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Bishop v. Wells Fargo & Co.

United States Court of Appeals, Second Circuit

May 5, 2016

PAUL BISHOP, ROBERT KRAUS, UNITED STATES OF AMERICA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, Plaintiffs‐Appellants, STATE OF NEW YORK, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF DELAWARE, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, DISTRICT OF COLUMBIA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF FLORIDA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF HAWAII, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF CALIFORNIA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF INDIANA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF ILLINOIS, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF MINNESOTA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF NEVADA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF NEW HAMPSHIRE, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, COMMONWEALTH OF MASSACHUSETTS, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF NEW MEXICO, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF MONTANA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF NORTH CAROLINA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF NEW JERSEY, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF OKLAHOMA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF RHODE ISLAND, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, STATE OF TENNESSEE, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, COMMONWEALTH OF VIRGINIA, EX REL PAUL BISHOP, EX REL ROBERT KRAUS, Plaintiffs
v.
WELLS FARGO & COMPANY, WELLS FARGO BANK, N.A., Defendants‐Appellees.

Argued: March 1, 2016

Appeal from the dismissal of a qui tam action under the False Claims Act ("FCA") by the United States District Court for the Eastern District of New York (Brian M. Cogan, Judge). The relators allege that defendants Wells Fargo & Company and Wells Fargo Bank, N.A., defrauded the government within the meaning of the FCA by falsely certifying that they were in compliance with various banking laws and regulations when they borrowed money at favorable rates from the Federal Reserve's discount window. The district court granted the defendants' motion to dismiss, holding that the banks' certifications of compliance were too general to constitute legally false claims under the FCA and that the relators had otherwise failed to allege their fraud claims with particularity. We agree with the district court that the relators have not sufficiently pleaded their claims under the FCA, and therefore affirm.

Joel M. Androphy, Zenobia Harris Bivens (Rachel L. Grier, on the brief), Berg & Androphy, Houston, Texas (George C. Pratt, Uniondale, New York, on the brief), for Plaintiffs-Appellants.

Gerald A. Novack, K&L Gates LLP, New York, New York (Amy P. Williams, K&L Gates LLP, Charlotte, North Carolina; Noam A. Kutler, K&L Gates LLP, Washington, District of Columbia, on the brief), for Defendants-Appellees.

Before: KATZMANN, Chief Judge, SACK and LOHIER, Circuit Judges.

Katzmann, Chief Judge

At the heart of the case before us is the False Claims Act ("FCA"), which forbids "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, Robert Kraus and Paul Bishop (together, the "relators") brought a qui tam action under the FCA on behalf of the United States against Wells Fargo & Company and Wells Fargo Bank, N.A. (together, "Wells Fargo"). The relators' claims hinge on what they allege to be massive control fraud perpetrated by Wachovia Bank and World Savings Bank from at least 2001 through 2008. World Savings Bank merged into Wachovia in 2006, and the combined entity merged into Wells Fargo in 2008. The relators contend that Wachovia and, after the merger, Wells Fargo defrauded the government within the meaning of the FCA by falsely certifying that they were in compliance with various banking laws and regulations when they borrowed money at favorable rates from the discount window operated by the Federal Reserve (the "Fed"). The relators contend that the Fed would not have permitted the banks to borrow at those favorable rates had it known that they were undercapitalized as a result of the fraud. The government declined to intervene in the relators' suit. Wells Fargo filed a motion to dismiss, which the district court granted, holding that the banks' certifications of compliance were too general to constitute legally false claims under the FCA and that the relators had otherwise failed to allege their fraud claims with particularity. The relators appealed.

We agree with the district court. As this Court has long recognized, the FCA was "not designed to reach every kind of fraud practiced on the Government." Mikes v. Straus, 274 F.3d 687, 697 (2d Cir. 2001) (quoting United States v. McNinch, 356 U.S. 595, 599 (1958)). Even assuming the relators' accusations of widespread fraud are true, they have not plausibly connected those accusations to express or implied false claims submitted to the government for payment, as required to collect the treble damages and other statutory penalties available under the FCA. Accordingly, we affirm the district court's judgment dismissing the suit.

BACKGROUND

A. Relevant Banking Regulations

We begin with some context about the banking regulatory scheme at work here. As the relators point out in their briefing, financial institutions in the United States are subject to many different laws and regulations, and are overseen by a number of different regulators, including the Fed. The Fed is responsible for maintaining the stability of the U.S. financial system. See Bd. of Governors of the Fed. Reserve Sys., The Federal Reserve System: Purposes and Functions 1 (9th ed. June 2005). As part of this mandate, the Fed, acting through its regional Federal Reserve Banks, acts as a backup lender of last resort for banks through its "discount window." Id. at 45–46. One of the purposes of the discount window is to enable banks to borrow to meet their reserve requirements. Under federal regulations, banks must hold certain balances, either in cash or in certain accounts with the Fed. Id. at 31. A low level of reserves does not by itself indicate that the bank is suffering from financial weakness; for example, a bank could have anticipated receiving cash from another source that did not come through at the expected time. Id. at 45.

Nonetheless, banks were historically reluctant to borrow through the Fed's discount window out of fear of being stigmatized as financially weak. The Fed had previously lent money to banks at below-market rates, but it did not want banks to borrow at the discount window only to relend at higher rates to other banks. Accordingly, it imposed a requirement that borrowers first prove they had exhausted other avenues for credit. See Extensions of Credit by Fed. Reserve Banks; Reserve Requirements of Depository Insts., 67 Fed. Reg. 67, 777, 67, 778 (Nov. 7, 2002). The result was that borrowing from the discount window indicated to the public that the bank had no other options. According to the Fed, this stigma "in turn . . . hampered the ability of the discount window to buffer shocks to the money markets, " especially in times of financial crisis, when the Fed most needed to strengthen the financial system. Id. To address this concern, the Fed adopted a new two-tiered structure in 2003.

