The U.S. Department of Justice has not proven its charges that Bank of America (BAC) misled investors about the quality of loans bundled into $850 million in mortgage-backed securities.

That’s the word from presiding U.S. Magistrate Judge David Cayer, who is recommending that the case be dismissed.  

Attorneys for the Justice Department can appeal the recommendation for dismissal.

The case against Bank of America is one in a series of prosecutions being brought by U.S. attorneys against financial institutions under the Financial Institution Reform, Recovery and Enforcement Act of 1989. The law allows the government to sue for fraud rather than just charge institutions with a crime when the alleged fraud is against a federally insured institution.

The recommendation for dismissal is significant because FIRREA cases don’t have the burden of proof for the state to meet as it does in criminal cases.

This is one of the first potentially successful dismissals in a string of such lawsuits brought by Justice against banks. Bank of America lost a similar suit related to legacy mortgages it inherited from Countrywide Home Loans.

In this case, U.S. attorneys charged that Bank of America misrepresented no-doc, subprime loans originated by third parties as verified, prime loans.

The DOJ suit, which was worked in tandem with the U.S. Attorney for the Western District of North Carolina, says Bank of America and several of its affiliates made intentionally false statements, failed to perform due diligence on loans and packed securitization deals with a “disproportionate amount of risky mortgages originated through third party mortgage brokers.”

Attorney General Holder said in November that the suit stems from the ongoing efforts of President Obama’s Financial Fraud Enforcement Task Force RMBS Working Group. The Securities and Exchange Commission filed similar civil charges in a Charlotte, N.C., federal court.

The suit contends 40% of the 1,191 mortgages in the securitization failed to substantially comply with Bank of America’s underwriting guidelines when they were originated. Furthermore, these same loans contained few enhancements to justify their ratings, the government suggests.

"If the judge's recommendation is accepted by the Federal District Court judge then this development will represent a significant setback for the government's legal efforts and likely mark the beginning of the end for crisis-era litigation," says a note from Compass Point Trading & Research.

The magistrate overseeing the case rejected the government’s allegation that the bank lied to the Federal Housing Finance Board.

“The complaint contains no factual allegations that the defendants’ statements occurred within the jurisdiction of the FHFB or affected its decisions,” Cayer said. "Materiality cannot be inferred from the allegation that a government agency (FHFB) oversaw the recipient of the alleged misstatements (FHLB-SF). The government’s argument here is even less compelling.”

Earlier this week Bank of America agreed to a $9 billion-plus settlement in another MBS lawsuit.