February 25, 2017

Score One for the Bank Whistle-Blowers

Here is something to celebrate: The United States Supreme Court just handed whistle-blowers one of their bigger wins in a long time.

People who expose wrongdoing in the workplace or among government contractors have taken a beating in recent years. The Obama Administration was especially assiduous in its pursuit of whistle-blowers, and President Trump has also singled them out for scorn.

So it was gratifying to see the Feb. 21 ruling from the nation’s top court on an important bank whistle-blower case dating back to the financial crisis. In its opinion, which vacated two lower courts’ dismissals of the case, the Supreme Court essentially confirmed that some courts have been using too narrow a legal standard when weighing whistle-blower suits under the False Claims Act, which is meant to punish those who defraud the government.

By highlighting a more expansive standard for what constitutes a false claim under the act, the court’s ruling is likely to open the door to more whistle-blower cases, according to lawyers who represent plaintiffs in these matters.

Because whistle-blowers help make the world a better place, that is a good thing.

But there is something else to like about the Supreme Court’s ruling. This particular case involved actions taken by the Federal Reserve Board and other regulators to shore up failing banks during the financial crisis. As the matter continues through the courts, it may shed new light on the details of these regulatory activities, including the entities that benefited and at what cost to taxpayers.

The case at the heart of the Supreme Court’s ruling was brought by two former bank employees who alleged that fraud was occurring at their institutions, Wachovia and World Savings Bank. Both companies became part of Wells Fargo during the mortgage crisis in 2008, so Wells Fargo is the defendant in the case.

Mary Eshet, a Wells Fargo spokeswoman, said in a statement: “We continue to believe these claims are without merit, as the previous court decisions have confirmed. We look forward to the opportunity to present our case again.”

The former employees, Paul Bishop from World Savings and Robert Kraus from Wachovia, filed the suit in 2011 under the False Claims Act; they seek damages from Wells Fargo on behalf of taxpayers for improprieties that occurred before and during the mortgage crisis.

Both men were fired after they told their superiors about the frauds. Mr. Bishop was a residential mortgage sales representative at World Savings, while Mr. Kraus was vice president and controller for the Real Estate Capital Markets group and the Corporate and Investment Bank Finance group at Wachovia. His expertise was in commercial real estate lending.

According to the lawsuit, the fraud identified by Mr. Kraus involved accounting maneuvers using an off-balance sheet entity that made Wachovia’s books look better than they were. Insiders at the bank had a name for the entity: the Black Box.

If Wachovia wanted to hide certain loans from internal or regulatory review, bank officials would temporarily move them to the Black Box, Mr. Kraus contended. This was problematic because accounting rules stated that off-balance sheet vehicles must be “demonstrably distinct” from the entities transferring loans to them. The Black Box was not, so the loans in it should have been consolidated onto the Wachovia balance sheet.

How big was the Black Box? As of Aug. 1, 2005, it contained some $6 billion in loans and other assets, the lawsuit said. That amounted to almost 13 percent of Wachovia’s equity capital at the time.

The plaintiffs contended that the use of the Black Box obscured risks at the bank and violated Sarbanes-Oxley, the Enron-era law that required executives to certify the accuracy of their companies’ financial reports. The Black Box kept billions of dollars in commercial real estate loans “outside the prying and meddling eyes of its regulators, shareholders, and risk management, internal control and accounting personnel,” the lawsuit said.

Even more troubling, the Black Box deceived federal regulators about the state of Wachovia’s financial health, the lawsuit said. And in 2007 and 2008, when the bank received financial support from the Federal Reserve, the Federal Deposit Insurance Corporation and other federal entities in response to the growing mortgage crisis, those payments were provided under false pretenses, the plaintiffs contended.

“During the financial crisis, the government was offering financial institutions great deals to borrow at unbelievable rates,” said Joel Androphy, a lawyer at Berg & Androphy and one of the lawyers representing the whistle-blowers in the Wells Fargo case. “Banks were borrowing billions of dollars, but they had to certify that they were safe and sound. Wells and its predecessor were in a difficult financial situation, but if they had disclosed that to the government, they would not have been able to get the money at those rates.”

The plaintiffs contend that taxpayers are owed damages reflecting the difference between what the banks paid for the billions of dollars in financial assistance and what they would have paid for that help if they had been truthful about their precarious financial position. If the former employees win their case, they will receive a portion of those damages.

Improper mortgage practices at World Savings, according to Mr. Bishop, also contributed to the deception of the bank’s regulators. Residential mortgages were made to borrowers without adequate disclosure of risks, he said, a problem he grew concerned about a few years after he joined the bank in 2002.

In May 2006, after Wachovia announced its purchase of World Savings, Mr. Bishop asked his superiors to warn Wachovia that it was buying a portfolio of “toxic” loans, the complaint stated. He was fired days later.

For both of the plaintiffs, the case has provided a wrenching education about what happens to those who speak truth to power.

Mr. Kraus, for example, has been unable to find work as a finance executive even with his deep experience and a master’s degree from New York University. He currently works at a McDonald’s in North Carolina and narrowly avoided losing his home to foreclosure.

“When you blow the whistle, you better be clear that you are on your own,” said Mr. Bishop, who is 69. “I naïvely believed there was a system behind me that would enforce the rules.”

After a long career in sales, Mr. Bishop has been able to find work more easily, he said. In 2009, he appeared on “60 Minutes” recounting what he saw at World Savings. During the aftermath of the financial crisis, he provided testimony on behalf of troubled borrowers helping save their homes from foreclosure. He said he testified in some 50 cases as an expert.

Today, Mr. Bishop has an insurance business. But he is also helping lower-level Wells Fargo employees who have been fired amid the recent phony accounts scandal.

Being a whistle-blower has been trying, Mr. Bishop said. Though the case is far from over, the recent Supreme Court ruling has proved something meaningful to him: Individuals can take on a powerful institution and — potentially — win.


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