Under that structure, banks in "generally sound financial condition" are eligible to borrow at the primary credit rate, which is set above the target Federal Funds Rate. 12 C.F.R. § 201.4(a); Bd. of Governors of the Fed. Reserve Sys., Lending to Depository Institutions, available at http://www.federalreserve.gov/ monetarypolicy/bst_lendingdepository.htm. Banks that are not eligible for the primary credit rate can instead borrow at the secondary credit rate, set above the primary credit rate. 12 C.F.R. § 201.4(b). Although the discount window is still intended to be only a "backup source of liquidity, " banks eligible for the primary credit rate no longer need to show that they have first exhausted other sources of credit. 67 Fed. Reg. at 67, 780. Indeed, purposefully little is required of the borrower at the time of the loan; the Fed describes the primary credit program as a "'no questions asked' program with minimum administration, " meaning that "qualified depository institutions seeking overnight primary credit ordinarily are asked to provide only the minimum amount of information necessary to process the loan. In nearly all cases, this would be limited to the amount and term of the loan." J.A. 437. The Fed clarified that these changes were necessary to induce banks to borrow from it, in turn increasing the Fed's ability to protect the financial system. See 67 Fed. Reg. at 67, 778.

To enhance its ability to influence liquidity during the recent financial crisis, the Fed instituted the Term Auction Facility ("TAF") from December 2007 through 2010. Term Auction Facility, Bd. of Governors of the Fed. Reserve Sys., https://www.federalreserve.gov/monetarypolicy/taf.htm (last updated Nov. 24, 2015). TAF operated as an auction; banks would bid on the amount of money they wanted to borrow at specific interest rates, and the Fed would match the amount it wanted to lend with the amounts requested, starting with the highest offered rates. The Fed would then set the rate for all borrowers at the lowest rate which would satisfy the total amount of money allotted to be loaned out. See Extensions of Credit by Fed. Reserve Banks, 72 Fed. Reg. 71, 202, 71, 203 (Dec. 17, 2007). Only banks in "generally sound financial condition" (i.e., those eligible for the primary credit rate) were permitted to participate. 12 C.F.R. § 201.4(e). There is no dispute that Wachovia and Wells Fargo borrowed money through the discount window at the primary credit rate and through TAF after the Fed deemed them eligible.

The Fed's authority to lend to banks is governed by Regulation A, 12 C.F.R. pt. 201, which was promulgated under the Federal Reserve Act and the International Banking Act of 1978, see 12 C.F.R. § 201.1. Regulation A provides that a "Federal Reserve Bank may extend primary credit on a very short-term basis, usually overnight, as a backup source of funding to a depository institution that is in generally sound financial condition in the judgment of the Reserve Bank. Such primary credit ordinarily is extended with minimal administrative burden on the borrower." 12 C.F.R. § 201.4(a). Similarly, Regulation A gives a Federal Reserve Bank the discretion to lend "to a depository institution that is not eligible for primary credit if, in the judgment of the Reserve Bank, such a credit extension would be consistent with a timely return to a reliance on market funding sources." 12 C.F.R. § 201.4(b). Regulation A is explicit that any loan is made at the sole discretion of the Fed: "This section does not entitle any person or entity to obtain any credit or any increase, renewal or extension of maturity of any credit from a Federal Reserve Bank." 12 C.F.R. § 201.3(b).

Regulation A also mandates the information that a Federal Reserve Bank must collect to determine whether a given bank is eligible to receive a loan through either the primary or the secondary credit program. See 12 C.F.R. § 201.4. Although Regulation A tasks each Federal Reserve Bank with obtaining adequate information about the banks under its supervision, it does not require the borrowing banks themselves to provide any specific information. See id. In practice, the Federal Reserve Banks rely on information that the banks are otherwise required to report to regulators, including quarterly Call Reports filed with banks' designated federal supervisory agencies. See 12 U.S.C. § 1817(a)(3); The Fed. Reserve System: Purposes and Functions supra, at 62–64. The Fed also relies on information gathered during bank examinations, which are conducted at regular intervals by banks' primary regulators. For example, Wells Fargo is primarily regulated by the Office of the Comptroller of the Currency, which conducts a "[f]ull-scope, on-site review" of each bank in its purview every 12–18 months and also frequently reviews each bank's compliance with specific federal laws or regulations. See Examinations: Overview, Office of the Comptroller of the Currency, http://www.occ.treas.gov/topics/examinations/examinations- overview/index-examinations-overview.html (last visited May 4, 2016).

B. Wells Fargo's Alleged Fraud

Notwithstanding this regulatory oversight, the relators allege that Wachovia and World Savings Bank engaged in massive fraud in the early-to-mid- 2000s, before Wachovia merged into Wells Fargo. According to the relators, Wachovia's executives relied on improper accounting practices to hide toxic assets off its balance sheet, making the bank look more profitable and in better financial health than it was. In reality, the relators allege, Wachovia was severely undercapitalized. Similarly, the relators assert that World Savings Bank violated applicable laws and regulations by failing to put in place required internal controls and by making inappropriate loans.

Both relators claim to have witnessed these misdeeds firsthand. Robert Kraus was a controller for two Wachovia groups from June 2005 to September 2006; Paul Bishop was a residential mortgage salesperson for World Savings Bank from November 2002 to May 2006. Each was fired after he complained internally about the bank's improprieties. Kraus also reported his allegations of fraud to the Federal Bureau of Investigation in 2007 and to the Securities and Exchange Commission ("SEC") in ...


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