On October 4, 2011, the New York Attorney General and the United States Attorney for the Southern District of New York filed separate lawsuits against Bank of New York Mellon (BNY Mellon),1 both accusing the bank of defrauding clients in foreign currency exchange transactions. The lawsuits represent the latest development in an ongoing controversy regarding foreign currency transactions — BNY Mellon and a rival custodial bank have both been subject to investigations and/or lawsuits by the Securities and Exchange Commission and officials in at least seven states2 — that the banks say reflects prosecutors' fundamental misunderstanding of industry-wide practices. The New York state and federal complaints mark the introduction of two heavy-hitting statutes into the fray: The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA)3 and New York's Martin Act,4 both of which allow recovery under less stringent standards, such as preponderance of the evidence, than would be required under criminal application of either the federal securities laws or New York State's fraud statutes.
The US Attorney's use of FIRREA is particularly significant. This litigation represents a new application of the statute, which was originally passed in the midst of the savings and loan scandals of the late 1980s, as part of the US Attorney's continued efforts to pursue civil alternatives to criminal charges against financial institutions. The recent filings are also of interest because, in an unusual move, both suits were filed on the same day for the same conduct, suggesting that there may have been a breakdown in cooperation between the US Attorney's Office and the New York Attorney General. Whether the result of friction or not, the parallel state and federal actions create challenges both for BNY Mellon, which will have to defend the case on two fronts and risk double exposure, and for the government lawyers.
The Foreign Exchange Transactions at Issue
As alleged in the complaints, the litigation centers around the foreign exchange services BNY Mellon offers to the custodial clients for whom it holds domestic and international financial assets. BNY Mellon offers two types of foreign exchange services: Customers may either negotiate an exchange rate with the bank's trading desk for each necessary currency trade or opt into the bank's "standing instruction" program.
Both the state and federal suits focus on the standing instruction program, pursuant to which clients authorize BNY Mellon to automatically exchange currency as needed.
The suits allege that BNY Mellon guaranteed its standing instruction customers that the currency transactions would be executed according to "best execution standards" or at the "best rate of the day," and that they would be completed free of charge.5 However, the suits also allege that BNY Mellon in fact determined the rate to charge for trades by reviewing the full range of prices at which the currencies traded over the course of the day, selecting the worst possible rate for each currency, and then charging customers a slight modification of that rate. According to the Attorney General's suit, this practice generated approximately $2 billion in profits for the Bank over the course of the last decade.6 The Attorney General is seeking not only disgorgement of profits under the Martin Act, but also treble damages and penalties under the New York State False Claims Act. The United States Attorney is seeking unspecified civil penalties and injunctive relief.
BNY Mellon has made it clear that it views the allegations in the complaints as completely inaccurate and that it intends to contest the suits vigorously.7 It has gone so far as to purchase a full-page ad in the New York Times proclaiming that the allegations are "flat out wrong."8
The Alleged Misrepresentations: Who Defines Best?
