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Criminal Investigations in the Meltdown

What to Do When the Feds Come Calling

By Travis P. Nelson

In recent months, federal and state law enforcement authorities announced that joint task forces in several U.S. cities – including Philadelphia, New York, Los Angeles, Dallas and Atlanta – will examine possible criminal and regulatory violations related to the subprime lending meltdown.  The task forces will determine, among other things, whether lenders and banks securitized fraudulent loans in the creation of subprime mortgage packages, and whether the securitizers of the packaged loans accurately disclosed the risks of the underlying subprime loans supporting the investment bundles.
Federal prosecutors, federal and state law enforcement agencies (including the FBI, postal inspectors and the HUD Inspector General), and regulatory examiners comprise the task forces.  They are investigating mortgage lenders, loan brokers, title companies, real estate developers and investment banks.
Among other issues, the prosecutors and regulators are attempting to determine whether securitizations disclosed that the underlying mortgages were made to some borrowers without proper underwriting documentation, whether lenders approved loans based on inappropriate loan to value ratios, and whether lenders and borrowers submitted or knowingly relied on fraudulent appraisals, financial statements, tax returns and other supporting documentation.
The tasks forces also are investigating other potential schemes, such as industry insiders in New York who allegedly sold their personal stakes before the collapse of the hedge funds they managed, individuals in South Florida who allegedly used fraudulent borrower qualifying information to obtain mortgage loans, individuals in Virginia who allegedly fraudulently obtained loans from federally insured institutions through furnishing false documentation and individuals in New York who allegedly received excessive mortgage loans through fraudulent loan applications and settlement statements. State attorneys general, for example in California, Illinois and Florida, have also launched investigations into the activities of major lenders in connection with alleged unfair and deceptive practices.
Mortgage lenders, mortgage brokers, title companies, investment banks, real estate developers and other related businesses must beware of these potentially highly disruptive investigations being conducted by prosecutors (the Justice Department, state attorneys general and local district attorneys) and regulators (Securities and Exchange Commission, Office of the Comptroller of Currency, Federal Reserve Board, U.S. Treasury Department and state regulators). These investigations could be the result of alleged fraud, insider misconduct or the actions of third parties.
How federal prosecutors, law enforcement agents and regulatory examiners identify and select suspected misconduct varies. Frequently, a disgruntled employee, attempting to invoke whistleblower status, comes forward with information. In other cases, routine regulatory examinations may uncover irregularities that lead to further investigation. Sometimes a prosecutor, agent or regulator opens the morning newspaper and decides to take a closer look at a company’s activities based on a media report.
Regardless of how the investigation begins, companies must take a proactive approach to mitigate the risk of intrusive investigations and potential bet-the-company prosecutions. When a prosecutor or regulator launches an investigation, the investigator typically will interview current and former employees, customers and vendors, generally showing up unannounced at these individuals’ homes. However, even before conducting interviews, investigators will use grand jury subpoenas or regulatory civil investigative demands to gather documentary and testimonial evidence, often obtaining this information from third parties and asking those third parties not to disclose the existence of the subpoenas. In cases where the investigation follows more egregious conduct, federal prosecutors may seek wiretaps and use other types of electronic surveillance to obtain evidence. Finally, a company (or its insiders) may be served with search warrants permitting investigators to seize computer hardware and software, as well as other company records.
To help prevent and effectively respond to probes by law enforcement and regulatory authorities, consider the following tips:

Implement a compliance program. To avoid and/or mitigate allegations of fraud and other misconduct, corporations must implement comprehensive compliance programs designed to detect wrongdoing perpetrated from within and outside of the company and effectively implement remedial measures.
Assign responsibilities. From the board of directors and executives to rank-and-file employees, each member of a company must know what his or her role is in compliance oversight. The tone for implementing and maintaining an effective compliance program must begin with the board of directors, the CEO and the chief compliance officer. Given the paramount role of compliance in the life of a highly regulated company, the chief compliance officer should not be the general counsel.
Know the rules. You cannot effectively defend your company against an investigation if you wait until a subpoena or search warrant arrives and then seek to learn the rules of the game.  Guidance from prosecutorial and regulatory authorities, such as the Justice Department’s McNulty Memorandum, the SEC’s Seaboard Factors, and the bank regulators’ civil money penalty matrix, set forth the government’s approach for dealing with corporate targets, addressing a variety of issues, including waiver of privilege, indemnification of officers/employees, targets, addressing a variety of issues, including waiver of privilege, indemnification of officers/employees, consideration of past violations, and the effect of misconduct on third parties. General counsel and chief compliance officers must understand the government’s policies before federal agents arrive at the door.
Involve counsel immediately. As soon as anyone becomes aware of a subpoena relating to the company or interviews of former or current employees, vendors, or customers, immediately notify corporate counsel and retain experienced outside counsel. Counsel can then begin a dialogue with the investigators and attempt to minimize the intrusiveness of the government investigation. Counsel also can begin an internal investigation to assess the risk and collect evidence favorable to the company.
Do not overreact. Sometimes intrusive government investigations cannot be avoided.  Sometimes when the government executes a search warrant, twice as many agents as needed show up. This is due, at least in part, to the government’s goal of overwhelming the target into making admissions of guilt. When informed of a search warrant, notify corporate counsel and retain experienced outside counsel. It also is important that the company’s personnel understand their legal rights and responsibilities.
Learn the players. Knowing who is leading the investigation will provide great insight into the goals of the investigation and the remedy that the government is seeking.
Document control. Many regulators have certain rules on document retention (e.g., what must be kept and for how long). Companies should implement comprehensive document retention policies that comply with the regulators’ policies and understand how those policies will be affected by a pending government investigation.
Internal compliance self-assessments. As part of an organization’s internal controls review, periodically review and test compliance programs. This will serve two purposes:  First, it will allow the organization to identify deficits and implement remedial measures to avoid future problems. Second, in the event of future investigations, periodic review and testing will demonstrate to prosecutors and regulators that the organization takes the compliance function seriously.
It’s not the crime, it’s the cover-up. If there is one thing that corporate and political scandals have shown, it is that lying about or covering up shortcomings or misconduct only compounds the problem. In the case of lying to federal investigators during the course of an official investigation, it means an indictment for making false statements, which can carry a punishment of five years in prison – even if the lie was not used to cover-up a crime. Similarly, based on a post-Arthur Andersen/Enron criminal statute, destroying documents related to an investigation can carry a punishment of twenty years in prison.
Following these recommendations and implementing other proactive measures will help companies avoid the potential adverse legal, financial and reputational consequences of government investigations. s

Travis P. Nelson is an attorney in the Financial Services and White Collar & Corporate Investigations Practice Groups at Pepper Hamilton, LLP, resident in its Philadelphia, PA office.  Mr. Nelson was formerly an attorney in the Enforcement Division of the Office of the Comptroller of the Currency, and formerly a member of the Maryland State Banking Board.  Mr. Nelson regularly represents institutions and individuals in matters involving regulatory compliance, internal investigations, enforcement, and litigation. He can be reached at

Posted on Monday, January 19, 2009 (Archive on Sunday, April 19, 2009)
Posted by Scott  Contributed by Scott


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