2nd Circuit Holds Federal Banks Are Government Entities For FCA Purposes, Revives Qui Tam Suit Against Wells FargoFebruary 11, 2020 – Analysis
The False Claims Act (FCA) was enacted to punish and deter fraud against the United States, and to recover moneys obtained through such fraud. Whether an alleged fraud was actually against the United States is a threshold question not posed in the typical FCA case, where allegations usually involve claims for payment submitted to the Army, Navy, Medicare, or other entity clearly part of the federal government. But some cases are not so clear.
In a qui tam action arising out of the subprime mortgage crisis of 2007–2008, and presenting a question of first impression, the Eastern District of New York held that Federal Reserve Banks (FRBs) are not the United States for purposes of the FCA. United States ex rel. Kraus v. Wells Fargo & Co., No. 11-cv-5457, 2018 U.S. Dist. LEXIS 79292 (E.D.N.Y. May 10, 2018). The Second Circuit then reversed on November 21, 2019, in a decision with potentially far-reaching implications for the banking industry and perhaps beyond. See United States v. Kraus v. Wells Fargo & Co., 943 F.3d 588 (2d Cir. 2019). In reversing, the Second Circuit focused on the emergency nature of the loans at issue to hold that the FCA applies.
Background of the Case
In November 2011, Robert Kraus and Paul Bishop (Relators) filed a qui tam suit alleging an elaborate fraud scheme by Wells Fargo & Company and Wells Fargo Bank, N.A. (jointly, Wells Fargo), id. at 591–94, in which Wells Fargo misrepresented its financial condition to FRBs when applying for emergency loans, id. at 591, 594. Following an investigation of the complaint, the U.S. Department of Justice (DOJ) declined intervention.
The district court’s analysis focused on whether FRBs are the “[g]overnment” within the meaning of the FCA, Kraus, 2018 U.S. Dist. LEXIS 79292, at *7–22—a question of first impression, id. at *7, 7 n.4. For this inquiry, the court applied factors drawn from paired Supreme Court decisions from 1958, Rainwater v. United States, 356 U.S. 590, and United States v. McNinch, 356 U.S. 595 (holding the Commodity Credit Corporation and the Federal Housing Administration, respectively, part of the government for FCA purposes). See id. at *7–9.
Under the first Rainwater/McNinch (“R/M”) factor, the court found that the Federal Reserve Act (FRA) showed Congress’s intent that the Federal Reserve Board (Board) be a federal agency, but that the FRBs have independent status, owned and operated by private banks, and normally free from direct exercise of the Board’s authority. See id. at *10–11, 13.
On the second R/M factor—government financial involvement—the court found FRBs were “private corporation[s], owned by . . . national banks” as private stockholders, operating without “government appropriations.” Id. at *13. The court further found FRB–government financial links, such as FRBs’ obligation to transfer surplus funds beyond a set level to the Board, for deposit in the U.S. Treasury, “too tenuous” to support FCA liability. Id. at *14–15.
The third and fourth factors—involving selection of an entity’s leadership and whether its personnel are federal employees—led the court to the same conclusion. Id. at *17–18. Regarding leadership, member banks elect six of an FRB’s nine directors; directors supervise and control an FRB’s day-to-day operations and hire all other officers and employees, thus giving FRBs “local control . . . independent of the [g]overnment.” Id. at *17. FRB personnel, in turn, are “at-will employees” outside the Civil Service Retirement System, not “[g]overnment employees.” Id at *18.
The government’s interest in the entity’s purpose and function, the fifth R/M factor, pointed the court in the same direction. Id. at *18–19. The court noted FRBs’ operation largely independent of the Board, id. at *18, and their lack of “authority to promulgate regulations having the force and effect of law,” id. at *19.
