ABA Section of Business Law
ABA Section of Business Law
Business Law Today
May / June 2000
That’s where the money is Bank crimes move beyond robbery to fraud
By JOHN K. VILLA
Many metaphors could make banking-related crimes clearer, but none is quite so apt as comparing them to a walk along a beautiful, rocky beach at high tide. All appears serene. As the tide recedes, however, the sea bottom looks increasingly irregular. Turn over the rocks and nasty little creatures are exposed.
So it is with banking-related crimes. When the economy is strong, interest rates are low and commercial loans are performing well, crimes against federally insured financial institutions are seldom discovered. Rising values of real estate as well as most other financial assets permit even the crooked loan officer and an accomplice or two to make a profit, pay off the fraudulent loan and move on without causing a ripple.
Seven-plus years of sustained economic growth have led many to believe that the crimes against federally insured financial institutions are things of the past. These beachcombers, however, would do well to remember the words of the philosopher George Santayana, "Those who cannot remember the past are condemned to repeat it." A sharp recession, rapidly falling asset values or rising interest rates would likely yield a dramatic increase in the number of reported and prosecuted crimes against banks and other federally insured financial institutions.
This article surveys the principal crimes involving financial institutions whose deposits are insured by federal agencies — including federal- and state-chartered banks, savings and loan institutions and credit unions. Its purpose is to assist the business lawyer in identifying troublesome activity that should warrant further investigation by experts.
While federal and state laws both potentially cover this criminal activity, this realm has historically been dominated by federal laws and federal law enforcement. The preeminent federal role is the result of the heightened federal interest in the economic health of these institutions — after all, a federal agency will pay off the depositors to the limits of deposit insurance ($100,000) if the financial institution becomes insolvent — and the much greater resources that the federal government has devoted to this effort. Except in a very few major cities — New York City being the most notable example — state law enforcement plays a decidedly secondary role, or none at all, in the prosecution of these crimes. This analysis will therefore focus exclusively on federal laws and law enforcement.
The universe of banking-related crimes is divided into two distinct groups. The first is composed of traditional banking crimes and their modern cousins that prohibit fraud or other crimes in which the financial institution is the victim. These crimes include the typical ones such as bank robbery (18 U.S.C. § 2113), false statements to a bank in order to obtain a loan (18 U.S.C. § 1014), misapplication or embezzlement of bank funds (18 U.S.C. § 656), false entries in a bank’s books (18 U.S.C. § 1005), bank bribery (18 U.S.C. § 215) and the newest and most comprehensive of all of these statutes, bank fraud (18 U.S.C. § 1344).
While these crimes are very different from one another because, for example, some require violence or a threat of violence and others can only be perpetrated by insiders, they have one common thread: The bank or financial institution is the victim, not the perpetrator, of the criminal conduct.
These traditional crimes are distinguished from the new breed of federal criminal statutes that now prohibit and punish the financial institution for allowing itself to be used as the middleman to effectuate or camouflage the criminal conduct of others. Unlike the traditional banking crimes, these new crimes focus on the bank (or other financial institution) as the perpetrator, not the victim, of the criminal conduct.
The impetus for criminalizing conduct by financial institutions was the inflow of drug money into the banking system in the early 1980s. Prosecutors realized that receiving deposits of drug money was not then per se illegal. They turned to Title II of the Bank Secrecy Act (BSA), 31 U.S.C. §§ 5311, et seq., which has little or nothing to do with secrecy, but requires the filing of reports for transactions in cash or currency over $10,000. The BSA, which was essentially a reporting statute, was fed steroids by subsequent amendments, but remained ill-suited for the heavy lifting that the federal government had in mind — the criminalization of receiving or handling the proceeds of illegal activity.
Thus was conceived the money-laundering statutes, 18 U.S.C. §§ 1956 and 1957, which were enacted in 1986. These two statutes, complemented by the forfeiture statutes that were also enacted at that time, 18 U.S.C. §§ 951 and 952, heralded a sea change in the federal law-enforcement attitude toward financial institutions. Now the government’s law-enforcement goals were not only to protect these institutions but also to punish severely those that facilitate (even through routine business transactions) the suspected criminal conduct of their customers.
The Department of Justice was able to achieve easy passage of the money-laundering statutes in order to combat the universally despised threat of drug money laundering. Who, after all, speaks up for narco-traffickers and their associated narco-launderers? Once having achieved this goal, the money-laundering statutes have been quietly, systematically expanded so that they now prohibit knowingly handling the proceeds of nearly every kind of criminal conduct. Now, financial institutions are required to refrain from knowingly doing business with nearly anyone who derives proceeds from any form of illegal activity.
At about the time that the money-laundering statutes appeared in the mid-1980s, what we now refer to as the savings and loan crisis exploded. Although the losses resulting from the S&L crisis (and a similar banking collapse in many of the Sun Belt states) were primarily due to government regulatory policies gone awry, Congress and the executive branch found it expedient to blame the problem on "the S&L crooks."
