Mutual Bank Connor Response Memorandum of Law Opposing Motion to Dismiss 6-14-13

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IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF ILLINOIS

EASTERN DIVISION

THE UNITED STATES OF AMERICA, ex

rel. KENNETH CONNER,

Plaintiff,

vs.

PETHINAIDU VELUCHAMY; AMRISH

MAHAJAN; JOHN BENIK; THOMAS

PACOCHA; JAMES MURPHY; RIC

BARTH; PARAMESWARI

VELUCHAMY; ARUN VELUCHAMY,

ANU VELUCHAMY; JAMES ROTH,

RONALD TUCEK, PATRICK

McCARTHY; JAMES REGAS; THE

VELUCHAMY FAMILY FOUNDATION;

ADAMS VALUATION CORPORATION;

and DOUGLAS ADAMS

Defendants.

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CASE NO. 11 CV 4458

QUI TAM LAWSUIT

Hon. Sharon Johnson Coleman

JURY TRIAL DEMANDED

RELATOR KENNETH CONNERS COMBINED RESPONSE TO MOTIONS TO

DISMISS FILED BY JOHN BENIK, ET AL, PATRICK MCCARTHY AND RONALD TUCEK, AND DOUGLAS ADAMS AND ADAMS VALUATION CORPORATION

Pursuant to leave previously granted by this Court to file a single response,

relator Kenneth Conner, by and through his attorneys, Matthew J. Sullivan and Joseph

T. Gentleman, states as follows in response to the three pending motions to dismiss

filed by defendants John Benik, et al, Patrick McCarthy and Ronald Tucek, and Douglas

Adams and Adams Valuation Corporation:

Case: 1:11-cv-04458 Document #: 88 Filed: 06/14/13 Page 1 of 30 PageID #:391

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INTRODUCTION

This is a case about a bank systematically hiding risky loan decisions from the

FDIC through its sweetheart relationship with an appraiser who, wherever necessary,

inflated appraisals to make loans made by the bank appear to conform to the 80 percent

or lower loan-to-value ratio supervisory limit set forth in the FDICs regulations. Why

would a bank want to do this? Banks pay premiums to the FDIC for their deposit

insurance, and those premiums are based on the banks risk category. When a bank

discloses to the FDIC a significant number of loans that do not conform to the FDICs

supervisory limits for loan-to-value ratio, a disclosure that is required under banking

regulations, its risk category goes up and it pays significantly more for its deposit

insurance. Mutual Bank of Harvey, as a result of the scheme described herein, was

assigned the lowest possible risk level by the FDIC and paid the lowest possible deposit

insurance premiums in the years leading up to the banks collapse and an estimated (by

the FDIC) loss to the FDICs insurance fund of $656-775 million.

This is also a case about Kenneth Conner, a whistleblower who worked in

appraisal review for Mutual Bank from 2005-2007. Most of the key allegations in

Conners Amended Complaint simply are not mentioned in the three motions filed by

defendants. Much more detail is provided below, but Conner repeatedly brought to the

attention of Mutual Banks management gross overvaluations of commercial real estate

collateral by Adams Appraisal Corporation and when he did so he was rebuffed,

upbraided, and instructed to just approve the appraisals. When he refused, he was


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told to stop work on the appraisal reviews. In certain instances he was told he could

not put his appraisal review criticizing Adamss work in the loan file. Mutual Bank

management variously told Conner that the inflated appraisals were necessary because

[bank president] Amrish Mahajan] and the Board want to do the deal anyway and

because if [bank chairman Pethinaidu] Velu[chamy] wanted good appraisals, you

would be reviewing good appraisals.

Instead of addressing what is actually alleged in the Amended Complaint,

defendants see fit sling mud at Conner. Benik, et al, for example, find it so significant

that Conner graduated college relatively recently (in 1999)1 that they look to a pleading

from another case in another court to incorporate that fact into their motion. Benik, et

al, at 2. Although not within the papers, Benik, et al, and Adams likewise go out of their

way point out that Conner is not a licensed appraiser (apparently without

appreciating the irony that they themselves put him in charge of appraisal review for

Mutual Bank). Id. Perhaps strangest of all, Benik, et al, spend almost as much time in

their statement of facts discussing a 2008 state court complaint for retaliatory discharge,

a case that was dismissed for want of prosecution after the bank collapsed, as they do

the case before the Court. 2 That they take this tact even though they are unable to point

out a single discrepancy between the two complaints (filed by different counsel) is

particularly baffling. Finally, they falsely state that Conners case was filed after the

1 To the extent that it is at all relevant to a motion to dismiss, Conner also earned an MBA in 2004.

2 Benik, et al, do not, as they cannot, contend that the state court retaliatory discharge case erects res judicata bar to the present action. In U.S. ex rel. Lusby v. Rolls-Royce Corp., 570 F.3d 849, 852 (7th Cir. 2009) the Seventh Circuit explicitly held that the resolution of personal employment litigation does not

preclude a qui tam action, in which a relator acts as a representative of the public.


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federal government itself sued the Banks officers and directors, where in fact Conners

lawsuit preceded that FDICs lawsuit by several months. Id. at 1. None of this should

distract from what is actually before the Court, which is the specific facts pleaded in the

Amended Complaint.

FACTS

Relator Kenneth Conner was tasked with reviewing commercial real estate

appraisals at the Mutual Bank, starting shortly after his transfer to the main branch of

the bank located in Harvey, Illinois, in fall 2005 until his termination in October 2007.

Amend. Compl. at 22-23. Although it is well understood in the banking industry that

having a high concentration of appraisals done by any one company puts a bank at risk

by failing to diversify, more than half of the appraisals that Conner reviewed at Mutual

Bank were conducted by defendant Adams Valuation Corporation (Adams Valuation

Corporation and its principal Douglas Adams are referred to collectively herein as

Adams.). Id. at 25-26.

