Banking and Finance Law Daily False Claim Act covers fraudulent requests for FRBank credit
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Thursday, November 21, 2019

False Claim Act covers fraudulent requests for FRBank credit

By Richard A. Roth, J.D.

Claims that various financial institutions misrepresented their financial conditions when they asked Federal Reserve Banks for discount window and Term Auction Facility credit can be raised under the False Claims Act both because the FRBanks are U.S. government agents and the government provided the money.

qui tam suit brought by two former bank employees who claim that financial institutions defrauded Federal Reserve Banks in order to obtain discount window and Term Auction Facility credit will move forward because the U.S. Court of Appeals for the Second Circuit has reversed a trial court decision that the False Claims Act does not apply. While the FRBank personnel to whom misrepresentations allegedly were made were not officers, employees, or agencies of the U.S. government, the appellate court agreed, the FRBanks are agents of the U.S. government and the federal government provided the money for the credit (U.S. ex rel. Krause, Nov. 21, 2019, Katzmann, R.).

Alleged fraudulent scheme. As alleged by the former employees, the scheme had its roots in mortgage loan practices by Wachovia Capital Markets LLC and World Savings, Inc., prior to the financial crisis. The companies, which later were acquired by Wells Fargo, originated and securitized low quality loans and then accounted for them improperly to evade equity capital concerns.

When problems arose, the former employees claim, Wachovia used its bank subsidiary, Wachovia Bank National Association, to seek support from the Federal Reserve Banks through discount window and TAF credit. However, this credit is available only to adequately capitalized and sound institutions, and the Wachovia organization did not qualify. The Wachovia organization falsely certified its compliance with requirements for credit, the employees assert. As a result, Wachovia and Wells Fargo fraudulently obtained tens of billions of dollars in loans.

False Claims Act requirements. The appellate court noted that "The text of the FCA is capacious," yet it is not intended to remedy every fraud that could affect the government. As the Act affects the former employees’ claims, it would apply to a fraudulent claim that was:

  • presented to an officer, employee, or agent of the federal government; or

  • presented to a "contractor, grantee, or other recipient," if the funds in question were to be spent to advance a federal program and the U.S. government had provided any part of the funds (31 U.S.C. 3729(b)).

The appellate court characterized the issue as being "whether a fraudulent loan request made to one of the FRBs is an effort to defraud a private entity or an effort to defraud the United States." The U.S. district court judge had decided that the alleged fraudulent loan requests would have been the former. The appellate court disagreed.

Officers or employees. The appellate court first agreed with the judge that FRBank personnel are neither officers nor employees of the U.S. government for purposes of the FCA. "Congress has gone out of its way to formally separate the FRBs from the government," the court pointed out. They are neither executive agencies nor regulatory agencies. Instead, FRBanks are corporations that operate under boards of directors who, under law, perform the ordinary duties of bank directors.

Agents of the United States. However, when they extend discount window or TAF credit, FRBanks are, for purposes of the FCA, agents of the U.S. government, the appellate court said. They meet the legal criteria for being agents: the federal government authorized the FRBanks to extend the credit in question; the FRBanks had accepted the task by extending credit; and the credit programs were under the control of the federal government, in the form both of the Federal Reserve Board, an independent agency of the executive branch, and Congress’s ultimate legislative authority.

Providing the funds. The United States also would have provided the funds the banks asked to borrow, the court said. There seemed to be no question that the credit advanced a federal government program, and the court determined it was irrelevant that the money did not come from the U.S. Treasury. The FCA did not specify that Treasury funds had to be involved, the court noted.

The court noted that discount window and TAF credit were based on the FRBank increasing its reserves, not lending out an existing deposit of funds. However, the Treasury and other banks were required to accept the funds. Thus, the United States was "the source of the purchasing power conferred on the banks when they borrow from the Fed’s emergency lending facilities," the court reasoned.

Moreover, the Fed puts money into circulation by supplying federal reserve notes to the FRBanks, the court observed. That meant a bank withdrawing the proceeds of discount window or TAF credit was receiving money literally provided by the Fed.

The argument that the FRBanks actually were owned by the banks that were its shareholders, not by the government, was unavailing. All of the FRBanks’ net earnings were passed to the Treasury, not the shareholders, which meant the banks’ interests functionally were debt interests, not equity interests.

Even in the case of the liquidation of an FRBank, anything remaining after all claims were paid was to go to the Treasury, not the shareholders, the appellate court added. That meant that a borrowing bank’s failure to repay credit would hurt the public, not the shareholders.

The case is No. 18-1746.

Attorneys: Jay W. Eisenhofer (Grant & Eisenhofer PA) for United States. Amy Pritchard Williams (Troutman Sanders LLP) for Wells Fargo & Co. and Wells Fargo Bank, N.A.

Companies: Wells Fargo Bank, N.A.; Wells Fargo & Co.; Wachovia Bank National Association; Wachovia Capital Markets LLC; Wachovia Corporation; World Savings, Inc.

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