The California Attorney General’s Office has recently taken a more aggressive role in combating the lingering effects of the financial crisis. Specifically, it has focused on the sale of mortgage-backed securities and the corresponding fallout in the housing market. One of the ways the office is targeting mortgage fraud is through use of California’s analogue to the Federal False Claims Act, the California False Claims Act (CFCA). Indeed, in 2011, California’s attorney general, Kamala Harris, created the Mortgage Fraud Strike Force to investigate and pursue those who allegedly engaged in misconduct with respect to mortgage servicing. The creation of the task force and other recent actions taken by the Attorney General’s Office pose significant risk to banks and other large financial companies in the wake of the financial crisis. Attorney General Harris indicated that she would use the CFCA to prosecute some of these actions. For example, the corporate-fraud team within the Mortgage Fraud Strike Force has been tasked with tackling misconduct involving investments and securities, subprime mortgages, and any false or fraudulent claims made to the state with respect to these securities.
The CFCA, which is being used extensively by the Attorney General’s Office, prohibits a person from knowingly presenting to the state of California a false claim for payment, or causing such a false claim to be presented, and also prohibits a person from knowingly using, making, or causing “to be made or used a false record or statement material to a false or fraudulent claim.” See Cal. Gov’t Code § 12651(a)(1)–(2). The CFCA provides for a penalty of “not less than” $5,500 and “not more than” $11,000 for each violation of the CFCA, and further authorizes treble damages. Thus, where an entity is alleged to have sold thousands of faulty mortgages, the potential exposure can be significant.
Given the high stakes, there have been significant monetary settlements in CFCA cases. For example, in late 2013, the Attorney General’s Office, along with the Department of Justice and several other states, settled an action with a large bank for almost $300 million. The suit alleged that the bank had made misrepresentations regarding mortgage-backed securities that were sold to public employees and also to teacher pensions. More specifically, the Attorney General’s Office alleged that the bank gave purchasers of its residential mortgage-backed securities incomplete information regarding the mortgages and did not appropriately research and exclude the poor-quality securities in offering the securities for sale.
Pursuant to the settlement agreement, Attorney General Harris agreed to fully release claims under the CFCA (among other California Code provisions) in exchange for payment of the settlement amount—the settlement agreement further noted that the payment was in an effort to remediate harms to the state of California, pursuant to California Government Code §§ 12650–12656 (the CFCA). This investigation and the ensuing settlement illustrate how the Mortgage Fraud Strike Force and the Attorney General’s Office are targeting large banks and financial institutions, and also act as a cautionary tale regarding the magnitude of potential exposure under the CFCA.
Also in 2013, the Attorney General’s Office specifically invoked the CFCA and sued Standard & Poor’s, a financial-services company. See People v. McGraw-Hill Cos., No. CGC-13-528491 (Cal. Super. Ct. Feb. 5, 2013). The complaint alleges that Standard & Poor’s violated the CFCA and other California statutes by using a faulty ratings process. See Complaint at ¶¶ 14–18, McGraw-Hill, No. CGC-13-528491. Further, the complaint alleges the company misrepresented its ratings process to the public and made false statements to the public about the risk factors associated with investments. Id. at ¶¶ 246–51. The Attorney General’s Office was not alone in filing suit against Standard & Poor’s—the office joined the Department of Justice and several other states in announcing lawsuits. However, in a press release announcing the commencement of the Standard & Poor’s litigation, the Attorney General’s Office noted that California’s suit is unique because it is being filed not only under California’s unfair competition laws but also under the state’s False Claims Act. This suit includes a claim for triple damages—because when the state makes a purchase based on a false statement, the defendant is responsible for the amount lost times three.The lawsuit was the result of a 20-month-long investigation by the Mortgage Fraud Strike Force into the sale of mortgage-backed securities by Standard & Poor’s and the way in which Standard & Poor’s rated its mortgage-backed securities.
The Standard & Poor’s litigation further illustrates the substantial risk facing financial institutions that were active in the sale of mortgage-backed securities. It shows the way in which the Mortgage Fraud Strike Force and the Attorney General’s Office use the CFCA during investigations and litigations to target large financial institutions, and it further highlights the magnitude of exposure that companies alleged to have violated the CFCA face. Companies should be aware of the potential for investigations into their activities surrounding the sale of mortgage-backed securities and other types of mortgage transactions. Further, banks and other large financial institutions should be aware of the financial repercussions of the CFCA—not only are there potential penalties for each false claim, but the treble-damages provision could result in crippling monetary damages.
Keywords: litigation, corporate counsel, California False Claims Act, CFCA, Mortgage Fraud Strike Force
David R. Singh is litigation counsel and Jessica K. Mohr is an associate with Weil, Gotshal & Manges LLP, in Redwood Shores, California.