This, in turn, led to an overhaul of the federal criminal statutes governing federally insured financial institutions. The two lasting effects were to increase dramatically the maximum penalties for banking-related offenses — from five years to 30 years — and to enact the modern bank fraud statute, 18 U.S.C. § 1344.
One way to analyze the traditional banking criminal statutes is to divide them based on the status of the alleged perpetrator — is the person an insider or not? In some instances, the fraud is perpetrated by an insider working with a noninsider — customer, vendor, borrower, etc. The lines then become blurred, and the noninsider can be charged with conspiracy with or aiding and abetting the insider.
Most statutes do not include the term "insider," but the relevant statutes are generally deemed to encompass any director, officer, employee, agent (and occasionally lawyer) of a financial institution. Any person who conspires with or aids and abets an insider will also generally be subject to these statutes. See 18 U.S.C. § 371 (federal conspiracy statute); 18 U.S.C. § 2 (aiding and abetting statute).
The statutes most often applied to insiders are 18 U.S.C. § 215 (the bank bribery statute), 18 U.S.C §§ 656 and 657 (the misapplication and embezzlement statutes for banks and thrifts, respectively), and 18 U.S.C. §§ 1005 and 1006 (the false-entry statutes for banks and thrifts, respectively).
Bank bribery is a straightforward sort of crime that any lay person can readily understand. The statute is violated by an insider who solicits or demands, or accepts or agrees to accept for himself (or another) a bribe (termed "anything of value") intending to be influenced or rewarded in connection with the business of the bank. Conversely, it also violates the statute for anyone to give, offer or even promise a bribe to a bank insider with the intent to influence or reward the insider in connection with the business of the bank.
The pivotal issue in most bank bribery prosecutions is the intent behind the payment — was it to influence the bank officer? Occasionally, the officer will argue that he (or some family member) was only given an arm’s-length investment opportunity by a borrower and that it was not "anything of value."
The misapplication and embezzlement statutes (18 U.S.C. §§ 656 and 657) — once the mainstay of federal prosecutors — have caused some problems for the Justice Department since the mid-1980s. Both embezzlement and misapplication require an intent to injure or defraud the bank — a requirement that, as we discuss below, proved a problem for the prosecutors in the S&L crisis.
The crime of embezzlement is clear enough: fraudulent taking of property by a person to whom the property has been entrusted or into whose hands it has lawfully come. A classic example of embezzlement is the bank teller who removes funds each night to bet at the local racetrack.
By contrast, the reach of the misapplication statute is less clear. Misapplication is defined as the conversion of bank funds by an insider to his or her own use or that of another other than the bank with the intent to injure or defraud the bank. The historical antecedents of this statute probably derived from tellers who literally deposited funds in the wrong account and then absconded with them.
Its ambiguous nature, however, coupled with the necessity of proving that the defendant intended to "injure or defraud" the bank, proved to be a flaw that was exposed as the S&L crisis developed. Trying to prove a motivation to injure or defraud the bank may be difficult unless the prosecutor can show personal gain or false statements — red flags of fraud. It became even more difficult in the crazy world of the S&L crisis.
Many of the most serious problems uncovered in the S&L crisis involved insiders who phonied the books to make a sick financial institution appear healthy. That was often accomplished by buying uncollectible loans out of the bank with the proceeds of new, and probably equally uncollectible loans, before the bank examiners arrived. While this practice may result in obscuring the extent of the bank’s losses, it arguably does not injure or defraud the bank itself. Indeed, many insiders made a plausible argument that their real intent was to help the bank. Proving the intent to injure or defraud the bank thus became a serious obstacle for prosecutors. This problem was remedied in large part by the bank fraud statute, 18 U.S.C. § 1344, discussed below.
The statutes prohibiting false entries in the books of a bank or thrift (18 U.S.C. §§ 1005 and 1006) are the last of the major bank statutes to apply to insiders. These statutes were originally included in the misapplication and embezzlement statutes but were split off during a recodification. Like Sections 656 and 657, the key is that the insider must have been motivated by an intent to injure or defraud the bank. Ordinarily, false-statement crimes were committed by insiders to cover up their primary criminal conduct.
The two primary noninsider banking criminal statutes are 18 U.S.C. §§ 1014 and 18 U.S.C. § 2113.
The false-statement statute, 18 U.S.C. § 1014, is the banking criminal statute that affects the most Americans. Broadly put, it prohibits making a false statement or report, or willfully overvaluing any land, property or security, for the purpose of influencing a financial institution’s action on a loan or other extension of credit. In short, this section prohibits false statements in loan applications, and providing false information about the collateral for a loan.
Most important for business lawyers, the statute could reach representations and warranties in loan agreements and may subject the person making the representation or warranty to criminal liability if made with knowledge that the statements were untrue. The key to understanding Section 1014 is to remember that it prohibits false statements and does not require fraud. Even if the bank did not actually rely on the false statement in the loan application, a crime may have been committed.