Although defendants omit it from their statement of facts, Conner repeatedly

brought the inflated appraisals to the attention of Mutual Bank management only to be

rebuffed, upbraided, told to stop work and eventually terminated. Id. at 37-38, 42,

45, 51, 53-54, 56-57, 59-61. In the just over two years that Conner was at the Harvey

branch of Mutual Bank, Conner identified to Mutual Banks management

approximately 75 commercial real estate appraisals that were significantly inflated, the

vast majority of which were conducted by Adams. Id. at 52. Except where Mutual

Bank management specifically instructed him not to do so (discussed below), Conner


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generated an appraisal review report, that was placed in the loan file, explaining why

he believed Adams appraisal was inflated. Id. at 53.

The complaint provides myriad specific examples that make clear that the fact

that Adams appraisals were inflated was well known to Mutual Bank management and

directors and was not accidental. In 2006, Conner was asked to review an appraisal,

conducted by Adams, for the proposed Venturella Resort and Spa to be located in

Orlando, Florida. Amended Compl. at 29. The Venturella was to be a renovation of

an existing hotel a little over a mile from Walt Disney World. Id. at 30. Rather than

relying on comparables that were nearby, Adams instead relied solely upon room price

and occupancy rates from an extreme high-end property called the Peabody Hotel that

was by a wide margin the most expensive hotel in the wider Walt Disney/Convention

Center area. Id. at 31. Whereas the Peabody is located directly adjacent to Orlandos

convention center, the Venturella was to be located half a block from a busy intersection

near a highway interchange, adjacent to a Dennys, an Olive Garden, a Burger King and

a Holiday Inn Express. Id. Likewise the Peabody was located in a 27-story building

with landmark appeal and balconies off of its rooms. Id. at 34. By contrast, the

proposed Venturella was to be located in a standard six-story hotel building without

balconies and with significantly smaller rooms than the Peabody. Id. Even though all

of the other hotels in the areaand especially the ones located near the proposed

Venturellaall had average daily room rates less than $300, Adams assumed for

purposes of its valuation that the Venturella would, like the Peabody, have an average

daily room rate in excess of $400. Id. at 35.


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Reviewing Adams appraisal, Conner conservatively estimated that Adams,

which had valued the Venturella property at $22 million, had inflated the appraisal by

at least $9.7 million. Amended. Compl. at 36. Adams told bank Senior Vice President

James Murphy, Conners immediate supervisor who was in charge of loan review for

the bank, that Adams had overvalued the Venturella property by around $10 million.

Id. at 13,37. Murphy responded that [Bank President] Amrish [Mahajan] and the

Board want to do the deal anyway because the borrower is going to get the bank out of

trouble with other properties. Id. at 37. Shortly thereafter, Conner was instructed by

Murphy to cease work on the Venturella appraisal review and not to put the work that

he had completed in the appraisal presentation. Id. at 39.

In 2007, Conner reviewed an appraisal for a two-story retail/office building in

Mount Olive, New Jersey. Amended Compl. at 40. The appraisal, which was

unsigned and appeared to be an incomplete rough draft, appraised the property for

approximately $2.5 million. Id. However, the draft appraisal failed to articulate any

reasonable basis for the $2.5 million figure. Id. Conner reviewed the other comparison

properties that were presented in the incomplete appraisal and found that they justified

a value of only about $1.5 million. Id. Conner thus informed Murphy that he could not

approve the appraisal because it was an incomplete draft that significantly overvalued

the property. Id.

Shortly thereafter, Mutual Banks Chief Lending Officer John Benik called

Conner into his office. Amended Compl. at 42. Benik was visibly angry. Id. Benik

upbraided Conner for interfering with a deal that he said the Board wanted to do. Id.


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Conner explained to Benik that the appraisal was just a rough draft and that it appeared

to overvalue the property by almost 70 percent. Id. Benik responded: What are you

doing? You are causing problems. Id. Benik told Conner to just go ahead and

approve the appraisal. Id. When Conner refused, Benik ordered Conner to cease work

on the appraisal review. Id.

Adams also systematically inflated its appraisals of gas stations. Amended

Compl. at 48. Here Adams entire methodology for value gas stations was faulty

because they used a market capitalization rate that was for retail buildings rather than

for gas stations. Id. All other appraisers used a much higher capitalization rate that was

specific to gas stations that resulted in much lower valuations. Id. at 49. Because gas

stations were a particular area of concentration for Mutual Bank, this systematic error

infected a substantial amount of Mutual Banks portfolio. Id. at 50. Conner informed

Murphy of the issue three or four times and, likewise, informed Benik and former Bank

senior vice president Ric Barth. Id. at 16, 51. All three were dismissive and

responded to the effect that Adams is an approved appraiser. Id.

In late 2006, a second appraisal, by a different appraisal firm, was conducted of a

hotel property in Evansville, Indiana, that Adams had previously valued at $21 million.

Amended Compl. at 47. The second firm determined that the value of the property

was only $12 million, stabilizing at $13 million, or some $9 million less than the inflated

figure Adams had come up with. Id. The new valuation was presented to the entire

Board of Directors, as well as Murphy and Tom Pacocha. Id. The members of the Board

of Directors were thus all aware that Adams had overvalued the property by nearly 100


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percent. Id. Nonetheless, Mutual Bank continued to use Adams for more than half of

its appraisals. Id.

The Amended Complaint provides other specific examples of properties that

were overvalued by Adams and brought to the attention of Mutual Bank management

by Conner: A two-story retail property in the Beverly neighborhood of Chicago; an

empty lot on the south side of Chicago; a Holiday Inn in Rolling Meadows; and a loft

condo conversion in Logan Square (valued on par with similar buildings in the, at the

time, more affluent neighborhoods of Bucktown and Wicker Park). Amended Compl.

at 44-46. Notably, Conner provides all of this detail without access to the

approximately 75 appraisal reviews he created criticizing various inflated appraisals,

which presumably remain in Mutual Banks loan files. See id. at 52-53.

