Case: 1:11-cv-04458 Document #: 120 Filed: 03/14/14 Page 1 of 15 PageID #:662

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. ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

CASE NO. 11 CV 4458 Hon. Sharon Johnson Coleman

JURY TRIAL DEMANDED

RELATOR KENNETH CONNERS COMBINDED REPLY IN SUPPORT OF HIS MOTION FOR LEAVE TO FILE A SECOND AMENDED COMPLAINT For his reply in support of his Motion For Leave To File His Second Amended Complaint, Relator Kenneth Conner (the Relator) states as follows: INTRODUCTION A. The Courts Previous Ruling The Court has already determined that the Relator adequately pled that a False Claims Act (FCA) violation took place and that certain of Mutual Banks officers and employees, as well as the banks primary appraisal firm, took part in it. The Court, 1

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however, dismissed without prejudice the Amended1 Complaint as to directors Ronald Tucek, Patrick McCarthy and James Regas, finding that facts pled in that iteration of the complaint did not establish the directors day-to-day involvement with the bank or, by extension, their knowing participation in the FCA violation. B. The Question Presented By Relators Motion As defendants acknowledge, the basic legal issue raised by the proposed pleading is whether the new allegations when combined with the existing ones make the Relators allegation that the directors participated in the scheme plausible. As a threshold matter, there is no doubt that the directors participated in the sense that their approval of the loans at issue was necessary to the fraud perpetrated upon the FDIC. See, e.g., U.S. ex rel. Marcus v. Hess, 317 U.S. 537, 544, 63 S.Ct. 379 (1943) (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.) Obviously, if the loans were not approved by the Board, there could have been no false claims concerning the collateral quality of those loans. Thus, distilled of what cannot seriously be disputed, the issue at bar is whether sufficient facts have been alleged to show that it is plausible that the directors knew they were participating in the scheme. As explained more fully below, the director defendants participation in the very transactions at issue, their duties as members of the Directors Loan Committee to While the Relator previously amended his complaint to add an additional theory of damages, the proposed second amendment would be the first amendment that followed an involuntary dismissal.
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monitor and approve the banks loan transactions, and in one case their direct dealings with the FDIC on behalf of Mutual Bank, when coupled with the other allegations concerning the directors in the original complaint, are more than enough. C. The Precise Issue Before the Court Was Addressed In the Countrywide Case. Bank directors, particularly at FDIC-insured institutions, are different than other directors. They are tasked, for example, with establishing and monitoring adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation. FDIC Statement of Policy 500 (emphasis added). In re Countrywide Financial Corp. Derivative Litigation, 554 F.Supp. 1044, 1052 (C.D. Cal. 2008) addresses the particular issue of whether knowledge of fraudulent loan initiation practices can be inferred from outside directors membership on bank directors committees. That court held that, under the higher strong inference of

scienter standard mandated by the Private Securities Litigation Reform Act (PSLRA), outside bank directors knowledge of faulty loan initiation processes, including knowingly inflated appraisals, could be inferred from bank directors membership on director committees where the duties of those committees dealt with loan initiation. Id. at 1058, 1065. Citing Countrywide with approval, Judge Kennelly recently described its holding as finding plaintiffs properly pled scienter as to directors who were specifically tasked with monitoring the very issues that underlay the allegations of fraud. Ross v. Career Education Corp., 2012 WL 5362431, *10 (N.D. Ill. 2012). Here, the defendant directors were, among other things, specifically tasked with 3

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1) evaluating the particular loans that had inflated appraisals; and 2) monitoring Mutual Banks adherence to statutes and regulations. LEGAL STANDARD Leave to amend a complaint should be freely given when justice so requires. Fed.R.Civ.P. 15(a). In the absence of any apparent or declared reasonsuch as undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, futility of amendment, etc.the leave sought should, as the rules require, be freely given. Barry Aviation Inc. v. Land OLakes Municipal Airport Comn, 377 F.3d 682, 687 (7th Cir. 2004). That leave be freely given is especially advisable when such permission is sought after the dismissal of the first complaint. Id. Unless it is certain from the face of the complaint that any amendment would be futile or otherwise unwarranted, the district court should grant leave to amend after granting a motion to dismiss. Id. With that being said, Relator does not take issue with Tucek and McCarthys suggestion (T & M at 7) that the court has the discretion to deny leave to amend if it were to determine an amendment to be futile. See, e.g., Charleston v. Board of Trustees of the Univ. of Illinois at Chicago, 741 F.3d 769, 777 (7th Cir. 2013). Relator, of course, vehemently disputes that the amendment is futile.

