that they identify as fraudulent, noncompliant with guidelines, or otherwise materially defective. Id.

Pursuant to these requirements, when the defendants sold loans to Fannie Mae, they represented that each loan conformed "to all the applicable requirements in [the] Guides and this [Master] Contract" and that the seller knew "of nothing involving the mortgage, the property, the mortgagor or the mortgagor's credit standing that [could] reasonably be expected to: cause private institutional investors to regard the mortgage as an unacceptable investment; cause the mortgage to become delinquent; or adversely affect the mortgage's value or marketability." Id . ¶ 39. In representing to Fannie Mae that each loan was an acceptable investment, the defendants further warranted that all required loan data was true and complete, that certain underwriting conditions were met for loans processed through automated systems, and that no fraud or material misrepresentation had been committed. Id . ¶ 41. Freddie Mac's guides and purchase contracts imposed similar requirements on loans sold to it by the defendants. Id . ¶¶ 44-45.

The Government alleges that notwithstanding these requirements - indeed, at a time of increasingly tight underwriting requirements imposed as the secondary market for single-family loans became more conservative - Countrywide sought to quickly boost its loan revenue by fraudulently modifying its loan origination process. Id . ¶ 66. More specifically, the Government alleges that in order to achieve its aim of maintaining its historically high revenue despite a cratering market for subprime mortgages, Countrywide's Full Spectrum Lending division initiated, in August 2007, a loan origination program called the "High Speed Swim Lane, " or "HSSL."

Ostensibly, the HSSL program was designed to reduce the number of days spent processing loans from 45-60 days to 10-15 days, with some loans processed within a single day. Id . ¶¶ 68-69. To achieve this reduction, however, the HSSL program reduced effective oversight of the loans and removed most of the so-called "toll gates" that were previously set up to ensure loan quality. For example, the HSSL program eliminated underwriter review of many riskier loans, and eliminated the position of "compliance specialist, " a position intended to perform a final independent check on a loan application before the loan was funded. Id . ¶¶ 70-71, 79. Instead, under the HSSL program, a "loan processor" simply verified that the data about a given loan that were entered into an automated loan processing system actually matched the underlying loan documentation. Id . ¶¶ 50, 70. Similarly, under the HSSL system, loan processors could fully process "stated income" loans (i.e., loans that require no documentation of a borrower's income) without oversight from an underwriter or other checks that were part of traditional mortgage processing. Id . ¶¶ 71-73. The HSSL program also removed the requirement that the loan processors complete underwriting checklists and how-to forms called "job aids" that were designed to assist reviewers in performing underwriting tasks, such as how to assess the reasonableness of stated income and how to review an appraisal. Id . ¶¶ 77-78.

According to the Amended Complaint, the HSSL program, by removing these, and other safeguards against originating dubious loans, effectively guaranteed that the loans that would thus be sold to Fannie Mae and Freddie Mac were of lower quality than represented. Id . ¶¶ 68-69.

The Amended Complaint further alleges that the riskiness of the HSSL program was enhanced by the introduction of compensation incentives that increased loan approval rates at the expense of loan quality. In particular, Countrywide introduced a "turn time" bonus for loan specialists and funders who moved their loans quickly, id. ¶ 80, and imposed quotas on loan specialists to fund 30 loans per month and a minimum of one loan every day. Id . In an HSSL center in Richardson, Texas, for example, loan specialists were instructed not to leave for the day until they cleared at least one loan for closing. Id . Moreover, in response to loan specialists' expressed concerns that their expanded authority would lead to higher defect rates that would lower their compensation, the Full Spectrum Lending division eliminated the loan-quality variable from the equation on which the loan specialists' and funders' compensation was based. Id . ¶ 81.

Although Countrywide initially promoted the HSSL program as a model suited only for "prime" - that is, "low-risk" - loans, individual defendant Mairone successfully proposed that Countrywide also implement a "Dirty Prime High-Speed Swim Lane" for loans that fell somewhere between the prime and subprime risk metrics. Id . ¶ 74. Further still, in September of 2007, Mairone emailed: "[w]e need to start to move toward all loans into [the HSSL] process." Id . ¶ 75 (emphasis supplied). As a result, loans that would ordinarily be considered "subprime" by Fannie Mae were processed using the HSSL "swim lane." Id.

By January of 2008, Countrywide's internal reports revealed material defect rates of 57% in the HSSL loan pool overall and nearly 70% for stated-income loans. Id . ¶ 88. Thus internal reports showed that more than half of the loans that the HSSL processing system had "cleared to close" were ineligible for sale to any investor, even though those loans were to be sold to Government-sponsored entities. Id . Post-closing quality control reports revealed analogous problems. By the first quarter of 2008, the material defect rate found in loans after closing climbed to nearly 40%, greatly surpassing the industry-standard defect rate of 4-5%. Id . ¶ 101.

According to the Amended Complaint, Mairone responded to these reports of high defect rates by pressuring her employees to conceal the reports. For example, Mairone, after reviewing the pre-funding reports from January of 2008, instructed the employee who prepared them not to circulate them outside of her division. Id . ¶ 88. A few months later, when underwriting managers in Richardson, Texas asked to meet with Mairone to express their concerns about deteriorating loan quality, she responded angrily: "Son of a bitch. You need to get with the program. We need to keep funding these loans to keep the lights on." Id . ¶ 89.[2] She responded similarly to a draft presentation that the relator in this qui tam action, Edward O'Donnell, prepared for Countrywide executives in his capacity as Executive Vice President. O'Donnell's presentation revealed the decline in FSL's loan quality; but, after reviewing the presentation, Mairone instructed O'Donnell to remove critical slides. Id . ¶ ...

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