On at least six occasions, Murphy scolded Conner for criticizing Adams

appraisals. Murphy instructed Conner: Your job is to approve these appraisals, not to

question Adams conclusions. Amended Compl. at 56. These conversations would

occur when Conner pointed out that an Adams appraisal had been inflated. Id.

Murphy further made clear that he did not want Conner to make determinations of

how much an appraisal was overvalued: We dont need you spending all this time

figuring out what the property is worth. We just need you to approve them. Id. at

57. Conner nonetheless continued to conduct full reviews of the appraisals, as he

believed it was necessary to competently complete his job duties. Id. at 58.


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Conner likewise had an encounter with Bank president Amrish Mahajan3

concerning the inflated appraisals. It was Mahajans practice to walk the office and talk

to the employees. Amended Compl. at 59. In Fall 2006, during one of Mahajans

walk-throughs, Conner approached Mahajan to inform him of the inflated appraisals.

Id. Conner explained to Mahajan that many of the appraisals that he was reviewing

were overvalued by 20-30 percent. Id. Mahajan replied, I heard there was a problem

with some of the appraisals. Ill set up a meeting with you and Jim [Murphy]. Id. The

meeting never occurred. Id. On multiple occasions, Conner reminded Murphy that

there was to be a meeting with Mahajan regarding the appraisal problem. Id. at 60.

Murphy would simply change the subject. Id. Finally, Conner told Murphy that he was

thinking approaching Mutual Banks chairman Pethinaidu Veluchamy regarding the

appraisal issue. Id. at 61. Murphy snapped back: Velu does not need you to tell him

that the appraisals are bad. If Velu wanted good appraisals, you would be reviewing

good appraisals. Id. Conner asked Murphy if he was sure Veluchamy was aware of

the issue. Murphy responded: Yes. Do you think he is an idiot. Id.

Conner was terminated in October 2007 about one week after the meeting with

John Benik where he refused Beniks order to approve the incomplete appraisal of the

Mount Olive, New Jersey property. Amended Compl. at 62. In July 2009, Mutual

Bank failed. Id. at 63. When the Office of Inspector General conducted its loss review

of Mutual Bank, examiners noted concerns with the appraisal company most

3 Mahajan filed an answer to the Amended Complaint wherein he avers that he lacks sufficient information to admit

or deny almost all of the allegations in the Amended Complaint, including those concerning his encounter with

Conner.


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commonly used by the bank, including the companys questionable support for

comparables, capitalization rates, and final values and the potential lack of objectivity

and diversification of the appraisal work in general. Id. at 64. However, nothing

about the Inspector Generals report, in itself, showed that Mutual Bank knew that

Adams appraisals were inflated or that this was deliberate rather than negligent

conduct. According to the Inspector Generals report, the FDIC insurance fund

sustained an estimated loss of $656 million from Mutual Banks failure. Id. at 66. That

figure has since been revised upward to $775 million.

As explained in much greater detail in the Amended Complaint, the FDIC has

promulgated a risk-based assessment system for determining deposit insurance

premiums. See Amended Compl. 67-75 (explaining system). In essence, based on a

banks risk profile, it is assigned a risk category from I-IV based on the quality of its

loan portfolio. Id. at 68,71-72. The risk category assigned makes an enormous

difference in a banks assessment for deposition insurance premiums. Id. at 73-74.

For example, depending on the particular year, a bank assigned Risk Category I would

pay between 2 and 4 basis points as its insurance premium whereas a bank assigned

Risk Category IV would pay 40 basis points, as much a twenty-fold difference. Id. at

73. During the time that Conner was at the bank, Mutual Bank was assigned Risk

Category Ithe lowest risk category possibleand therefore paid at or near the lowest

possible assessment rates to the FDIC for its deposition insurance. Id. at 75.

Mutual Bank was only able to receive the lowest possible risk category and

therefore pay the miniscule rates for its deposit insurance through a systematic fraud of


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which Adams inflated appraisals were the lynchpin. In substance, the inflated

appraisals allowed Mutual Bank to hide risky loans, i.e., loans with high loan-to-value

ratios,4 from the FDIC. The FDIC provides minimum standards for loan-to-value ratios

for commercial real estate lending. 12 C.F.R. 365.2; Amended Compl. at 78. In

particular, the FDICs supervisory limit for commercial real estate loans is an 80 percent

loan-to-value ratio. 12 C.F.R. 365, App. A; Amended Compl. at 78. Within certain

limits, the FDIC permits exceptions to this rule for credit-worthy borrowers who do not

fit within the FDICs loan-to-value ratio limit. However, for each loan in excess of these

limits, the FDIC requires that the bank create a lending policy exception report

(hereinafter exception report) identifying the loan and setting forth all the relevant

credit factors that support the underwriting decision. 12 C.F.R. 365, App. A;

Amended Compl. at 79. Exception reports are specifically reviewed by the FDIC

during annual bank examinations and an excessive volume of exceptions to an

institution's real estate lending policy may signal a weakening of its underwriting

practices, or may suggest a need to revise the loan policy. 12 C.F.R. 365, App. A;

Amended Compl. at 80 Further, the FDIC further had a hard cap on loans in excess of

the supervisory loan-to-value limits for all commercial, agricultural, multifamily or

other non-1-4 family residential properties of 30 percent of total capital. 12 C.F.R. 365,

App. A; Amended Compl. at 81.

4 A loan-to-value ratio expresses the ratio of the first mortgage lien as a percentage of the total appraised value of real property.