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ARGUMENT A. Relator Has Pled Facts That Show That Tucek, McCarthy and Regas Participation In the Scheme Is Plausible. 1. Relator Must Plead The Grounds For His Suspicions Of Fraud And Those Grounds Must Make His Allegations Plausible. 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). 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). Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally. Fed.R.Civ.P. 9(b). [W]hen 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. U.S. ex rel. Goldberg v. Rush University Medical Center, 2013 WL 870651, *5 (N.D. Ill. 2013). In such circumstance, [t]he grounds for the plaintiffs suspicions must make the allegations plausible. T & M at 8, quoting Pirelli Armstrong Tire Corp. Retiree Medical Benefits Trust v. Walgreen Co., 631 F.3d 436, 442-43 (7th Cir. 2011) (emphasis original to case). This standard less stringent standard applies here because Conner 1) has never met any of Tucek, McCarthy or Regas; 2) had no access to the boardroom during his employment;

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and 3) has never had access to the documents that memorialize the directors activities on the Directors Loan Committee. To be liable under the FCA, the false claim to the government need only be the natural and foreseeable consequence of the persons actions. Industries, Inc., 731 F.Supp.3d 730, 739 (N.D. Ill. 2010). 2. Relators Allegation That Tucek, McCarthy and Regas Participated In the Scheme Is Plausible. Bank directors of FDIC insured banks are responsible for, among other things, establishing the banks business strategies and monitoring the banks adherence to statutes and regulations: The duty of care requires directors and officers to act as prudent and diligent business persons in conducting the affairs of the bank. This means that directors are responsible for selecting, monitoring, and evaluating competent management; establishing business strategies and policies; monitoring and assessing the progress of business operations; establishing and monitoring adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation. FDIC Statement of Policy 500. The bank directors, thus, had responsibility for Mason v. Medline

monitoring whether the bank was using inflated appraisals and whether it was following federal regulations that required it to disclose loans in access of the FDICs loan-to-value ratio limits.

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The Countrywide case, although decided under the much higher strong inference standard of the PSLRA,
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presents facts that are remarkably similar to the

present case. Countrywide, like Mutual Bank, allegedly sought to hide highly risky loans that it was making, in this case from investors rather than the FDIC. The plaintiffs in Countrywide alleged that, in violation of its own underwriting policy, Countrywide regularly initiated loans with no documentation of the borrowers income. Id. at 1051. Many of these loans were for riskier second mortgages or non-conforming loans, that is, loans that could not be resold to Fannie Mae or Freddie Mac. Id. at 1051. The complaint further alleged that some individuals were given loans based on knowingly inflated home appraisal values that would put them upside down immediately after purchaseand also more susceptible to default. Id. at 1058. For their securities fraud claim, the Plaintiffs contend[ed] that [various individually sued directors caused statements to be made by the company that] were misleading because they failed to inform the public about the true nature of the loans originated by the Company and the risk to the Company's long term prospects. Id. at 1053. As here, the director defendants sought dismissal on the basis that none of the [former employee] sources are alleged to have ever spoken or had other contact with any of the seven non-management directors. Id. at 1060. The Court roundly rejected that argument, finding that the directors membership on board of directors

And even the strong inference standard does not require more likely than not but rather that the inference is at least as compelling as any opposing inference one could draw from the facts alleged. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 321 (2007).
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committees was sufficient to infer scienter under the PSLRAs enhanced standard: These Defendantswere members of at least one of five Board Committees that was specifically tasked with monitoring detailed aspects of the Company's financial performance, business operations, and risk exposures: the Audit & Ethics Committee, the Credit Committee, the Finance Committee, the Operations & Public Policy Committee, and the Compensation Committee. concluded: Plaintiffs have sufficiently pled facts regarding the directors' roles on various committees and the duties which required that they be informed on certain aspects of Countrywide's business. Because this information implicated underwriting practices at the core of Countrywide's business model, Plaintiffs raise a strong inference of scienter with respect to every outside director except Dougherty and Snyder [who were not on relevant committees]. Id. at 1064-65. The allegations in Relators proposed complaint are more compelling than those in Countrywide and, at the same time, the pleading standard the Relator must meet is lower. As members of the Directors Loan Committee, each of the three director Id. at 1060. Thus, Countrywide

defendants at issue had responsibility for reviewing and approving all loans in excess of $1 million, a relatively low threshold for commercial real estate loans. SAC 7-9. As such, Tucek, McCarthy and Regas reviewed and approved many of the sample loans alleged in the complaint to be based on knowingly inflated appraisals. They approved

