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The U.S. Department of Justice Takes Aim at Deutsche Bank in False Claims Act Suit Charging Fraudulent FHA Loan Practices
The U.S. Department of Justice Takes Aim at Deutsche Bank in False Claims Act Suit Charging Fraudulent FHA Loan Practices
V&E False Claims Act Update E-communication, May 6, 2011
Confirming our recent predictions of increased mortgage fraud litigation under the federal False Claims Act (see March 23, 2011, American Banker article by Vinson & Elkins LLP partner John Faust), the U.S. Department of Justice (DOJ) this week has sued international banking giant Deutsche Bank AG for fraud in obtaining federal mortgage insurance. The suit was filed in federal court in Manhattan, and seeks more than $1 billion in damages and penalties. It makes good on the DOJ’s commitment to Congress earlier this year that it would make “mortgage fraud” a “top priority” in the agency’s effort to “recapture billions of taxpayer dollars lost to fraud.” Because the case has just been filed, Deutsche Bank has not yet responded in court.
The Government’s Allegations
The Complaint alleges that Deutsche Bank and its wholly owned subsidiary, MortgageIT, Inc., violated the False Claims Act (FCA) by making false statements and certifications to the Department of Housing and Urban Development (HUD) to obtain and maintain MortgageIT’s status as an approved Federal Housing Authority (FHA) lender, and to cause HUD to approve faulty loans for FHA backing.
Mortgages covered by FHA insurance are highly marketable for resale to investors because the loans are presumed to have met all applicable HUD standards and are insured by the full faith and credit of the United States. According to the DOJ Complaint, the substantial economic benefit of “FHA-insured” status led MortgageIT (and Deutsche Bank, too, after it acquired MortgageIT in 2007), to defraud the government in order to maintain its status as a Direct Endorsement Lender, and to originate as many FHA-backed loans as possible for profitable resale to investors. When thousands of those mortgages fell into default, the investors who had purchased them — at prices that allegedly reflected their government-backed status — came knocking on HUD’s door. The Complaint alleges that, as of February 2011, 12,500 of the 39,000 loans approved by MortgageIT defaulted, causing the government to pay out nearly $386 million in insurance proceeds to cover the losses.
According to the Complaint, between October 1999 and October 2009, MortgageIT approved 39,000 loans for FHA insurance, representing over $5 billion in underlying principal obligations. MortgageIT was an FHA-approved mortgage company and member of HUD’s “Direct Endorsement Lender” program, which meant that it was entrusted with evaluating proposed loans on behalf of HUD to determine whether they qualified for FHA insurance. Relying on MortgageIT’s certifications that proposed loans qualified, FHA endorsed thousands of loans — and obligated HUD to insure them.
To qualify for continued eligibility as a Direct Endorsement Lender, MortgageIT was required, among other things, to implement and maintain a quality control plan to ensure that its underwriters complied with HUD rules and conducted audits on all early payment defaults. MortgageIT allegedly failed to implement meaningful quality control and audit procedures, however, despite multiple certifications and repeated representations to the contrary. For example, the Complaint alleges that the companies “egregiously violated HUD’s quality control rules,” by failing to review all early payment defaults, failing to implement the minimal quality control processes they purportedly had in place, and by “chronically understaff[ing] quality control.” The Complaint further alleges that when MortgageIT’s outside auditor identified serious underwriting and quality control problems, employees at MortgageIT “stuffed the letters, unopened and unread, in a closet.” Additionally, when several HUD audits found serious deficiencies in MortgageIT’s quality control and audit processes, the lender allegedly made false representations to the agency that it had corrected or would correct the problems.
The Complaint also asserts that MortgageIT endorsed and falsely certified sub-standard loans as qualified for FHA insurance, causing FHA to approve mortgages containing levels of risk above HUD threshholds. The Complaint cites six specific failed loans — each from a different state — for which MortgageIT obtained FHA insurance despite significant due diligence deficiencies, including failing to verify the borrower’s employment or to develop the borrower’s credit history where the borrower had no credit score. All six loans were in default within nine months or less after closing, and one survived only two months before default.
Potential Damages of $1 Billion or More
In its Complaint, the government seeks treble damages and penalties under the FCA for claims paid by HUD for mortgages that were federally insured as a result of MortgageIT’s alleged false representations. The government also requests civil penalties under the FCA, which are available at up to $11,000 per violation. The Complaint alleges that MortgageIT approved 39,000 loans, 12,500 of which are already in default, and made numerous false certifications, so the statutory penalties could quickly add up. The DOJ also seeks compensatory and punitive damages under the common law theories of breach of fiduciary duty, gross negligence, and negligence, and requests indemnification for claims that HUD expects to pay in the future as more loans endorsed by MortgageIT end up in default. If successful on all those claims, the government could recover more than $1 billion in damages. No individuals have been charged, although the Complaint identifies several senior officers by name in connection with certifications of compliance with HUD regulations and guidelines.
Implications
If there was any doubt that large-scale mortgage fraud litigation under the False Claims Act would follow the collapse of the U.S. housing market, the Deutsche Bank lawsuit should erase it, and may also provide an early guide — both to the theories the government is likely to pursue in the cases to come, and to the viability of the industry’s legal and factual defenses. This case was brought by the government directly, but many FCA cases originate through individual “whistleblowers,” typically industry insiders, who receive a share of any damages the government recovers. Whistleblowers now have a strong incentive to come forward with similar allegations against other institutions.
For additional information, please contact Vinson & Elkins lawyers Tirzah Lollar or Lindsey Vaala. Visit our website to learn more about V&E's False Claims Litigation practice, or e-mail one of the practice contacts.
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