The bank-robbery statute, 18 U.S.C. § 2113, is more than meets the eye. The section not only prohibits armed robberies, it also extends to entering a bank with the intent to commit a felony — for example larceny — a nonviolent crime. Because of its harsh maximum penalties (20 years), the bank-robbery statute was occasionally used in the late 1980s by prosecutors in white-collar cases. This practice largely ceased, however, when the maximum penalties in the basic banking crimes were increased first to a maximum of 20 years, and then to 30 years, of imprisonment.
As one can discern from a review of these banking statutes, they are a hodge-podge. Prior to 1984, whether criminal conduct was subject to prosecution under federal law was dependent on elements of Civil War-era laws that bore no relationship to modern banking practice. To remedy this flaw, in 1984 Congress enacted the bank-fraud statute, 18 U.S.C. § 1344. The bank-fraud statute is patterned after the well-known mail- and wire-fraud statutes, 18 U.S.C. §§ 1341 and 1343, respectively.
Bank fraud is defined as any scheme or artifice to defraud a financial institution, or to obtain any money or property owned by, or under the custody or control of, the financial institution by means of false or fraudulent pretenses. It adopts the familiar concepts in the mail- and wire-fraud statutes but deletes the requirement that the crime be perpetrated using U.S. mail or interstate wire communication. Instead, the government need only show that the victim of the fraud (however executed) was the financial institution. It applies to insiders, customers and even vendors to banks. In sum, the mail-fraud statute eclipses some of the prior federal criminal statutes where the bank was the victim.
Although there are an infinite array of possible scenarios for bank crimes, the following examples identify many of the most common fact patterns found in either insider or noninsider cases.
• False-credit application — Undoubtedly the most common bank crime is a false statement in a loan application. The statement can range from misstating the applicant’s current financial condition (either overvaluing assets or understating liabilities, or both), denying a poor credit history (such as omitting prior bankruptcies), inflating the value of the collateral for the loan or even misstating the purpose for the loan. The garden-variety false-credit applications result in a large number of small losses.
• Kickback or bribe — One of the most common forms of serious bank fraud is the kickback or bribe to the lending officer by the potential borrower. The typical scenario is that the loan officer, or some person related to the loan officer, is paid to induce the loan officer to recommend favorably a loan or extension of credit. Since lending decisions are often the product of many subjective credit judgments about the value of illiquid collateral, etc., there is a large opportunity for abuse. Loan-related fraud results in the largest dollar losses for all financial institutions.
• "Dead-horse-for-a-dead-cow" or "cash for trash" — One of the enduring legacies of the S&L crisis is the unusual transactions that were apparently motivated by the need to lull regulators into believing that ailing financial institutions were, in fact, healthy. Often the situation involved one or more major loans that were coming due that the loan officers and borrowers realized could not be repaid. Instead of showing the loans as delinquent, and thus recognizing potential losses that would adversely affect the financial institution’s capital, loan officers would camouflage the problems.
Sometimes these ploys would involve lending additional money to the borrower (or the borrower’s cohorts) on a new loan and then funneling the new loan proceeds back to the same institution to pay off the old loan or at least bring it current. In other situations, two financial institutions, both of which had troubled loans, would, in effect, lend money to each other’s borrowers to bring both loans current. There are dozens of variations on this theme, but they all involve a form of deferring and hiding weaknesses in loans that may result in greater losses if the financial institution continues to deteriorate.
• Hidden interests — Another common fraud perpetrated by insiders is to direct transactions between the bank and an outside company that is secretly controlled by the bank insider. As a result, goods or services, or occasionally assets, are purchased by the bank at inflated prices or on unfavorable terms. The potential for losses in these less-than-arm’s-length transactions, however, is typically much less than in the fraudulent loan cases.
• Embezzlement from customer or trust accounts — Many foreign customers or trust-account customers leave large balances in their accounts for extended periods. These inactive, large balance accounts are a temptation to a fraudulent bank officer or employee. In a rising stock or real estate market, bank employees have dipped into the accounts to fund their speculative urges. If the market rises, they can replenish the plundered account. If not, they often embezzle from a second account to restore the first account, and then double their bets to return to even money.
In most instances, the final tally is major losses in several dormant accounts. This type of fraud, while deeply embarrassing for the bank as it affects customer accounts, seldom results in the seven- or eight-figure losses commonplace in loan fraud.
Financial institutions are unusual in that their primary commodity is money and credit. No one thinks it unusual for a bank to release millions or, indeed, tens of millions of dollars. These sums and the ease with which they can be spirited out of the bank can and have corrupted insiders and bank customers. Banking crimes can be explained simply in the words of another, less-distinguished, philosopher, the infamous bank robber Willie Sutton, who, when asked why he robbed banks, answered: "Because that’s where the money is."
Villa is a partner at Williams & Connolly LLP, in Washington.
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