The court also cited the reasoning of circuit courts finding neither Amtrak, see United States ex rel. Totten v. Bombardier Corp., 380 F.3d 488, 491–92 (D.C. Cir. 2004), nor Fannie Mae and Freddie Mac, see United States ex rel. Adams v. Aurora Loan Servs., Inc., 813 F.3d 1259, 1260 (9th Cir. 2016), were “the United States” for FCA purposes. Id. at *20–21. Additionally, the court drew on the Eighth Circuit’s analysis finding FRBs not “an agency of the federal government” for purposes of Federal Rule of Civil Procedure 4, in Scott v. Fed. Reserve Bank of Kan. City, 406 F.3d 532 (8th Cir. 2005). Id. at *22.
The court also rejected Relators’ argument that FRB personnel are “agents” of the United States, id. at *22–24, noting statutory mentions of FRBs as mere “fiscal agents of the United States” in certain circumstances, id. at *23. Acknowledging that FRBs are colorably government “instrumentalities” and fulfill “important governmental functions,” id. at *24–25 (citation omitted), the court nonetheless declined to deem FRBs “the United States (or its agents)” for FCA purposes, id. at *25 (cautioning FRBs “are not departments of the government” but merely “private corporations in which the government has an interest”) (citation omitted). Finally, the court briefly held that requesting FRB loans did not give rise to FCA liability under § 3729(b)(2)(A)(ii), because the government neither “provided any portion of the money loaned to defendants, [n]or reimbursed FRBs for making the loans.” Id. at *26.
The court concluded FRBs are not “the government” for FCA purposes because “(1) FRB personnel are not ‘officer[s], employee[s], or agents[s] of the United States’ within the meaning of § 3729(b)(2)(A)(i); and (2) the United States does not ‘provide . . . the money . . . requested or demanded’ by Fed borrowers within the meaning of § 3729(b)(2)(A)(ii).” Kraus, 943 F.3d at 591–92 (quoting Kraus, 2018 U.S. Dist. LEXIS 79292, at *6–7) (alterations and omissions in original). Relators appealed.
In an opinion “narrowly focused” on the FCA, the court of appeals reversed, finding that a bank’s emergency loan application to an FRB is a “‘claim’ under the FCA because the FRBs are ‘agents of the United States’ within the meaning of § 3729(b)(2)(A)(i), and also because the ‘money . . . requested’ by Fed borrowers is ‘provided’ by the United States to advance a Government program or interest within the meaning of § 3729(b)(2)(A)(ii).” Id. at 592 (alteration added, omissions in original). The court’s analysis focused on the nexus between the purpose of the FCA—providing broad protection of government funds from fraud “regardless of the particular form, or function, of the government instrumentality” involved, id. at 596 (quoting Rainwater, 356 U.S. at 592) (emphasis added in Kraus)—and the FRBs’ emergency lending to banks, id. at 599–601.
Within that framework, the Second Circuit reviewed the same R/M factors as the district court but reached the opposite conclusion. First, the Second Circuit held that FRBs are “agents of the United States” within the meaning of § 3729(b)(2)(A)(i) because they perform a Congressionally-mandated function. Id. at 598. Applying general principles of agency law, the court found FRBs’ substantial autonomy in day-to-day operations and lending decisions did not defeat agency, because a principal may “delegate the power to act on its behalf to another party” and give that party “some discretion.” Id. at 599 (citing Restatement (Third) of Agency § 2.02 (2006)). Second, the court found that the Board “exercises substantial control over FRB emergency lending activities” through, for instance, its statutory authority to examine FRBs’ books, and to suspend or remove any FRB officer or director. Id. at 599–600. Third, the court underscored that “the FCA does not require that ‘agents of the United States’ be agents of a United States agency,” but merely that FRBs act, with legal authority, “on behalf of the United States.” Id. at 600. FRB emergency lending is carried out “pursuant to a statutory delegation from Congress,” on “terms set forth by Congress in the FRA,” and on terms and authority subject to Congress’s change or revocation. Id. This conclusion was a stark rejection of the position of the United States and the Board, who argued as joint amici that FRBs’ emergency lending powers came via direct grant of authority, not an agency relationship. See id. at 599.