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each of the Venturella loan, the Mount Olive loan, the Holiday Inn Rolling Meadows loan and the Evansville loan.3 SAC 38,45,48,49. The directors involvement with the Venturella loan was particularly extensive. When Conner complained that Adams had overvalued the property by $10 million, his boss Jim Murphy told him: 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. SAC at 35. Conner was then told to cease work on his appraisal review and not to put his completed work in the appraisal presentation. SAC at 36. Thereafter, Tucek, McCarthy, Regas and the other members of the Directors Loan Committee approved the original loan. SAC at 38. Then, according to the FDIC4: Less than a year after the [Venturella] loan was originated, federal regulators classified the loan as substandard. Despite this obvious danger signal, [Pethinaidu Velucham, Parameswari Veluchamy, Arun Veluchamy, Anu Veluchamy, Regas, Tucek and McCarthy] approved a renewal and increase of funds in June 2006. In May 2008, [they] approved an additional increase that raised the total loan amount to $15,600,000 despite the substandard status of the loan and the collapse of the real estate market. SAC at 39. This of course, much corroborates Murphys statement the Board

want[ed] to do the deal anyway, since even in the face of the loan being classified by

Regas complains that his approvals of the Mount Olive and Holiday Inn Rolling Meadows loans are alleged on information and belief, but the allegations have a clear basis: The loans are alleged to be over $1 million, and Regas had responsibility for approving loans over $1 million.
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To be clear, the FDIC first made its allegations concerning the Venturella loan several months Conner raised the Venturella transaction in his original complaint.
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federal regulators as substandard, the Board obstinately continued to do the deal anyway. Likewise, as previously pled, the Board knew that Adams had overvalued a hotel in Evansville, Indiana by $8 million. SAC at 49. Whereas Adams valued the hotel at $21 million when the loan was initiated, a second appraisal ordered in 2006 (while the real estate market was still going up), valued the hotel at only $12 million stabilizing at $13 million. Id. Finally, as above, the Board had responsibility for determining the Banks business strategy and monitoring its adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation. FDIC Statement of Policy 100. There is no reason to assume that Tucek, McCarthy and Regas were not fully informed about what was squarely within the scope of their duties as directors. Based on the above, it is far more than plausible that the directors were involved in the scheme. None of Tucek, McCarthy or Regas offer authority that is anything close to factually similar to the present case. Regas cites DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir. 1990) for the premise that it is necessary that the defendant benefited from the alleged fraud other than by receiving normal professional fees for services. Regas at 10. DiLeo is not on point. That case dealt with a major accounting firms potential aiding and abetting liability in securities fraud case. Significantly, the

defendant simply speculated that there must be fraud solely from the fact t hat the 10

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accounting firms clients financial disclosures became less rosy over a period of time. DiLeo, 901 F.2d at 629. As the Seventh Circuit put it, the defendant present[ed]

nothing other than the change in the stated condition of the firm to suggest that [the outside accounting firm] was so much as negligent in auditing [the firm]'s financial statements. Id. True, the Court also pointed out that the accounting firm had no motivation to commit fraud because an accountant's greatest asset is its reputation for honesty, followed closely by its reputation for careful work. Id. at 629. But the larger point was that there was no evidence of fraud, motivation or otherwise. Nor, for that matter, are directors in the same position as accountants who are not employed by the company and did not select the companys management. 3. Additional Allegations Further Show Regas Involvement In the FCA Violations. Relators proposed complaint adds additional allegations with respect to Regas that show that, besides being a member of the Directors Loan Committee, he was Mutual Banks mouthpiece to the FDIC. The proposed complaint alleges: Regas likewise acted as general counsel to Mutual Bank. According to the FDIC, Regas counseled the bank regarding regulatory compliance, including preparing responses to the to the regulatory examination process. Especially significant here, Regas actively participated in discussions with state and federal regulators, and thus, [was] fully aware of the extreme risk to which [the Veluchamys, Mahajan, Tucek, McCarthy, Barth and Pacocha] exposed the bank. SAC at 9. It seems more than a little unlikely that, in the course of his counseling the bank regarding regulatory compliance, including preparing responses to the regulatory examination process and his active[] participat[ion] in discussions with state and federal regulators, Regas would have failed to realize the scheme that was afoot. In 11

