Second Circuit Raises Bar for Proof of Fraud Under Federal Statutes: Requires Proof of Contemporaneous False Representation and Fraudulent Intent; Overturns $1.27 Billion Civil FIRREA Penalty

Sullivan & Cromwell LLP - May 26, 2016
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On May 23, 2016, the United States Court of Appeals for the Second Circuit issued an important decision in United States ex rel. O’Donnell v. Countrywide Home Loans, Inc., no. 15-496-cv, reversing a jury verdict finding Countrywide and Bank of America, among others, liable under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) for mail or wire fraud affecting a federally insured financial institution.  Overturning a $1.27 billion civil penalty against the defendants, the Second Circuit held that the evidence at trial in connection with the defendants’ sale of allegedly non-investment quality mortgages to government-sponsored entities was insufficient to prove fraud as a matter of law because the government failed to introduce evidence proving that the defendants fraudulently intended to breach the representations in their sale contracts at the time the contracts were executed.  Absent such evidence of contemporaneous fraudulent intent, the Second Circuit held, breach of a contractual promise—even if intentional—cannot support a violation of the federal fraud statutes.

Though Countrywide leaves open a number of questions, it sets a high standard for the government to prove fraud against companies and individuals under federal fraud statutes, including as a prerequisite for civil penalties under FIRREA.  In particular, the decision may have a direct impact on the government’s pending cases and investigations into financial crisis-era mortgage-backed securities, and may also encourage financial institutions to push back more forcefully against perceived government overreach.