March 3, 2014
Fannie and Freddie Boards: Caveat Fairholme
Fairholme Capital Management has sent stern letters to the the boards of Fannie Mae and Freddie Mac (the letters are essentially the same). Fairholme’s funds have millions of common and preferred shares in the two companies and Fairholme has taken a multi-pronged to trying to wring some value out of those shares. It has sued the federal government. It has offered to buy the two companies’ mortgage guaranty operations. Now, it is threatening the board of the two enterprises with personal liability for their actions and inaction.
In regard to the cash dividends that the two companies have paid to the Treasury as a result of their Preferred Stock Purchase Agreements (as amended), Fairholme writes,
It is common sense that no Board should approve cash distributions without independent financial advice as to the effect of such payments on the Company’s safety, soundness, and liquidity. Moreover, corporate laws generally prohibit the payment of dividends in many circumstances, imposing personal liability on Directors for illegal dividends – a liability that, pursuant to the Housing and Economic Recovery Act of 2008, is not assumed by the Conservator. (Fannie Letter, 3) (emphasis added)
This is a straightforward threat that will likely get the attention of the directors of the two companies and get them to check in with their D&O insurer before taking any further actions. But it is genuinely unclear what they should be doing at this point.
As I note in a forthcoming article, An Overview of the Fannie and Freddie Conservatorship Litigation (NYU J. Law & Bus.), the Fannie/Freddie shareholder litigation raises all sorts of complex and novel legal issues, and I am not willing to predict their outcomes. But I will go as far to say that Fairholme presents the way out of this mess as far clearer than it is — “Various solutions are simple, equitable, and need not be contentious.” (5) The ones that Fairholme has in mind likely involve large payouts for shareholders, one way or the other.
At the same time that Fairholme presents the solution as simple, it does acknowledge (as it really must) that the problem itself is not: “we are aware of no circumstance in which the controlling shareholder and its affiliates simultaneously act as director, regulator, conservator, supervisor, contingent capital provider, and preferred stock investor.” (3-4) Yup, this is one big mess with no real precedent. I am confident, however, that the federal government has no interest in reaching a settlement with shareholders that shareholders would find acceptable. So, no end in sight to this aspect of the Fannie/Freddie situation, a far as I can tell.