Thursday, December 19, 2019

FYI: 2nd Cir Holds False Claims Act Applies to Loans Made By the FRBs

The U.S. Court of Appeals for the Second Circuit recently held that the federal False Claims Act ("FCA") applies to persons who present false or fraudulent loan applications to Federal Reserve Banks because the latter are "agents of the United States" within the meaning of the FCA and the loan money is provided by the United States to advance a Government program or interest within the meaning of the FCA.


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


Two individuals (the "relators") who were former employees of a federally-chartered bank and a savings and loan association that were acquired in October 2006 by another federally-chartered bank, filed an action under the FCA in November 2011 alleging that the acquiring holding company and its federally-chartered bank presented fraudulent applications for emergency loans to several Federal Reserve Banks ("FRBs") that misrepresented their financial condition. The relators alleged they were terminated in 2006 because they questioned the allegedly illegal business practices of their employers.


In October of 2008, the acquired bank "requested billions of dollars in loans from two of the emergency lending facilities operated by the Fed: the Discount Window and the Term Auction Facility ('TAF')." Despite this, the bank could not "survive as a standalone entity," and it merged into the acquiring bank in December of 2008. The acquiring bank then borrowed "$15 billion in January 2009 and $30 billion in February 2009. … at an interest rate of 0.25%."


"The Discount Window is a standing facility through which the Fed makes short-term loans to depository institutions. … The terms of these loans depend on a borrower's financial condition[.]"


"The TAF was a temporary facility created by the Board on December 12, 2007, to increase liquidity in financial markets at the outset of the financial crisis. The program's goal was to address the reluctance of financial institutions to borrower from the Discount Window at that time. … Only firms in a generally sound condition are eligible to participate."


The defendants moved to dismiss and the trial court granted the motion, "holding that relators' complaint failed to allege false claims under the FCA." The relators appealed and the Second Circuit affirmed. The relators then "petitioned for certiorari and, the Supreme Court vacated [the Second Circuit's] decision … and remanded the case for further consideration …."


On remand, the Second Circuit "vacated the trial court's judgment and remanded the case 'for the trial court to determine, in the first instance, whether the relators have adequately alleged the materiality of the defendants' alleged misrepresentations.'"


On remand to the trial court, the relators amended their complaint and defendants again moved to dismiss. In May 2018, "the trial court granted the motion, holding that loan requests made to FRBs are not 'claims' within the meaning of the FCA because (1) FRBs are neither part of the government, nor agents of the government, and (2) the United States does not 'provide … the money … requested or demanded' by banks that borrow from the Fed's emergency lending facilities." The relators appealed again.


In the second appeal, the Second Circuit reviewed "the trial court's grant of defendants' Rule 12(b)(6) motion to dismiss de novo, 'accepting all factual claims in the complaint as true and drawing all reasonable inferences in the plaintiff's favor.'"


The Court explained that "the Fed is comprised of twelve FRBs, which are separately incorporated banks dispersed geographically throughout the country, and a Board, which is based in Washington, D.C. and is an independent agency within the executive branch."


Under the Federal Reserve Act ("FRA") and "regulations promulgated by the Board[,]" FRBs can extend credit at a preferred "'primary credit rate' as a backup source of funding to a depository institution … that is in generally sound financial condition,' … and at a higher, 'secondary credit rate' … to a depository institution that is not eligible for primary credit …."


"But the FRBs are not permitted to extend credit through the Discount Window to those institutions that are insolvent or to those that are borrowing for the purpose of lending to a person who is insolvent."


First, the Second Circuit discussed the FCA's background and statutory framework, explaining that the FCA was adopted as the result of congressional investigations into the sale of worthless or over-priced goods to the War Department during the Civil War. "The Act was passed in sum and substance 'to stop this plundering of the public treasury."


"[T]he FCA imposes liability on any person who either 'knowingly presents … a false or fraudulent claim for payment or approval,' … or 'knowingly makes … a false record or statement material to a false or fraudulent claim[.] … The term 'claim' means any request or demand, whether under a contract or otherwise, for money or property and whether or not the United States has title to the money or property, that— (i) is presented to an officer, employee, or agent of the United States; or (ii) is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government's behalf or to advance a Government program or interest …."


The Court then concluded that "[r]equests made to FRBs for loans from the Fed's emergency lending facilities are 'claim[s]' within the meaning of the False Claims Act[,]" reasoning that the statute's language "reflects a broad legislative purpose that is most faithfully effectuated by recognizing that the FCA applies, in some cases, to functional instrumentalities of the government and to agents pursuing its ends."