The Attorney General and US Attorney allege that BNY Mellon made false and misleading statements to its clients about how the transactions would be priced. These allegations revolve largely around the definitions of terms BNY Mellon used in its communications. Among the misrepresentations the New York Attorney General and US Attorney accuse BNY Mellon of making are:
- That the bank offered the "best rate of the day" or the "best execution"
- That it priced transactions "at levels generally reflecting the interbank market" or the "market rate"
- That clients would receive the "same attention and competitive pricing"
- That trades would be executed "free of charge"
- That the conversion process was based on the "current foreign exchange rate input"9
BNY Mellon will likely argue that those communications are consistent with the bank's practices.10 It may argue, for example, that "best rate" indicates the best rate offered in comparison to other custodial banks' retail transactions —not the lowest daily rate offered on the wholesale, interbank currency exchange market. Both the Attorney General and the US Attorney have attempted to preclude this argument by defining how particular terms are "commonly understood"11 or are defined in the industry.12 BNY Mellon points out, however, that the government's definitions demonstrate a "fundamental misunderstanding" of the "role of custodian banks and the operation of institutional [foreign exchange] markets."13 It further argues that the government's construction of "free of charge" would require the bank to offer its services at cost, which "no rational commercial institution would do."14
Bringing Out the Big Guns: FIRREA and the Martin Act
What makes the New York-based suits particularly noteworthy are the heavy-hitting statutes that they invoke. The US Attorney's lawsuit brings charges under FIRREA, the Financial Institutional Reform, Recovery, and Enforcement Act.15 Under FIRREA, parties who violate specific sections of the criminal code are subject to civil penalties. The FIRREA charge is significant for several reasons. Not only does the suit mark the first legal action filed by federal prosecutors in the foreign exchange controversy, but it also signals a revitalization of FIRREA and a new take on its applicability. Congress passed FIRREA in the wake of the savings and loan crisis in the 1980s, and previous FIRREA suits have largely involved fraudulent statements made regarding federally insured loans.16 Here, the federal government is seeking monetary penalties and injunctive relief based on a theory of mail and wire fraud related to currency transactions, citing the criminal statutes, yet it has elected not to file any corresponding criminal charges. This represents a tactical decision by the US Attorney to use FIRREA to punish alleged wrong-doers without having to prove beyond a reasonable doubt that they acted fraudulently. That decision creates a significant advantage for the prosecution.
Though this matter represents a new use of FIRREA, the increased use of civil avenues to target financial institutions is typical of the US Attorney's Office for Southern District of New York under Preet Bharara. In March 2010, Bharara announced the creation of a new Civil Frauds Unit, which was specifically charged with pursuing civil prosecution of "large-scale and sophisticated financial frauds."17 The unit was designed, in part, to take advantage of the lower burden of proof required in a civil prosecution. Indeed, Bharara made clear that he and his office intend to leverage the advantages of civil enforcement, noting that civil enforcement "offers a number of benefits unavailable under the criminal laws, including a less stringent standard of proof than in criminal fraud cases, the ability to freeze assets early, and broad pretrial discovery."18 Bharara also pointed to the availability of statutory civil penalties and treble damages as an advantage of the civil enforcement strategy.19 Civil enforcement offers prosecutors another benefit — by selecting charging statues that require a lower burden of proof, prosecutors indirectly place more pressure on potential defendants to settle.
The New York Attorney General's lawsuit, joined by the City of New York, charges BNY Mellon with violations of both the New York State False Claims Act20 and the Martin Act.21 This is the first time the Attorney General's office has applied both acts in the same case,22 and the combination is formidable. Passed in 1921 and popularized by former Attorney General Eliot Spitzer, the Martin Act gives the Attorney General wide-ranging power to investigate and prosecute fraud. The Act's broad definition of fraud encompasses nearly any misrepresentation, whether material or not, and the Attorney General can prove violations of the statute without demonstrating intent.23 The Martin Act also confers broad jurisdiction upon the Attorney General, allowing him or her to file suit for misrepresentations made to both New York and Non-New York-based parties.24 It also grants the Attorney General expansive administrative discovery powers, enabling the Attorney General to accumulate a trove of evidence before filing suit. Former Attorney General Spitzer was notorious for using the Martin Act's open-ended power to create settlement leverage, and it appears that the current Attorney General may be taking a page from that playbook. He has in this case added the New York False Claims Act charges as a powerful second punch, which allows him to seek treble damages and civil penalties from parties who fraudulently obtain government assets.
The Practical Ramifications of the Simultaneous Filings
The US Attorney's and New York Attorney General's lawsuits carry practical ramifications above and beyond the legal ones discussed above.