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Mutual Banks commercial real estate loans were substantially all twenty-percent

down loans. Amended Compl. at 82. By using inflated appraisals, Mutual Bank was

able to mask the fact that the loans actually had loan-to-value ratios that were

considerably in excess of the eighty percent limit. Id. at 83. In substance, the inflated

appraisals artificially increased the loan-to-value ratio denominator in order to make

the loan-to-value ratios appear much lower than they really were. Id. Thus, the

appraisals enabled Mutual Bank to conceal from the FDIC the fact that its loans did not

conform to the FDICs loan-to-value limits because the required exception reports were

never generated. Id. at 84. Likewise, the inflated appraisals enabled Mutual Bank to

hide from the FDIC that the aggregate value of its commercial real estate loans that had

loan-to-value rations higher than 80 percent was exponentially in excess of the FDICs

limit of 30 percent of total capital. Id. at 85.

The Amended Complaint alleges that all of the individual defendants had

knowledge of the inflated appraisals and that the principals of the two corporate

entities (of which, only Adams Appraisal Corporation is at issue in the present motions)

had knowledge that the appraisals were inflated. Amended Compl. at 94. Further it

alleges that, in violation of 31 U.S.C. 3729(a)(1)(g), defendants knowingly caused to be

submitted to the FDIC false records and knowingly caused to be concealed from the

FDIC material information concerning the collateral on its commercial real estate loans,

including but not limited to the fact that the loan-to-value ratios on its loans were in

excess of FDIC limits. Id. at 96.


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ARGUMENT

A. The Complaint Is Timely Because It Was Filed Within Six Years of The Date

the Violations Were Committed.

The various defendants contention that the action is time-barred grossly

misreads the applicable statute of limitations. Section 3731(b) sets forth what is in

essence a six-year statute of limitations with a three-year discovery rule and a ten-year

statute of repose:

(b) A civil action under section 3730 may not be brought

(1) more than 6 years after the date on which the violation of section 3729 is committed, or (2) more than 3 years after the date when facts material to the right of action are known or reasonably should have been known by the official of the United States charged with responsibility to act in the circumstances, but in no event more than 10 years after the date on which the violation is committed,

whichever occurs last.

31 U.S.C. 3731(b). The key phrase in the statute relative to the issue before the Court is

whichever occurs last. Analyzing that phrase, courts in this Circuit have repeatedly

held that the three-year discovery rule set forth in section (b)(2) only comes into play if

the six-year statute of limitations in section (b)(1) has expired. See, e.g., Goldberg v. Rush

University Medical Center, 2013 WL 870651, *15-16 (N.D. Ill. March 6, 2013) (six-year

statute of limitations applies to relators claim if it is longer than three-year discovery

rule); U.S. ex rel. Dismissed Relator v. Lilwani, 2012 WL 4739922, *5 (C.D. Ill. 2012) (three-

year statute of limitations in subsection (b)(2) does not apply where case is filed


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within six-year statute of limitations in subsection (b)(1) under plain reading of

Section 3731(b), which provides whichever occurs last is applicable.)

Here, relators complaint was filed on June 30, 2011.5 Defendants do not claim

that Conner has failed to allege violations that continued after June 30, 2005. In fact,

Conner was not even transferred to the Harvey branch of the bank until fall 2005. Thus,

this case was clearly filed within the six-year statute of limitations set forth in Section

3731(b)(1). Because Conner has no need to claim the benefit of the three-year discovery

rule set forth in subsection (b)(2), it is irrelevant to this case.

Defendants arguments to the contrary evince an obvious misunderstanding of

both the plain language of the statute and case law cited in their briefs, which has

nothing to do with the issue at bar. The fundamental problem is that their argument

pretends that the statute says whichever occurs first, where it in fact says the

opposite. None of the defendants attempt to explain why they apparently believe that

the whichever occurs last language of the statute does not apply to make the six-year

statute of limitations of subsection (b)(1) applicable here. McCarthy and Tucek,

shamefully, avoid the issue entirely by selectively quoting Section 3731(b) to omit

entirely the six-year statute of limitations set forth in subsection (b)(1) and the

whichever occurs last language. McCarthy & Tucek Memo at 6. Both the Adams

defendants and Benik, et al, fully quote the applicable statute, but nonetheless do not

undertake to explain how the language of the statute supports the self-serving

5 Plaintiffs Amended Complaint, filed October 24, 2011, relates back to the initial June 30, 2011 filing date under Rule 15(c)(2) because the amendment asserts a claim or defense that arose out of the conduct, transaction or occurrence set outor attempted to be set outin the initial pleading. FRCP 15(c)(2).


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conclusion that they reach. Nor do they address the above-cited case law in this Circuit

that holds that the three year discovery rule in subsection (b)(2) applies only where the

six year statute of limitations in subsection (b)(1) has run.

Furthermore, the case law cited by defendants relates to a wholly different issue,

namely whether a relator, or only the Government, can claim the benefit of the three-

year discovery rule set forth in Subection (b)(2) (and, if so, whether the relevant date is

the Governments knowledge or the relators knowledge). See Goldberg, 2013 WL at 15

(discussion of split between the circuits on this issue). This line of authority, which

holds that, contrary to the rule in some other circuits, relators, in addition to the

Government, may claim the benefit of the three-year discovery rule to extend the

otherwise applicable six-year statute of limitations does not stand for the proposition that

only the three-year discovery rule applies to relators.

For example, in U.S. ex rel King v. F.E. Moran, Inc., 2002 WL 2003219, at *13 (N.D.

Ill. Aug 29, 2002) (relied upon by McCarthy & Tucek and Adams), the relator sought to

amend its complaint to add new claims related to different projects more than six years

after the date of the violations. The Court held that, even though the Government had

been aware of the violations more than three years prior, the relevant date for purposes

of the three-year discovery rule was the date that the relator found out about the

violations. Thus, the Court allowed the claims to proceed because the discovery rule in

section (b)(2) extended the statute of limitations.

