On May 3, 2011, a civil fraud lawsuit was filed by the United States against Deutsche Bank AG, DB Structured Products, Inc., Deutsche Bank Securities, Inc. (collectively "Deutsche Bank") and MORTGAGEIT, INC. ("MORTGAGEIT") seeking damages under the federal False Claims Act for repeated false certifications to U.S. Department of Housing and Urban Development ("HUD") in connection with the residential mortgage origination practices of MORTGAGEIT, a wholly-owned subsidiary of Deutsche Bank AG since 2007.
The Complaints filed in Manhattan federal court alleged that between 1999 and 2009, MORTGAGEIT was a participant in the Direct Endorsement Lender Program ("DEL program"), which delegates authority to participating private lenders to endorse mortgages for Federal Housing Administration's ("FHA's") insurance. As a Direct Endorsement Lender, MORTGAGEIT had the authority to originate, underwrite, and endorse mortgages for FHA insurance. If a Direct Endorsement Lender approves a mortgage loan for FHA insurance and the loan later defaults, the holder of the loan may submit an insurance claim to HUD for the associated default costs, which HUD is obligated to pay.
SIDE BAR: Under the DEL program, neither the FHA nor HUD reviews a loan before it is endorsed for FHA insurance. Direct Endorsement Lenders are required to follow program rules designed to ensure that they are properly underwriting and endorsing mortgages for FHA insurance. Inherent in that obligation is to maintain a quality control program that can prevent and correct any underwriting deficiencies. Such a quality control program must include a full review by the lender of all loans that go into default within the first six payments, known as "early payment defaults."
Early payment defaults may be signs of problems in the underwriting process, and by reviewing early payment defaults, Direct Endorsement Lenders are able to monitor those problems, correct them, and report them to HUD
The Complaint alleges that MORTGAGEIT failed to comply with the requirements of a quality control program.
Further, since 1999, MORTGAGEIT endorsed over 39,000 mortgages for FHA insurance. During that same period, FHA paid in excess of $369 million in insurance claims on over 3,200 mortgages endorsed for FHA insurance by MORTGAGEIT ( including more than $58 million in defaulted loans that occurred after Deutsche Bank AG's 2007 acquisition of MORTGAGEIT . The Complaint alleged that a portion of those losses was caused by the false statements that the defendants made to HUD to obtain FHA insurance on individual loans. MORTGAGEIT had knowingly falsely certified that each of these loans was eligible for FHA insurance - in large part because MORTGAGEIT failed to perform basic due diligence and repeatedly endorsed mortgage loans that were not eligible for FHA insurance.
Also, the Complaint alleges that MORTGAGEIT annually certified to HUD that it was in compliance with the rules governing its eligibility in the DEL program, including that it conduct a full review of all early payment defaults, as early payment defaults are indicators of mortgage fraud. The Complaint alleged that, in fact, MORTGAGEIT failed to implement a compliant quality control program, and failed to review all early payment defaults. After Deutsche Bank acquired MORTGAGEIT in January 2007, Deutsche Bank managed the quality control functions of the DEL business, and had its employees sign and submit MORTGAGEIT's DEL annual certifications to HUD. Furthermore, by the end of 2007, MORTGAGEIT was not reviewing any early payment defaults on closed FHA-insured loans. Between 1999 and 2009, the FHA paid more than $92 million in FHA insurance claims for loans that defaulted within the first six payments.
On May 10, 2012, pursuant to a settlement of the charges, MORTGAGEIT and Deutsche Bank admitted, acknowledged, and accepted responsibility for certain conduct alleged in the Complaint, including that,
- contrary to the representations in MORTGAGEIT's annual certifications, MORTGAGEIT did not conform to all applicable HUD-FHA regulations;
- MORTGAGEIT admitted that it submitted certifications to HUD stating that certain loans were eligible for FHA mortgage insurance when in fact they were not;
- FHA insured certain loans endorsed by MORTGAGEIT that were not eligible for FHA mortgage insurance; and
- HUD consequently incurred losses when some of those MORTGAGEIT loans defaulted.
The defendants agreed to pay $202.3 million to the United States to resolve the Government's claims for damages and penalties under the False Claims Act.
