Lack of Due Diligence Basis for False Claims Act Liability

Written by on May 20, 2011 in Business Practices - No comments

By Manik Rath, Senior Vice President, General Counsel & Corporate Secretary, LMI

On May 3, the Department of Justice filed suit against Deutsche Bank and its subsidiary, Mortgage IT Inc., in the Southern District of New York for fraud in connection with mortgages generated and sold subject to FHA insurance.   

This may presage a new set of False Claims Act prosecutions to recover government funds mismanaged in the recent economic crisis.   This case is notable because of the government’s attempt to use the False Claims Act to turn due diligence failures into fraud. 

The complaint brings claims under three sections of the False Claims Act: 31 U.S.C. §§ 3729(a)(1)(A), 3729(a)(1)(B), and 3729(a)(1)(G). In these claims, the government asserts that the defendants knowingly, or with deliberate ignorance or reckless disregard (1) presented or caused to be presented false claims to an officer or employee of the government, (2) made, used, or caused to be made or used, false records or statements material to false or fraudulent claims for payment, and (3) made, used, or caused to be made, false records or statements in order to avoid, decrease, or conceal an obligation to pay money to the government. The complaint also alleges claims for breach of fiduciary duty, negligence, gross negligence, and indemnification. 

            According to the complaint,

“MortgageIT repeatedly made false certifications to HUD to obtain approval of mortgages that MortgageIT underwriters wrongfully endorsed for FHA insurance. These mortgages were not eligible for FHA insurance under HUD rules. Notwithstanding the mortgages’ ineligibility, underwriters at MortgageIT endorsed the mortgages by falsely certifying that they had conducted the due diligence required by HUD rules when, in fact, they had not. By endorsing ineligible mortgages and falsely certifying compliance with HUD rules, MortgageIT wrongfully obtained approval of these ineligible mortgages for FHA insurance, thereby putting millions of FHA dollars at risk.” 

In addition, according to the complaint, MortgageIT and Deutsche Bank never implemented the quality control procedures required of direct endorsement lenders.  On various occasions when HUD discovered evidence that MortgageIT was violating the quality control requirement, MortgageIT falsely stated the failures had been corrected. 

The government’s complaint reinforces the need for a robust compliance program, including following up on any statements of corrective action or other identified issues, taking seriously certifications of compliance with rules and regulations, and being thorough in due diligence of potential acquisition targets, including their compliance with government rules and regulations.

Leave a Comment