U.S. ex rel Hudalla v. Walsh Cost. Co., 834 F.Supp.2d 816, 824 (N.D. Ill. 2011) (relied

upon by Benik, et al and Tucek & McCarthy), which cites King as its basis, is of similar


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tenor. There the Court found that there is no statute of limitations defense because the

suit was brought within three years of the relator learning of the suit. In that case, there

was no need to analyze whether the case also fit within the six year statute of

limitations set forth in section (b)(1) and that court undertook no such analysis.

Because the three-year discovery rule of subsection (b)(2) is inapplicable to a

case, such as this one, that is filed within the six-year statute of limitations in subsection

(b)(1), defendants statute of limitations argument must fail.

B. Conner Has Sufficiently Alleged Violations Of The FCA Under Rules 8 and 9(b).

All three sets of defendants mistakenly argue that Conners pleading is

insufficient under Rules 8 and 9(b). Because these arguments contain common issues of

law and both common and individual issues concerning the facts that have been

pleaded as to the various defendants at issue here, this section is structured with a

general discussion of the law at the outset followed by individual discussions of

defendants.

As defendants correctly point out, Rules 8 and 9(b) are both applicable to FCA

cases. Rule 9(b) requires a pleading to state with particularity the circumstances

constituting the alleged fraud. See Fed.R.Civ.P. 9(b). This ordinarily requires

describing the who, what, when, where, and how of the fraud, although the exact level

of particularity that is required will necessarily differ based on the facts of the case.

U.S. ex. rel Upton v. Family Health Network, 900 F.Supp.2d 821, 827 (N.D. Ill. 2012).

Malice, intent, knowledge, and other conditions of a person's mind may be alleged


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generally. Id., quoting Fed.R.Civ.P. 9(b). Courts should not take an overly rigid view

of this formulation and requisite information may vary on the facts of a given case.

Id. at 827-828, see also Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust v. Walgreen

Co., 631 F.3d 436, 442 (7th Cir. 2011) (Yet, because courts and litigants often

erroneously take an overly rigid view of the formulation, we have also observed that

the requisite information may vary on the facts of a given case.).

To say that fraud has been pleaded with particularity is not to say that it has been

proved (nor is proof part of the pleading requirement). Upton, 900 F.Supp.2d at 828. A

plaintiff merely needs some firsthand information to provide grounds to corroborate

its suspicions. Pirelli, 631 F.3d at 446. Accordingly, Rule 9(b) does not require a

relator to plead evidence and is to be read in conjunction with Federal Rule of Civil

Procedure 8, which requires a short and plain statement of the claim. U.S. ex rel

Yarberry v. Sears Holding Corp., 2013 WL 1287058, *2 (S.D. Ill. March 28, 2013). In the

Seventh Circuit, a plaintiff who provides a general outline of the fraud scheme

sufficient to reasonably notify the defendants of their purported role in the fraud

satisfies Rule 9(b). U.S. ex rel. Goldberg v. Rush University Medical Center, 2013 WL

870651, *5 (N.D. Ill. 2013), quoting Midwest Grinding Co. v. Spitz, 976 F.2d 1016, 1020 (7th

Cir. 1992). Further, when details of the fraud itself are within the defendant's exclusive

knowledge, specificity requirements are less stringent. Under those circumstances, the

complaint must plead the grounds for the plaintiffs suspicions of fraud. Id.

Section 3729(a)(1)(G) of the FCA provides for liability for a so-called reverse

false claim: Anyone who knowingly makes, uses, or causes to be made or used, a


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false record or statement material to an obligation to pay or transmit money or property

to the Government, or knowingly conceals or knowingly and improperly avoids or

decreases an obligation to pay or transmit money or property to the Government is

liable to the United States Government for civil penalty 31 U.S.C. 3729(a)(1)(G).

Under this provision, one who knowingly conceals, information from the

Government, as well as one who makes affirmative false statements, violates the FCA.

See, e.g., U.S. v. Rogan, 517 F.3d 449, 452 (7th Cir. 2008) (omission of fact that patient

referrals were obtained by kickback scheme violated FCA where Medicare only paid for

properly referred patients). Likewise, omissions and false statements that decrease an

obligation to pay, as in the case of Mutual Banks deposit insurance premiums, are

expressly covered by the FCA. 31 U.S.C. 3729(a)(1)(G).

1. Plaintiff Need Not Have Witnessed The Failure To Create Exception Reports And It Is Sufficient For The Failure To Create Exception Reports To Be The Foreseeable Consequence Of Defendants Actions.

All three sets of defendants go to great lengths to point out that Conner did not

physically witness the creation of (or really the failure to do so) of exception reports for

loans in excess of the 80 percent loan-to-value ratio limit. McCarty & Tucek at 8; Benik,

et al at 10; Adams at 5. In doing so, they variously misstate both the facts alleged in the

Amended Complaint and the law.

The Seventh Circuit squarely addressed this issue in U.S. ex rel. Lusby v. Rolls-

Royce Corp., 570 F.3d 849 (7th Cir. 2009). In Lusby, the relator (in a striking parallel to the

present case) had repeatedly told his supervisors that parts being shipped to the

Government did not conform to the companys contract with the Government and


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Rolls-Royce nonetheless shipped the parts. Id. at 853-854. In that case, the trial court

dismissed the relators complaint because the relator had no direct knowledge of the

specific request for payment, as he had not seen any of the invoices and

representations that Rolls-Royce submitted to its customers. Id. at 854. The Seventh

Circuit reversed, specifically finding that the submission of a false claim can be inferred

at the pleading stage based on surrounding circumstances:

We don't think it essential for a relator to produce the invoices (and accompanying representations) at the outset of the suit. True, it is essential to show a false statement. But much knowledge is inferential-people are convicted beyond a reasonable doubt of conspiracy without a written contract to commit a future crime-and the inference that Lusby proposes is a plausible one.

Id (emphasis added). The Lusby Court explained the inference in that case: Federal

regulations required Rolls-Royce to submit a certification (again, parallel to the present

case) that all supplies furnished were in accordance with all applicable requirements.

