Wednesday, September 20, 2017

FYI: 2nd Cir Remands False Claims Act Claim on Materiality of Bank's Representations

The U.S. Court of Appeals for the Second Circuit recently remanded a federal False Claims Act ("FCA") lawsuit based upon alleged misrepresentations made by a bank when it applied to borrow funds from the Federal Reserve System's discount window. 


The Second Circuit remanded the case to the trial court to determine whether the relators adequately alleged the materiality of the bank's alleged misrepresentations. 


In so doing, the Second Circuit held that the Supreme Court had abrogated both the express designation requirement for implied false certification claims, and the particularity requirement for express false certification claims, in its recent ruling in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016) ("Escobar").


A copy of this opinion is available at:  Link to Opinion


As you may recall, the FCA prohibits "knowingly present[ing], or caus[ing] to be presented, a false or fraudulent claim for payment or approval" to the United States government.  31 U.S.C. § 3729(a)(1)(A).


In 2011, the relators brought a qui tam action against the bank under the FCA.  The relators claimed that the bank falsely certified its compliance with banking laws in order to borrow money at favorable rates from the Federal Reserve System. 


According to the relators' complaint, two entities which had merged into the bank had perpetrated a massive fraud, including by using improper accounting practices to hide toxic assets off their balance sheet and by making inappropriate loans.  The bank later borrowed money from the Federal Reserve System's discount window.


The relators alleged that the bank had made several express false certifications pursuant to its lending agreement with the Federal Reserve.  In particular, the lending agreement required the bank to certify that it was "not in violation of any laws or regulations" when it borrowed from the discount window. 


Alternatively, the relators argued that the bank was liable for an implied false certification insofar as the Federal Reserve used and relied upon certain financial statements issued by the bank in determining the bank's eligibility to borrow from the discount window. 


Specifically, the Relators pointed to Regulation A, 12 C.F.R. pt. 201, which was promulgated under the Federal Reserve Act and the International Banking Act of 1978.  Regulation A mandates certain information which the Federal Reserve must collect to determine whether a given bank is eligible to receive a loan.  In practice, the Federal Reserve Banks rely on information that the banks are otherwise required to report to regulators.  The relators argued that the Federal Reserve had relied on "untrue" or "misleading" financial statements in determining whether the bank was eligible to receive the loan.


The trial court dismissed the relators' lawsuit and the Second Circuit initially affirmed.  The Second Circuit relied upon its prior ruling in Mikes v. Straus, 274 F.3d 687 (2d Cir. 2001) ("Mikes") for two limitations placed upon false claims act allegations. 


First, Mikes required that "implied false certification is appropriately applied only when the underlying statute or regulation upon which the plaintiff relies expressly states the provider must comply in order to be paid."  And second, Mikes also held that "[a]n expressly false claim is … a claim that falsely certifies compliance with a particular statute, regulation or contractual term, where compliance is a prerequisite to payment."


The Second Circuit found that the bank's certification that it was "not in violation of any laws or regulations" did not certify compliance with a particular statute and thus could not support a False Claims Act lawsuit.  The Second Circuit also found that the relators could not assert an implied false certification claim because Regulation A of the Federal Reserve Act did not apply to the banks themselves, instead it governed the Federal Reserve's authority to lend to banks.  12 C.F.R. pt. 201. 


The Supreme Court of the United States vacated and remanded the Second Circuit's opinion in light of its recent ruling in Escobar. 


As you may recall, Escobar set out a materiality standard for FCA claims that had not been applied to the relator's claims by the trial court:  "[A] misrepresentation about compliance with a statutory, regulatory, or contractual requirement must be material to the Government's payment decision in order to be actionable under the [FCA]."  Escobar, 136 S. Ct. at 2002. 


The Supreme Court explained that "proof of materiality can include, but is not necessarily limited to, evidence that the defendant knows that the Government consistently refuses to pay certain claims in the mine run of cases based on noncompliance with the particular statutory, regulatory, or contractual requirement.  Conversely, if the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements were not material."  Id. at 2003-04.


Escobar directly abrogated Mikes's express designation requirement for implied false certification claims.  In addition, the Second Circuit also determined that Escobar also abrogated Mike's particularity requirement. 


The Second Circuit observed that Escobar had indicated that limitations on liability under the FCA must be grounded in the text of the FCA.  And, the Second Circuit found that there was no textual support in the FCA for Mikes's particularity requirement.


Accordingly, the Second Circuit remanded the case to the trial court to determine whether the relators adequately alleged the materiality of the bank's alleged misrepresentations.




Ralph T. Wutscher
Maurice Wutscher LLP
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