DOJ Files First Civil Fraud Suit Alleging False Claims Act And FIRREA Violations In The Sale Of Loans To Fannie Mae And Freddie Mac


On October 24, the United States Attorney’s Office for the Southern District of New York (SDNY) filed a $1 billion civil mortgage fraud lawsuit against a mortgage lender and a major financial institution in connection with loans sold to the government-sponsored enterprises (GSEs), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Filed as a complaint-in-intervention in a pending qui tam, or whistleblower, lawsuit, the complaint alleges that the mortgage lender engaged in a scheme to defraud the GSEs in connection with the mortgage loans it sold to them, and that the financial institution that later acquired the lender was aware of and continued the misconduct. The suit seeks damages and penalties under the False Claims Act (FCA) and the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). This is the first civil suit brought by the Department of Justice concerning mortgages sold to the GSEs, and indicates that the government might commence other suits based on the sale of conventional mortgages to those entities.

The government’s allegations focus on a loan origination system initiated by the lender in 2006 that allegedly eliminated checkpoints on loan quality and led to fraud and other defects in the loans. The complaint alleges that the lender and the financial institution sold these loans to the GSEs but misrepresented that the loans complied with GSE requirements. The GSEs pooled the loans into mortgage backed securities and sold them to investors, subject to guarantees on principal and interest payments. As the allegedly defective loans defaulted, the GSEs suffered over $1 billion in losses through the payment of guarantees to investors.

These allegations set forth a theory of liability that the government had not previously articulated. Previous cases brought by the government primarily involved loans made by government program participants and alleged misrepresentations made directly to government agencies, whereas the complaint in this case is based on conventional loans and alleged misrepresentations to the GSEs. Moreover, unlike previous cases, defendants did not receive federal funds directly from the government, but rather only may have received such funds indirectly based on the government’s funding of the GSEs.

In addition, the complaint also represents another use by the government of FIRREA. Here, FIRREA is used to pursue the alleged profits made by defendants from the challenged loan origination system. See Understanding FIRREA’s Reach: When Does Fraud ‘Affect’ a Financial Institution.” The case also marks yet another financial fraud qui tam action filed in New York. Both the FCA and FIRREA provide substantial rewards for whistleblowers and the government’s relatively quick decision to intervene, along with its fast response in other recent matters, may encourage other such suits in the SDNY. See “Whistle-Blower Bounties May Encourage Residential Mortgage-Backed Securities Fraud Reporting.”

In short, this action is another example of the government’s increasingly aggressive efforts to recoup losses stemming from the financial meltdown, as well as a reminder of the significance of the whistleblower provisions in both the FCA and FIRREA. Most importantly, it is a clear sign that government loan program participants are no longer the only targets for financial fraud recovery, and that the government may challenge the conduct of any lender who sold loans to the GSEs.


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