The concept of “national emergency” loomed large in the court’s reasoning, in relation to both the context of the FCA’s enactment, id. at 595 (characterizing Civil War-era Congressional testimony as “paint[ing] ‘a sordid picture of how the United States,’ during a national emergency, ‘had been . . . generally robbed in purchasing the necessities of war’”) (quoting McNinch, 356 U.S. at 599) (emphasis added), and the subprime mortgage crisis, see id. at 601. The court explained that its plain reading of “agent of the United States” comported with the FCA’s purpose: “In the best of times, few if any entities can borrow [tens of billions of dollars] even with advance notice and planning. Yet defendants were able to secure these amounts on short notice” through FRB emergency loans. Id. “Fraud during a national emergency against entities established by the government to address [such] emergenc[ies] . . . is precisely” what Congress meant the FCA to deter. Id. (emphasis added).
The court also held the emergency loans sought by Wells Fargo were “provided” by the United States within the meaning of § 3729(b)(2)(A)(ii). Id. at 601–06. Tracing in detail the complex processes by which FRB emergency loans to banks become money, the court concluded FRBs “do not lend out preexisting funds” but rather “create ‘funds’ . . . ex nihilo” (out of nothing) by increasing banks’ reserves. Id. at 602–03. Moreover, in this creation of money, FRBs exercise a power conferred on Congress by the Constitution, id. at 603 (citing U.S. Const. art. I, § 8, cl. 5), and “delegated to the [Federal Reserve System],” id. The court was unpersuaded by Wells Fargo’s argument that the loans made use of “[n]o U.S. Treasury Funds . . . nor were the FRBs reimbursed” by the Treasury for the loans, thus rendering the fraudulent loan applications not “claims” under the FCA. See id. at 602. “[T]he FCA nowhere limits liability to requests involving Treasury Funds,” observed the court, id. at 602 (internal quotation marks omitted); rather, the “deliberately broad” statutory language, id., refers to “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,” id. (quoting 31 U.S.C. § 3729(b)(2)(A)) (omissions in original).
The Second Circuit’s holding in Kraus marks a significant, case-specific victory for the qui tam relators. Of course, the opinion represents no adjudication on the merits; the court of appeals merely reversed the 12(b)(6) dismissal below, allowing the action to proceed. Nevertheless, holding that FCA liability may attach to false statements made to FRBs in order to obtain emergency loans stakes out new ground and, at least within the bounds set forth in the opinion, broadens the FCA’s reach, particularly in the context of Fed emergency loans.
 The allegations also involved conduct by entities later acquired by Wells Fargo, including Wachovia Capital Markets LLC, a Wachovia Corporation subsidiary, and World Savings, Inc.
 The case had a somewhat complex history prior to the district court’s May 2018 decision. The Eastern District of New York dismissed the complaint on the defendants’ motion, in July 2015, holding Relators’ complaint failed to allege false claims under the FCA. See United States v. Wells Fargo & Co., 117 F. Supp. 3d 215, 228 (E.D.N.Y. 2015). Relators appealed and the Second Circuit affirmed. See Bishop v. Wells Fargo & Co., 823 F.3d 35, 39 (2d Cir. 2016). Relators petitioned for certiorari, which the Supreme Court granted. The Court subsequently vacated the decision in Bishop, 823 F.3d 35, and remanded the case for further consideration in light of Universal Health Servs. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016). See Bishop v. Wells Fargo & Co., 136 S. Ct. 1067 (2017). On remand, the Second Circuit vacated the district court’s judgment in Kraus, 117 F. Supp. 3d 215, and remanded for determination, “in the first instance, whether the relators have adequately alleged the materiality of the defendants’ alleged misrepresentations.” See Bishop v. Wells Fargo & Co., 870 F.3d 104, 107 (2d Cir. 2017) (per curiam). On remand, Relators obtained leave to amend, the defendants again moved to dismiss, and on May 10, 2018, the district court granted the motion. See Kraus, 2018 U.S. Dist. LEXIS 79292.
The court of appeals agreed with the district court “that FRB personnel are not ‘officer[s]’ or ‘employee[s] . . . of the United States’ within the meaning of § 3729(b)(2)(A)(i).” Kraus, 943 F.3d at 596–98.