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BofA's $1.27B 'Hustle' Penalty Overturned: A Huge Relief

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In what can be called as a major win for banks, the 2nd U.S. Circuit Court of Appeals in New York dismissed the $1.27 billion penalty imposed on Bank of America Corporation (BAC - Free Report) related to the sale of risky residential mortgage-backed securities (RMBS) by Countrywide Financial Corp. (acquired in 2008).

The three-judge panel found the evidences inadequate to hold the bank responsible for the fraud. The appeals court stated the evidence provided by the regulators only proved that underlying mortgages were of lower quality than promised in the agreements. However, they were not sufficient to to prove that Countrywide intended to do any fraudulent activity.

While giving its ruling, U.S. Circuit Judge Richard Wesley said, “The trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises.”

The Behind Story

The $1.27 billion fine was levied in Jul 2014 by the U.S. District Judge Jed Rakoff, after a jury held BofA accountable for selling defective loans to Fannie Mae and Freddie Mac from Aug 2007–May 2008 via Countrywide. The bank was accused of selling loans underlying these RMBS without properly assessing the creditworthiness of borrowers.

The Federal prosecutors indicted Countrywide for creating the program 'high-speed swim lane' or 'Hustle,' which rewarded employees for the quantity rather than quality of loans. These loans, worth approximately $2.96 billion, were bundled and sold off to Fannie Mae and Freddie Mac.

BofA was sued under the Financial Institution Reform, Recovery and Enforcement Act of 1989. The act permits the government to pursue civil charges against any party for fraud that affects any federally insured financial institution. Moreover, it provides 10-year time limit to bring-in cases.

Moreover, a former Countrywide executive, Rebecca Mairone was found guilty of civil fraud. Mairone was ordered to pay $1 million for allegedly playing a lead role in the above-mentioned program. Notably, the fine imposed on her has also been revoked.

What Next?

The revocation of BofA’s penalty is a huge setback for the U.S. prosecutors who have been trying hard to hold banks liable for the 2008 financial crisis. Notably, this is the second major legal setback for the government this year. In March, a federal judge had overturned the government’s decision to enforce new regulatory oversight on MetLife Inc. (MET - Free Report) after officials had deemed the insurer "too big to fail."

Further, the current ruling is likely to encourage other banks, who hasten to settle government cases, without contesting such litigations. Also, the decision is expected to affect the other remaining lawsuits/probes pertaining to similar allegations, including several foreign banks like Royal Bank of Scotland Group PLC and UBS Group AG (UBS - Free Report) .

Nonetheless, the government may choose to appeal against the ruling to either the full appeals court or Supreme Court.

For BofA, the decision of overturning the penalty is a breather. Though the bank has been able to move past the legal hassles, huge penalties had significantly hampered its profitability.

Currently, BofA carries a Zacks Rank #4 (Sell).

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