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Royal Bank of Scotland’s record $4.9 billion fine shows just how powerful FIRREA can be

Dundas House, Royal Bank of Scotland's current headquarters, in Edinburgh, Scotland. Photo credit: dun_deagh via Flickr/CC license

FIRREA – the Financial Institutions Reform, Recovery and Enforcement Act – has proven to be a powerful law when it comes to prosecuting banks for misconduct involving the issuance of residential mortgage-backed securities leading up to the global financial crisis in 2008.

The Royal Bank of Scotland set a record for the largest FIRREA penalty when it agreed in July to pay the US $4.9 billion to settle allegations of misconduct involving the bank’s issuance of residential mortgage-backed securities between 2005 and 2008.

Last year, Deutsche Bank paid a FIRREA penalty of $3.1 billion as part of a $7.2 billion settlement with the US last year resolving federal and civil claims that Deutsche Bank misled investors in the packaging, securitization, marketing, sale and issuance of residential mortgage-backed securities between 2006 and 2007. The total settlement was the largest by a single entity for conduct involving issuance of residential mortgage-backed securities.

In the RBS case, the US Department of Justice alleged that the bank caused investors considerable losses by issuing residential mortgage-backed securities backed by high-risk loans, without disclosing the significant risks. DOJ also alleged that RBS made numerous false statements and representations that harmed investors.

The bank’s own reviews of loans found that loan originators issued mortgages to borrowers who couldn’t afford to repay them. While RBS identified those high-risk loans at risk of defaulting, it failed to remove them from its securities.

The Department of Justice said that after losses mounted and many mortgage lenders who originated those loans went out of business, “RBS executives showed little regard for this misconduct and made light of it.”

Although RBS paid a record $4.9 billion, analysts had predicted that the penalty could have been as high as $11 billion.

FIRREA authorizes civil enforcement and penalties of certain criminal violations for offenses affecting a financial institution. These offenses include crimes such as defrauding the US Department of Housing and Urban Development, making false statements or overvaluing land to the Federal Housing Administration, wire or mail fraud, or making false or fictitious statements or representations to a US department or agency.

While it doesn’t appear that a whistleblower alerted the government to RBS’s wrongdoing, FIRREA does allow whistleblowers to report potential violations to the US Attorney General and receive a reward. Whistleblowers who report under FIRREA first must make a declaration about the violation to the US Attorney General and receive approval in order to pursue litigation independently.

Under FIRREA, a whistleblower may share in the first $10 million recovered through the action, capping the whistleblower’s total potential recovery at a maximum of $1.6 million. The statute entitles whistleblowers to 20 percent to 30 percent of any recovery up to the first $1 million recovered, 10 percent to 20 percent of the next $4 million recovered, and 5 percent to 10 percent of the next $5 million recovered. FIRREA allows for the US Attorney General to consider the size of the settlement and the helpfulness of the whistleblower in determining the award.

Some cases involving violations of FIRREA also might allege violations of the False Claims Act, if the government suffers a monetary loss from the conduct.

The False Claims Act has a more generous reward provision than FIRREA, allowing whistleblowers who bring a lawsuit on behalf of the government to receive between 15 percent and 30 percent of the government’s recovery.

The RBS settlement with the Justice Department is the bank’s latest settlement involving claims that the bank had issued toxic residential mortgage-backed securities. Last year, RBS paid over $4.5 billion as part of a settlement with the Federal Housing Finance Agency. The bank previously entered into settlements with the National Credit Union Administration, the Special Inspector General for the Troubled Asset Relief Program, and the states of California and Connecticut for allegations related to its mortgage-backed securities.

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