Bank of America (BAC): Yes, Proof Is Required

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The 2nd U.S. Circuit Court of Appeals stunned the Justice Department this week by holding that, in order to commit fraud, you actually have to set out to defraud somebody.

This sounds pretty basic, but apparently not so to the government lawyers who see both criminal and civil actions as mere opportunities to squeeze money from deep pockets.

In a unanimous ruling, the 2nd Circuit threw out a finding that Bank of America Corp. (BAC) was liable for mortgage fraud connected to the “Hustle” program run by the former Countrywide Financial Corp. The original case, which resulted in a $1.27 billion penalty for the bank, sharpened the knives for the government’s scalp hunt, about which I have written before.

While the appeals court’s ruling is narrow, it illustrates the ways in which government officials overreached in their efforts to identify and sacrifice any likely scapegoat in the wake of the 2008 financial crisis. Brandon Garrett, a law professor at the University of Virginia, explained to The Wall Street Journal that proving fraud is legally quite difficult, though this didn’t slow Justice down very much.

“Obviously, people don’t normally come out and admit that they know they were selling deceptive products,” he said. “It’s hard to get smoking guns. And now the courts are saying, you need smoking guns at the beginning and end of the deal.”

The federal district judge who set the now-discarded Bank of America penalty was Jed Rakoff, whose penchant for slamming banks with enormous fines previously triggered pushback from the Court of Appeals. Rakoff seems to have mounted a personal crusade in his courtroom to hold financial institutions and their executives accountable for their alleged misdeeds. He rejected a proposed settlement between Citigroup and the Securities and Exchange Commission in 2011 because, in his view, it was not harsh enough. The Court of Appeals for the 2nd Circuit agreed with Citigroup’s argument that Rakoff had overreached in that case, too.

While the details of the Citigroup (C) decision and the Bank of America case are not the same in their particulars, they share a common foundation in a mindset that weights punishment for its own sake more heavily than justice. In its appeal, Bank of America argued that Rakoff’s history raised serious questions about his impartiality. “From beginning to end, what took place in this case was not only unfair, but utterly unprecedented,” the appeal concluded.

At this point, Rakoff ought to be granting motions to recuse himself from similar cases, though I have no reason to believe he will. The appearance of impartiality has not been a high priority for him up to this point. Bank of America has asked that, if the case is retried, it be assigned a judge other than Rakoff, for obvious reasons.

The “Hustle” case centers on a 2012 lawsuit filed by the U.S. attorney’s office of Manhattan. In essence, Countrywide entered into a contract to originate mortgages and then sell them to the federally sponsored entities Fannie Mae and Freddie Mac. As the housing frenzy mounted a decade ago, Countrywide’s lending standards declined, as did those of many lenders in the industry. Some of this trend was due to the fact that Fannie and Freddie wanted more loans made to low-income borrowers, but never mind that.

Many of the lower quality loans blew up amid the housing bust, and Countrywide’s resulting financial troubles resulted in its takeover by Bank of America in 2008. The Justice Department subsequently claimed that the subpar loans represented not merely a breach of contract, but actual fraud.

This argument is something like saying a football player who promises to win the Super Bowl commits fraud when his team ultimately fails to deliver on that promise. Now, if the star quarterback somehow knew that his team would lose, perhaps because he had accepted a bribe from gamblers, the situation would be different. Fans might have been defrauded; the player’s employers certainly were. But in order for this scenario to be fraud, the player had to know at the time he made the promise that he had no intention of delivering on it.

As the 2nd Circuit panel held, the Justice Department produced no evidence that Countrywide entered its contracts with the intent to fail to fulfill them. The most the government managed was to show that Countrywide breached its agreements after the fact. Failure to comply with a contract is only fraud when the party entering the contract never intended to honor it in the first place

In other words, to defraud someone, you have to intend to defraud them. The Court of Appeals wisely stepped in to remind Justice that this is the case, even when the party in question happens to be a bank.

About Larry M. Elkin 553 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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