October 10, 2012
Understanding US v. Wells Fargo
Posted by David Zaring

The principals behind the US civil fraud suit against Wells Fargo are the US Atty's Office for the SDNY, which you know best for its insider trading investigation against hedge funds (it has been much less active on the financial crisis front), HUD, and HUD's IG (two institutions that do not always work so great together).  Some observations about this interesting suit:

  • This is another dead-bang heart of the financial crisis suit.  The US is arguing that Wells Fargo processed a ton of mortgages that HUD insured with fraudulently lackluster diligence.  Which is basically the argument you must make if you think that financial institutions were responsible for the financial crisis.  In this sense it parallels New York's suit against JPMorgan.
  • Wait, HUD insures mortages?  Yes, indeed, its Federal Housing Authority arm insures mortgages for low income homebuyers, and somewhat surprisingly, did not suffer the problems that Fannie and Freddie or the private insurers suffered during the financial crisis.
  • Some of the allegations made against Wells Fargo are the kinds of allegations that could be made against any number of banks.  From the press release, cribbing in turn from the complaint:
    • WELLS FARGO aggravated its widespread underwriting violations by: hiring temporary staff to churn out and approve an ever-increasing quantity of FHA loans; failing to provide its inexperienced staff with proper training; paying improper bonuses to its underwriters to incentivize them to approve as many FHA loans as possible; and applying pressure on loan officers and underwriters to originate and approve more and more FHA loans as quickly as possible. In addition, WELLS FARGO senior management repeatedly ignored its own Quality Assurance department’s efforts to have management correct the practices leading to the material violations it found in a significant portion of WELLS FARGO’s retail home loans, and failed to report loans to HUD that it knew were rife with serious violations or fraud
  • This suggests that more complaints could be coming, and to be fair to the SDNY, it has brought five other such claims over FHA misstatements, suggesting that this is a relatively wide-ranging investigation.
  • The federal civil frauds statute includes provisions providing for treble damages.  It requires that that the statement be made to a government entity, and that the defendant "knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval."  Passed during the Civil War, it has that 19th century breadth that is absolutely terrifying, and without the protections of criminal procedure.
  • Nonetheless, big reputable companies fall afoul of the statute frequently, and continue to do business with the United States.  Name your large health care provider, and I'll name you a company that has paid a penalty to the United States for defrauding it.
  • HUD is shaping up to be a relatively active litigator on both this and other financial crisis related fronts.
  • So: how has the financial crisis been addressed in the courts so far?  We've got these cases.  The state of New York under the Martin Act.  Private counterparties of bailed out auto companies and AIG.  And almost no criminal activity.  We may be beginning to see a a developing pattern, as the crisis begins to approach some statutes of limitation.

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