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any case, his involvement with regulators, coupled with his activities on the Directors Loan Committee, far more than establish that it is plausible that Regas knew and participated. And as general counsel to the bank, Regas was clearly involved in its dayto-day operations.5 Regas responds that it is well established that Reports of Examination by banking regulators are addressed directly to the board of directors [citation omitted] and the FDICs own Report of Examination Instructions require the FDIC to obtain the signatures of each director on the Report. Regas at 7-8. Fine, but Regas is alleged to have done more than sign a Report of Examination. He was alleged to have counseled the bank on regulatory matters and actively participated in the discussions with federal and state regulators. That he may have also signed a Report of Examination does not mean that that is all he did in the face of express allegations to the contrary. B. Defendants Miscellaneous Arguments Are Without Merit. The defendants raise a series of miscellaneous arguments that are dealt with individually below. First, both defendants repeatedly chide the Relator for using allegations previously made by the FDIC in his proposed complaint. Neither cite to authority that suggests that this is anything but entirely permissible. This is especially so because the allegations taken from the FDIC relate to objective facts that the FDIC as receiver is in a

The FDIC as receiver for Mutual Bank has sued Regas for legal malpractice for his activities as general counsel and legal advisor to the bank. This may explain why Regas, knowing Relators allegation must be taken as true at this stage, sees fit to deny that he was ever general counsel to the bank or that he ever rendered the bank legal advice. See Regas at 3, n.1. 12

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position to know, like the defendants job duties and documented actions taken by the Directors Loan Committee. Second, Regas, but not Tucek and McCarthy, contends that because the new allegations are sourced from the FDIC, the proposed complaint implicates the public disclosure bar. Regas at 9. This argument is frivolous. 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). The FDIC-sourced allegations relate mainly to the defendants former job duties and have meaning only when coupled with the allegations of fraud that this Court has already held did not violate the public disclosure bar. They are a far cry from the critical elements exposing the transaction as

fraudulent. Third, Regas, but again not Tucek and McCarthy, finds relevant a provision of the Illinois Banking Act that allows directors to rely on statements of management and outside consultants in state law negligence actions. Regas at 7; see 205 ILCS 5/16(b). Regas does not explain, nor is it obvious, what this potential defense to a common law tort claim has to do with Regas knowledge of the fraud scheme. He does not claim, for example, that it preempts the required monitoring duties for directors of FDIC-insured institutions noted above. To top it off, Regas selectively quotes the statute, leaving out that any reliance must be in good faith, after reasonable inquiry if the need for such inquiry is apparent under the circumstances and without knowledge that would cause such reliance to be unreasonable. 205 ILCS 5/16(b). 13

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Finally, although entirely irrelevant to the issue at bar, undersigned counsel feels compelled to address Regas uncalled for reference to 28 U.S.C. 1927 in footnote 2 of his brief. Regas at 5, n.2. The footnote states in part: While in court for the hearing on the motion to dismiss, Defense counsel informed Plaintiffs counsel that Defendant Adams Valuation Corporation never performed any appraisal with respect to the Venturella loan for Mutual Bank. Rather, another appraisal firm was retained and issued an appraisal opinion. Mr. Regass counsel has asked that Plaintiffs counsel therefore withdraw all claims concerning the Venturella loan. Id (emphasis in

original). Regas counsel Nancy Temple did indeed make such a statement, although it was at the February 10, 2014, status hearing. But the footnote omits that, when undersigned counsel asked Ms. Temple for documentation supporting her assertion, she refused to provide any. Nor does it at all follow from the fact that another appraisal firm conducted an appraisal of the Venturella property that Adams did not also conduct one. Presumably many appraisals were conducted of the collateral on this eight figure loan that was renewed and increased at least twice before going into default. As Regas counsel surely well knows (to say otherwise would revolutionize civil practice), an opposing counsels rote denial of a complaint allegation is not a basis upon which that allegation must be withdrawn. CONCLUSION For all of the foregoing reasons, the Court should grant Relator Kenneth Conners Motion to File His Second Amended Complaint.

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Dated: March 14, 2014

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) matt@sullivanlawchicago.com Joseph T. Gentleman Joseph T. Gentleman, P.C. 33 N. Dearborn Street Suite 1401 Chicago, IL 60602 (312) 220-0020 (tel) jgentleman@gentlemanlaw.com

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