Id. Given that it was unlikely the Government would have accepted and paid for the

goods at issue without the required certificate, the Court held that it could be inferred

that the false certification was furnished. Id. The Court noted that even a requirement

of proof beyond a reasonable doubt need not exclude all possibility of innocence; nor

need a pleading exclude all possibility of honesty in order to give the particulars of

fraud. It is enough to show, in detail, the nature of the charge, so that vague and

unsubstantiated accusations of fraud do not lead to costly discovery and public

obloquy. Id. at 854-855.


20

The instant case presents facts remarkably similar to Lusby. At Mutual Banks

behest, Adams conducted appraisals that it inflated by 20-30 percent, or more in certain

cases. Federal regulations required Mutual Bank to disclose to the FDIC in exception

reports loans in excess of the 80 percent loan-to-value ratio limit. Amended Compl. at

76-85; 12 C.F.R. 365, App. A. Because the appraisals were inflated, the loans were

booked as if they had loan-to-value ratios below 80 percent. Is it theoretically possible

that Mutual Bank management might have, despite having Adams prepare inflated

appraisals over a period of years, experienced repeated changes of heart when it came

time to disclose the loans to the FDIC as having loan-to-value ratios in excess of 80

percent in exception reports? As in Lusby, any such possibility is a remote one. Lusby,

570 F.3d at 854. This is all the more so because Mutual Bank had the lowest possible

risk rating from the FDIC (Amended Compl. at 75) during a time period where it was

serially making loans in excess of the FDICs loan-to-value ratio supervisory limits,

which in itself makes it impossible that this activity was being disclosed like it was

supposed to be.

McCarthy and Tucek cite U.S. ex rel. Crews v. NCS Healthcare of Illinois, Inc., 460

F.3d 853, 856 (7th Cir. 2007) for the dubious premise that a [r]elator also must allege

specific details about the actual submission of false claims. McCarthy & Tucek at 8.

Crews is a case that deals with summary judgment and, hence, has nothing at all to say

about what a relator must allege in a complaint. Crews, 460 F.3d at 855. In any event,

whether or not he physically witnessed the Banks failure to create exception reports,


21

Conner has described in considerable detail the nature of the submissions at issue,

which is more than sufficient under the law.

Benik, et al, for their part, confine their analysis concerning submissions to the

FDIC entirely to Mutual Banks call reports. Call reports, discussed in paragraphs 86-

91 of the Amended Complaint, are only one of two ways in which Mutual Bank should

have been reporting the loans at issue to the FDIC. As above discussed above, the

primary false claim is the failure to provide exception reports for loans with loan-to-

value ratios in excess of 80 percent. Amended Compl. 76-85. Thus, claiming that

there is no entry on Call Reports to record appraised values (Benik, et al, at 10) is an

entirely moot exercise where Benik offers nothing to dispute that Mutual Bank was

required to create exception reports for the loans at issue and failed to do so.6

The Adams defendants, the instrument of the fraud, protest that there is no

allegation suggesting that Adams had any part in communicating anything to the

United States government. Adams at 7. That the Adams defendants did not

themselves communicate with the Government is a distinction without legal

consequence. The U.S. Supreme Court long ago held that the FCA indicates a purpose

to reach any person who knowingly assisted in causing the government to pay claims

which were grounded in fraud, without regard to whether that person had direct

contractual relations with the government. U.S. ex rel. Marcus v. Hess, 317 U.S. 537,

6 Moreover, this was never Conners point with respect to the call reports. Instead, Conner alleges that Mutual Bank misrepresented the quality of its collateral on its real estate loans to the FDIC on its call repots by inter alia: failing to identify non-accrual loans and failing to book proper loan-loss reserves for loans that it had reason to know had a substantial probability of default. Amended Compl. at 92. a


22

544, 63 S.Ct. 379 (1943); see also U.S. v. Bornstein, 423 U.S. 303, 313, 96 S.Ct. 523 (1976)

(subcontractor was liable for false submission of prime contractor); U.S. ex rel. Schmidt v.

Zimmer, 386 F.3d 285, 245 (3rd Cir. 2004) (third partys conduct merely need be

substantial factor in bringing about false claim to be actionable under FCA); Mason v.

Medline Industries, Inc., 731 F.Supp.3d 730, 738 (N.D. Ill. 2010) (The wealth of case law

supports the proposition that the FCA reaches claims that are rendered false by one

party, but submitted to the government by another.). Here there can be little doubt

that Mutual Banks failure to disclose the loans in excess of the FDICs 80 percent loan-

to-value ratio limits was the natural and foreseeable consequence of Adams inflated

appraisals that masked the true loan-to-value ratios for the loans. Mason, 731 F.Supp.2d

at 739.

2. Conner Properly Alleged An FCA Claim With Respect To the Director Defendants.

Former Mutual Bank directors James Regas,7 Patrick McCarthy and Ronald

Tucek claim that Conner has failed to state a claim against them because, they say,

Relator makes not a single allegation, nor could he, that the Outside Directors knew of

the allegedly inflated appraisals McCarthy & Tucek at 13. This is not so. As a

threshold matter, Rule 9(b) itself provides that malice, intent, knowledge, and other

conditions of a person's mind may be alleged generally (Fed.R.Civ.P. 9(b)) and Conner

certainly does so (Amended Complaint at 95-96). But he does much more than that.

7 Despite being referred to in defendants brief as an outside director, Regas was in fact Mutual Banks general

counsel. As such, he had substantial dealings with the FDIC on behalf of Mutual Bank. Parenthetically, Regas is

currently serving a federal prison term for his activities as a chairman of the board of directors of another defunct

bank, Western Springs National Bank & Trust, including his falsification of regulatory documents.


23

For example, the explanation Conner was given by Mutual Bank management for being

asked to destroy his work showing that the Venturella property had been overvalued

by almost $10 million was that Amrish and the Board want to do the deal anyway

because the borrower is going to get the bank out of trouble with other properties.