The New York Attorney General and the US Attorney are suing under broad statutes that enable them to act with respect to a geographically diverse group of bank customers. The two suits not only overlap with each other, but also with suits that have been, or may be, brought in other states. BNY Mellon therefore may face double exposure —or worse — for the same conduct. For example, the New York Attorney General claims misrepresentations were made to the Virginia Retirement System Fund, on whose behalf the state of Virginia has already sued.25 The risk of double exposure is obviously relevant to any ultimate litigation outcome and also will make settlement of any single suit more difficult.
The multiplicity of lawsuits will also make the course of litigation more complicated. Removal of the state case to federal court, or otherwise coordinating discovery, will be vitally important. If those efforts are unsuccessful, fighting on two fronts not only would require additional resources, but would also create a risk of inconsistent decisions (either on dispositive motions or discovery practice) and inconsistent statements by witnesses. The United States Attorney's Office and the New York Attorney General face similar challenges caused by their overlapping suits. The strategic decisions that they make in one case might impact the other, and the prosecutors run the risk that BNY Mellon will obtain discovery of communications between them.
In other cases involving parallel litigation, such as with criminal prosecutions and SEC enforcement actions, it is common for federal authorities to seek to stay the parallel proceeding. It remains to be seen if such coordination is present here or if the two offices will be at loggerheads about which action should proceed first. Moreover, to the extent that the offices coordinated their investigation, there is a risk that those communications will ultimately be subject to disclosure because the filing of separate suits supports an argument that there is no common interest privilege between the government attorneys. Depending on what was said prior to the decision to file separate suits, such disclosure could not only be damaging to the governments' claims but also be embarrassing if it shows a breakdown of cooperation.
On a broader level, New York Attorney General Eric Schneiderman's suit represents another step in his continued campaign against the banking industry. The BNY Mellon foreign exchange suit is the Attorney General's second action against BNY Mellon in the last two months. In August, he sued to intervene and block an $8.5 billion settlement proposed by BNY Mellon and Bank of America regarding residential mortgage-backed securities, accusing BNY Mellon of misconduct in its role as trustee.26 While Attorney General Schneiderman has been vocal in his criticism of the banks, both suits could be viewed as somewhat opportunistic. The Bank of America suit followed only after a settlement had been reached in that matter, and the current suit follows litigation in other states, a whistleblower False Claims Act complaint, and — at least to some degree — a joint effort with the US Attorney for the Southern District. It remains to be seen whether and to what degree the New York Attorney General will step out and act independently against the financial industry.
Footnotes
1 Complaint and Superseded Complaint, New York ex rel. FX Analytics v. Bank of New York Mellon, No. 09/114735 (N.Y. Sup. Ct. Oct. 4, 2011) [hereinafter N.Y. Compl.]; Complaint, U.S. v. Bank of New York Mellon, 11 Civ. 06969 (S.D.N.Y. Oct. 4, 2011) [hereinafter S.D.N.Y. Compl.].
2 See Complaint in Intervention, Florida ex rel. FX Analytics v. Bank of New York Mellon, No. 2009 CA 4140 (Fla. Cir. Ct. Aug. 11, 2011); Complaint in Intervention, Virginia ex rel. FX
Analytics v. Bank of New York Mellon, No. CL-2009-15377 (Va. Cir. Ct. Aug. 11,
2011); Complaint in Intervention, California ex rel. Edmund G. Brown, Jr. v. State Street Corp., No. 34-2008-00008457-CU-MC-GDS (Cal. Super. Ct. Oct. 20, 2009); Press Release, WA Attorney Gen., State Recovers $11.7 Million for Washington's Public Pension Funds (Oct. 26, 2010); Carrick Mollenkamp and Jean Eaglesham, New York's Top Cop Jumps Into Fray, Wall St. J., Aug. 3, 2011.
3 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), 12 U.S.C. § 1833a (2006).