However, because the FCA "does not reach frauds directed at private entities that only incidentally lead to payments with money provided by the government[,]" the Court reasoned that "[t]he overarching question in this case, therefore, is 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 specific questions are whether (1) FRB personnel are 'officer[s]' or 'employee[s]' … of the United States … ; (2) the FRBs, in operating the Fed's emergency lending facilities, are 'agent[s] of the United States' …; or (3) fraudulent loan requests knowingly presented to one or more of the FRBs are 'claim[s]' under the FCA because the 'money … requested' is 'provided' by the United States …."


Addressing each question in turn, the Second Circuit first concluded that "FRB personnel are not 'officer[s]' or 'employee[s] … of the United States' within the meaning of § 3729(b)(2)(A)(i)" because "[t]he FRBs are not part of any executive department or agency … [n]or do they have the authority to promulgate regulations with the force and effect of law. Instead, they are corporations … that operate 'under the supervision and control of a board of directors,' which 'shall perform the duties usually appertaining to the office of directors of banking associations.'" The Court thus "agree[d] with defendants that fraudulent loan requests made to the FRBs do not qualify as claims under the first clause of § 3729(b)(2)(A)(i)."


Turning to the second question, the Court concluded that "the alleged fraudulent loan applications [were] nonetheless 'claims' under the FCA [because] the FRBs act as 'agents of the United States' under § 3729(b)(2)(A)(i) when operating the Fed's emergency lending facilities." The Court cautioned, however that it did so "on a narrow reading where we confine ourselves to only to the circumstances at hand, which require use to determine the meaning of the FCA in the context of extending emergency credit."


In light of the purpose of the FCA, the Second Circuit saw "no reason to depart from the plain meaning of the phrase 'agent of the United States' [because] … [f]raud during a national emergency against entities established by the government to address that emergency by lending and spending billions of dollars is precisely the sort of fraud that Congress meant to deter when it enacted the FCA."


Turning to the third question, the Court also concluded that "the alleged fraudulent loan applications are 'claims' under the FCA because the United States 'provides' the money 'requested' by borrowers from the Fed's emergency lending facilities within the meaning of § 3729(b)(2)(A)(ii) and the money requested is to be spent to advance a Government program or interest."


The Second Circuit rejected the argument of amici and defendants that "the Fed's emergency lending facilities do not qualify as money requested or demanded by the U.S. because the FRBs are not funded by the United States Treasury[,]" reasoning that "the FCA nowhere limits liability to requests involving 'Treasury Funds.' … The text of the FCA is deliberately broad, including 'any request or demand … for money or property … whether or not the United States has title to the money or property,' as long as 'the United States Government … provides or has provided any portion of the money or property requested or demanded.'"


The Court found that the government provided the money because "the FRBs are the issuers of base money. They do not lend out preexisting funds; they create 'funds' in the most elemental sense. They perform this function on behalf of the United States, as federal instrumentalities. When banks request loans from the FRBs, the FRBs extend those loans by increasing these reserves. …These new reserves are created ex nihilo, at a keystroke. They are promises by the FRBs to pay Federal Reserve notes (dollar bills) to the banks on demand. … The FRBs' promises to pay notes serve as money or legal tender because they must be accepted by the Treasury and by other banks as payment. … Had Congress not delegated this power to the Fed, the FRBs would be unable to extend the loans at issue in this case. And we see no reason why Congress's decision to separate the FRBs from the Board and the Board from the Treasury Department should alter our conclusion that the United States is the source of the purchasing power conferred on the banks when they borrow from the Fed's emergency lending facilities."


The Second Circuit reasoned that "[t]he loans in this case are also money provided by the United States in a further sense. The Board puts Federal reserve notes into circulation by supplying them to the FRBs, which are the actual direct issuers. … Thus, when banks like [the defendant and the bank it acquired by merger] withdraw the proceeds of loans requested from (and extended by) the FRBs, the banks quite literally receive money 'provided' by the Board, i.e., money made available and/or supplied by the United States."


Accordingly, the Court "disagree[d] with the trial court that fraudulent loan requests made to the FRBs do not qualify as claims under § 3729(b)(2)(A)(ii)(I)" of the FCA, vacated the lower court judgment, and remanded the case for further proceedings.




Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
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Chicago, Illinois 60602
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