Amended Compl. at 37. With respect to the Mount Olive, New Jersey property

Conner, again before being instructed to cease work on his appraisal review, was

accosted and scolded by Mutual Bank management for interfering with a deal that

the Board wanted to do. Id. at 42. With respect to Adams valuation of the Evansville

hotel property, the new valuationshowing that Adams had overvalued the property

by almost 100 percentwas presented to the entire Board. Id. at 47. All of these facts

tend to show that the Board well understood that risky loans were being made by the

Bank for which the true loan-to-value ratios were being hidden from the FDIC.

Like Adams, McCarthy and Tucek too point out that there is no allegation that

they physically submitted anything to the FDIC. According to this perverse argument,

as directors, these defendants can sit at the apex of a scheme to mask risky loans and

escape liability merely because they were not themselves tasked with physically

creating the exception reports. Unsurprisingly, this is not the law. The FCA, by its

terms, applies to one who causes to be made a false statement or knowingly

conceals information from the Government. 31 U.S.C. 3729(a)(1)(G). Accordingly,

[t]he FCA places liability not only on persons who cause false claims to be submitted

or who cause false statements to be made, but also on those who cause the claims or

statements to be false in the first place. Mason, 731 F.Supp.2d at 738.


24

Finally, that Conner had limited personal contact with the Board makes the

pleading requirements with respect to these defendants less stringent. Goldberg, 2013

WL 870651 at *5. Under such circumstances, the complaint need only plead the

grounds for the plaintiffs suspicions of fraud. Id. Given what Conner was told by

Bank management who were in a position to know and had no reason to lie, Conner has

more than met this relatively low standard.

3. Conner Has Properly Alleged An FCA Claim With Respect to the Management Defendants.

All of Murphy, Benik, Barth and Pacocha were senior management at Mutual

Bank during the time that Conner worked there, all were heavily involved with the

Banks commercial real estate loan portfolio and all had interactions with Conner

concerning Adams inflated appraisals. As related in the Amended Complaint, Conner

has alleged their involvement in a series of specific transactions for which Adams

performed inflated appraisals that masked the true loan-to-value ratios for the

underlying loans. The Amended Complaint describes how Conner repeatedly brought

the inflated appraisals to these individuals attention only to be variously rebuffed,

reprimanded and told to stop criticizing the appraisals for deals that the Banks

directors wanted to do. Amended Compl. 37-38, 42, 45, 51, 53-54, 56-57, 59-61.

These defendants well understand what they are charged with, and Conner has gone

considerably beyond the Seventh Circuits requirement of providing some firsthand

information to provide grounds to corroborate [his] suspicions. Pirelli, 631 F.3d at 446.


25

4. Conner Has Properly Alleged An FCA Claim With Respect To The Adams Defendants.

Adams primary contention, that they did not themselves submit a false claim is

dealt with above in subsection 1 (supra at 21-22). Adams also suggests that the Court

should disbelieve Conners allegations because, they say, he is not a licensed

appraiser. Adams at 8. This argument, to put it mildly, gets it backwards at the

complaint stage where the Court must make all reasonably inferences in favor of the

plaintiff. Adams asks the Court to assume, despite the fact that Conner, who had an

MBA and was put in charge of reviewing appraisals by Mutual Bank, did not know

how to review an appraisal and that his allegations are, therefore, factually inaccurate.

Notably, this argument is factually undermined by the fact that the FDIC ultimately

agreed with Conners analysis, finding concerns with the appraisal company most

commonly used by the bank, including the companys questionable support for

comparables, capitalization rates, and final values and the potential lack of objectivity

and diversification of the appraisal work in general. Amended Compl. 64.

Regardless, this presents a fact question that is clearly inappropriate for the pleading

stage.

As above, a relator may allege knowledge generally and the FCA sets a fairly

low standard of intent that includes recklessness. U.S. ex rel. Chandler v. Cook County,

Ill., 227 F.3d 969, 976 (7th Cir. 2002). Even absent this, what can readily be inferred from

the fact that Adams was a licensed appraiser is that it would have well understood

what it was doing (and certainly met the FCAs standard of acting recklessly) when it


26

repeatedly inflated appraisals relating to Mutual Bank loans by 20-30 percent, or more

in the case of many of the loans specifically discussed in the Amended Complaint.

Finally, as previously, an FCA defendant is presumed to have intended the natural

consequences of its actions, in this case the masking of loan-to-value ratios of Mutual

Bank loans based on its inflated appraisals. Mason, 731 F.Supp.2d at 738.

For all of these reasons, the defendants arguments that Conner has not

adequately pleaded a cause of action under the FCA are without merit.

C. The Allegations Set Forth In The Amended Complaint Were Not Publicly Disclosed Prior to Filing. McCarthy and Tucek and Benik, et al, but notably not Adams, argue that this

action is barred by Section 3730(e)(4)(A) of the FCA, which provides for dismissal of

claims where substantially the same allegations or transaction as alleged in the action

were publicly disclosed. 31 U.S.C. 3730(e)(4)(A). This argument fails on multiple

independent levels. Section 3730(e)(4)(A) poses three questions: (i) are disclosures of

allegations or transactions revealing the fraud in the public domain?; (ii) is the suit

based upon those disclosures?; and (iii) if so, is the relator nonetheless an original

source of the information? U.S. ex rel. Balthazar v. Warden, 635 F.3d 866, 867 (7th Cir.

2012). The answer to all three of these questions is emphatically no. First, nothing

about the Inspector Generals report exposes the transactions as necessarily fraudulent

as opposed to negligent. It is Conners information that Mutual Banks management

and directors knew about and encouraged the fraudulent appraisals thereby masking

true collateral value that makes this fraud. Second, relatedly, Conners suit is based


27

upon his interactions with Mutual Bank management concerning Adams inflated

appraisals and his own review of those appraisals as part of his job, not public

information. Third, Conner is clearly an original source of information as it has been

defined by the Seventh Circuit.