4 N.Y. Gen. Bus. Law (Martin Act) § 352 et seq. (Consol. 2011).
5 N.Y. Compl., supra note 1, ¶ 4; S.D.N.Y. Compl., supra note 1, ¶ 4.
6 N.Y. Compl., supra note 1, ¶ 19.
7 See, e.g., Press Release, BNY Mellon, BNY Mellon Says New York Attorney General's FX Lawsuit Is Wrong On Facts and Law, Oct. 4, 2011 [hereinafter BNY Mellon Press Release] ("All of our FX alternatives offer our clients valuable services at a competitive price in a transparent market.").
8 Advertisement, An Open Letter From BNY Mellon, N.Y. Times, Oct. 6, 2011, at B3.
9 N.Y. Compl., supra note 1, ¶ 4 and Exhibit 1; S.D.N.Y. Compl., supra note 1, ¶ 34 et seq.
10 See BNY Mellon Press Release, supra note 7.
11 Press Release, U.S. Attorney S.D.N.Y., Manhattan U.S. Attorney Sues Bank of New York Mellon Corporation for Fraudulent Practices in Connection with Foreign Exchange Services, Oct. 4, 2011.
12 N.Y. Compl., supra note 1, ¶ 29.
13 BNY Mellon Press Release, supra note 7.
14 Id.
15 FIRREA, supra note 3.
16 See, e.g., U.S. v. MIC Dairy, Inc. No. 05-1613CCC, 2006 U.S. Dist. LEXIS 67258 (Sept. 18, 2006 D.P.R.) (FIRREA charges based on fraudulent statements made regarding an application for an emergency loan and application for indemnity under the Livestock Indemnity Program granted by the U.S. Department of Agriculture); U.S. v. Stemberger, No. C 98-1807 CRB, 1998 U.S. Dist. LEXIS 18078 (Nov. 16, 1998 N.D. Cal.) (FIRREA charges based on falsified residential loan application); Complaint, U.S. v. Buy-A-Home, LLC, No. 10 CV 9280 (Dec. 13, 2010 S.D.N.Y.) (FIRREA charges based on alleged fraudulent mortgage records submitted to the Department of Housing and Urban Development).
17 Press Release, U.S. Attorney S.D.N.Y., U.S. Attorney Preet Bharara Announces Formation of Civil Frauds Unit (Mar. 31, 2010).
18 Id.
19 Id.
20 N.Y. State Fin. Law (New York State False Claims Act) § 187, et seq. (Consol. 2011).
21 Martin Act, supra note 4.
22 Press Release, N.Y. Attorney Gen., A.G. Schniderman & NYC Sue Bank of New York Mellon for Defrauding Pension Funds, Other Customers in Foreign Currency Trading (Oct. 4, 2011).
23 See, e.g., People v. Federated Radio Corp., 244 N.Y. 33, 38–39 (1926) ("[T]he words 'fraud' and 'fraudulent practices' should . . . be given a wide meaning so as to include all acts, although not originating in any actual evil design or contrivance to perpetrate fraud or injury upon others, which do by their tendency to deceive or mislead the purchasing public come within the purpose of the law."); People v. Royal Sec. Corp., 165 N.Y.S.2d 945, 949 (Sup. Ct. 1955) (absence of scienter or intent to defraud does not relieve defendant from liability under the Martin Act); People v. Greenberg, No. 401720/05, 2010 N.Y. Misc. LEXIS 5575 (Sup. Ct. Oct. 21, 2010) (showing of specific intent to defraud is not required to establish a violation under the Martin Act).
24 The Act confers jurisdiction over any "advertisement, investment advice, purchase or sale within this state of any commodity dealt in on any exchange within the United States of America." N.Y. Gen. Bus. Law § 352 (Consol. 2011).
25 Compare Complaint in Intervention, Virginia ex rel. FX Analytics v. Bank of New York Mellon, supra note 2, ¶ 1 with N.Y. Compl., supra note 1, ¶ 45.
26 Verified Pleading in Intervention, Bank of New York Mellon v. New York, No. 651786/2011 (N.Y. Sup. Ct. Aug. 4, 2011).
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