Senate Bill (Leahy) Would Strengthen Securities Fraud and Financial Fraud Enforcement

A bill to improve enforcement of securities fraud and financial institution fraud involving asset-backed securities and fraud related to federal assistance and relief programs was introduced by Senator Patrick Leahy, chair of the Judiciary Committee. Fraud contributed to an unprecedented collapse in the mortgage-backed securities market, he noted, and as Congress passes legislation to make sure this kind of collapse cannot happen again, a component of reform must be the reinvigoration of federal anti-fraud measures.

The Fraud Enforcement and Recovery Act, S 386, makes a number of important improvements to fraud and money laundering statutes to strengthen prosecutors' ability to combat this growing wave of fraud. Specifically, the legislation would amend the federal securities fraud statute to cover fraudulent schemes involving commodities futures and options, including derivatives involving the mortgage-backed securities that caused such damage to the banking system

The bill also amends the definition of financial institution in the US criminal code in order to extend federal fraud laws to mortgage lending businesses that are not directly regulated or insured by the federal government. These companies were responsible for nearly half the residential mortgage market before the economic collapse, yet they remain largely unregulated and outside the scope of traditional federal fraud statutes. This change will apply the federal fraud laws to private mortgage businesses like Countrywide Home Loans and GMAC Mortgage, just as they apply to federally insured and regulated banks.

Expanding the term financial institution to include mortgage lending businesses will also strengthen penalties for mortgage frauds and the civil forfeiture in mortgage fraud cases. It would also extend the statute of limitations in investigations of mortgage fraud cases to be consistent with bank fraud investigations. The new definition would also provide for enhanced penalties for mail and wire fraud affecting a financial institution, including a mortgage lending business.

This definition of financial institution would not apply to the Suspicious Activity Reports (SARs) that banks and other financial institutions are required to file, since “financial institution” is defined separately under the Bank Secrecy Act.

The bill would also amend the major fraud statute to protect funds expended under the Troubled Asset Relief Program (TARP) and the economic stimulus package, including any government purchases of preferred stock in financial institutions. This change will give federal prosecutors and investigators the explicit authority they need to protect taxpayer funds.

This amendment will make sure that federal prosecutors have jurisdiction to use one of their most potent fraud statutes to protect the government assistance provided during this most recent economic crisis, including money from the TARP and circumstances where the government purchased preferred stock in companies to provide economic relief. These amendments, however, only apply to major frauds against the government, where the value of the contract or services is more than $1,000,000.

This bill will also strengthen one of the core offenses in so many fraud cases, money laundering, which was significantly weakened by a recent Supreme Court case. The bill would amend the federal criminal money laundering statute to make clear that the proceeds of specified unlawful activity include the gross receipts of the illegal activity, not just the profits of the activity. The money laundering statutes make it an offense to conduct financial transactions involving the proceeds of a crime, called specified unlawful activity in the statutes. These statutes, however, do not define the term “proceeds” and the term has been left to be defined by the courts. For 22 years, since the money laundering statutes enactment in 1986, courts have construed “proceeds” to mean gross receipts and not net profits of illegal activity consistent with the original intent of Congress.

But in United States v. Santos, 128 S.Ct. 2020 (2008), the Supreme Court suggested that the term “proceeds” was ambiguous and gave the term a narrower meaning. In this decision, according to the chair, the Court mistakenly limited the term “proceeds” to the profits of a crime, not its receipts, and as a result, the decision limited the money laundering statute to only profitable crimes, and permits criminal defendants to reduce their culpability for money laundering by deducting the costs of their criminal conduct.

For example, under the decision, an executive who committed securities fraud could not be charged with money laundering if the fraud were unsuccessful in making a profit, even though there was a fully completed financial transaction. This decision is contrary to the intent of Congress in passing the money laundering statutes, said the chair, and weakens one of the primary federal tools used to recover the proceeds of illegal activity, including mortgage and securities frauds.