The first failing of defendants argument is basic. To be sure, there was public

information about Mutual Banks failure and its unsound banking practices.

However, [a] public disclosure exists under 3730(e)(4)(A) when the critical elements

exposing the transaction as fraudulent are placed in the public domain. U.S. ex rel.

Feingold v. AdminiStar Fed, Inc., 324 F.3d 492, 495 (7th Cir. 2002) (emphasis added).

Public disclosure that shows only negligence is insufficient. For example, as Judge

Easterbrook recently explained, public disclosure of miscoded Medicare submissions

would not foreclose a FCA claim because the errors may have been caused by

negligence rather than fraud (which means intentional deceit). Balthazar, 635 F.3d at

867.

Both defendants rely on a statement in the Material Loan Loss Review that

specifically referenced problems with appraisals:

Mutual Banks appraisal review process needed strengthening

examiners noted concerns with the appraisal company most commonly used by the bank, including the companys questionable support for

comparables, capitalization rates, and final values and the potential lack of objectivity and diversification of the appraisal work in general.

McCarthy & Tucek at 5; Benik, et al, at 7. This obviously confuses exposing appraisals

as being poorly or negligently done for exposing fraud.


28

McCarthy & Tucek also suggest that the critical elements of Relators claims

are contained in the banks call reports previously submitted to the FDIC. McCarthy

& Tucek o at 15. McCarthy and Tucek then (helpfully) invite the Court to read all the

call reports at a web address they provide, without ever saying what it is about the call

reports that they think publicly discloses the FCA claim.

Benik, et al, simply cite Mutual Banks unsound banking practices.

Other documents that were publicly disclosed prior to Conners June 20, 2011 qui tam suit include the December 30, 2008 Order to Cease and Desist issued by the FDIC itself , which states that the FDIC and the

Division determined that they had reason to believe that the Bank had engaged in unsafe or unsound banking practices. And hazardous lending and lax collection practices, including failing to recognize loss in

a timely manner, operating with an inadequate loan policy, operating with inadequate policies to determine loan losses, and operating with an excessive level of adversely classified assets, delinquent loans and nonaccrual loans.

Benik, et al, at 7-8. Unsafe banking practices are not necessarily fraud, and Benik, et al,

do not explain why they see this as exposing their transactions as fraudulent. Because

defendants have not shown that public disclosure prior to the filing of Conners lawsuit

exposes their transactions as fraudulent, this argument must fail.

Conners FCA suit is likewise not based on allegations that are in the public

domain. Where a relators suit provides vital facts that were not in the public

domain, it is not based on publicly disclosed information. Balthazar, 635 F.3d at 869.

Furthermore, courts should not interpret public disclosure of allegations or

transactions (the statutory language) at a high level of generality because then

disclosure of some frauds could end up blocking private challenges to many different


29

kinds of fraud. U.S. ex rel. Goldberg v. Rush University Medical Center, 680 F.3d 933, 935

(7th Cir. 2012)

Both sets of defendants making this argument rely on Glazer v. Wound Care

Consultants, Inc., 570 F.3d 907, 920-21 (7th Cir. 2009). That case is a far cry from the

present facts. There the relator, a former patient of the defendant clinic, learned from her

attorney about billing irregularities that the Government had publicly said it was

investigating. As the Seventh Circuit put it: The allegations in Gear parroted the GAO

report; Gear added nothing to the public disclosure except the name of a teaching

hospital, and as the GAO report suggested that all (or almost all) teaching hospitals

billed for unsupervised work by residents, Gear had not added anything of value.

Goldberg, 680 F.3d at 935 (distinguishing Gear, and reversing dismissal at complaint

stage where relator provided genuinely new and material information).

A cursory review of Conners complaint makes clear that he has provided

genuinely new information relating to his own review of Adams inflated appraisals

and his dozens interactions with Mutual Banks management concerning those

appraisals. This argument is without merit for this additional reason.

Finally, although clearly unnecessary, Conner is an original source of the

information as defined by the Seventh Circuit. An original source of information under

the FCA must meet two criteria. First, he must be original; i.e., he must have direct

and independent knowledge of the information on which the allegations are based.

Feingold, 324 F.3d at 496. In other words, he must be someone who would have

learned of the allegation or transactions independently of the public disclosure. Id.


30

Second, he must be a source; i.e., he must have voluntarily provided the information to

the Government before instituting a suit. Id. The question is whether the relator is an

original source of the allegations in the complaint and not whether the relator is the

source of the information in the published reports. Balthazar, 635 F.3d at 869. Here,

Conner is the original source of the information in the complaint. Additionally,

although not alleged in the Amended Complaint, Conner was interviewed by the FBI

concerning Mutual Bank prior to his filing of the Amended Complaint. Accordingly,

for all three independent reasons discussed above, this argument fails.

CONCLUSION

For all of the foregoing reasons, the Court should deny the motions to dismiss

filed by defendants Patrick McCarthy and Ronald Tucek, John Benik, et al, and Douglas

Adams and Adams Valuation Corporation.

Dated: June 14, 2013 Respectfully submitted

KENNETH CONNER __/s/Matthew J. Sullivan_______ One of his attorneys The Law Office of Matthew J. Sullivan, LLC 55 W. Wacker Drive, Suite 1400 Chicago, IL 60601 (312) 912-8012 (tel) (312) 962-4955 (fax) [email protected] Joseph T. Gentleman Joseph T. Gentleman, P.C. 33 N. Dearborn Street, Suite 1401 Chicago, IL 60602 (312) 220-0020 (tel) [email protected]


Mutual Bank Connor Response Memorandum of Law Opposing Motion to Dismiss 6-14-13

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Transcript of Mutual Bank Connor Response Memorandum of Law Opposing Motion to Dismiss 6-14-13