Bill Singer's Comment
Yet another decisive settlement for Southern District of New York's US Attorney Preet Bharara and his staff. Once again, unlike his counterparts at the Securities and Exchange Commission who appealed a federal judge's decision to reject a settlement with Citigroup in which the SEC failed to insist upon some admission of liability, Bharara extracted some admissions. Consider my observations from a recent "Street Sweeper" column: Judge Rakoff's Wall Street Zombies Arise In FINRA Citi Settlement (March 2012):
Rakoff Ain't Buyin' It
As I wrote in "Judge Rakoff Rejects SEC's "Contrivances" In Citigroup Settlement" ("Street Sweeper" November 29, 2011), on November 28, 2011, Judge Jed S. Rakoff, refused to approve theConsent Judgement submitted by both Citigroup and the SEC in United States Securities and Exchange Commission v. Citigroup Global Markets Inc. (SDNY, Opinion and Order, 11-CIV-7387, November 28, 2011). In rejecting the proposed settlement, which allowed for Citigroup to neither admit nor deny the allegations, Judge Rakoff noted:
As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup's position in this very case.
Of course, the policy of accepting settlements without any admissions serves various narrow interests of the parties. In this case, for example, Citigroup was able, without admitting anything, to negotiate a settlement that (a) charges it only with negligence, (b) results in a very modest penalty, (c) imposes the kind of injunctive relief that Citigroup (a recidivist) knew that the S.E.C. had not sought to enforce against any financial institution for at least the last 10 years (d) imposes relatively inexpensive prophylactic measures for the next three years. In exchange, Citigroup not only settles what it states was a broad-ranging four-year investigation by the S.E.C. of Citigroup's mortgage-backed securities offerings, but also avoids any investors' relying in any respect on the S.E.C. Consent Judgment in seeking return of their losses. If the allegations of the Complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business. . .
By the S.E.C.'s own account, Citigroup is a recidivist, and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup. . .
Second Circuit Victory for SEC and Citi
On December 15, 2011, the SEC filed a Notice of Appeal seeking a ruling by the United States Court of Appeals for the Second Circuit that would reverse Judge Rakoff's rejection of the proposed consent judgment and his order directing the parties to prepare for trial in July 2012. In his public comment on the appeal, SEC Enforcement Direct Robert Khuzami argued that Judge Rakoff was
incorrect in requiring an admission of facts - or a trial - as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. . .
On March 15, 2012, Khuzami and his SEC got its wish. The Second Circuit set aside Judge Rakoff's rejection of the settlement. As I commented on the SEC's victory in "The SEC Couldn't Stop Madoff or Stanford But Jams Up Judge Rakoff Over Citigroup Settlement" (" Street Sweeper" March 15, 2012):
We now find ourselves in an Alice-In-Wonderland world where the Circuit Court seems to agree that Rakoff should not be required to merely rubber stamp the SEC's settlement but, on the other hand, the judge should defer to the SEC's assessment that the settlement is fair. A fine enough proposition but one that seems made in a vacuum of recent history.
The SEC has run off these cookie-cutter settlements without admission of liability for decades. It is a bankrupt approach to regulation that partially contributed to the onset of the Great Recession and seems likely to saddle our society with a future filled with more impotent responses. If this regulatory policy is fair and effective, then why has it only left a swath of devastation in its historic path?
As noted in the commentary above, there is a chasm between how the SEC and the SDNY US Attorney's office approach high-profile financial industry settlements. Perhaps it is a cultural issue fostered by the SEC's civil capacity versus the US Attorney's more typical criminal role - except in the Deutsche Bank case, the US Attorney has filed a civil fraud suit. More cynical folks would point to Wall Street's fabled revolving door or suggest that the politics of regulation and prosecution have played some role in fashioning the differences. Submitted solely as a curio, consider this section from the Wikipedia page concerning "Robert Khuzami":
In 2002, Khuzami was hired by Richard H. Walker to work at Deutsche Bank in New York as Global Head of Litigation and Regulatory Investigations, where he oversaw litigation and regulatory investigations. In 2004, he was promoted to serve as General Counsel for the Americas, where he supervised more than 100 lawyers.  From 2002 to 2004, he headed their global litigation and regulatory investigations. He stayed at the bank until 2009. Walker, who had met Khuzami at Cadwalader, Wickersham & Taft when Walker was a partner there, later recommended him for the enforcement job at the SEC, a job he had once held himself.