Tag Archives: Administrative Procedures Act

Tough Row to Hoe for Frannie Shareholders

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Inside Mortgage Finance quoted me in a story, GSE Jr. Preferred Shareholders Have a Tough ‘Row to Hoe’ in Winning Their Lawsuits (behind a paywall). It reads,

Expect a long and winding legal road to resolution of investor lawsuits challenging the Treasury Department’s “net worth sweep” of Fannie Mae and Freddie Mac earnings, warn legal experts.

More than a dozen lawsuits filed against the government – including hedge funds Perry Capital and Fairholme Capital Management – are pending in federal district court in Washington, DC, and in the Court of Federal Claims. The private equity plaintiffs allege that the Treasury’s change in the dividend structure of its preferred stock leaves the government-sponsored enterprises with no funds to pay anything to junior shareholders.

The complaints raise complex constitutional and securities law issues, according to Emily Hamburger, a litigation analyst for Bloomberg Industries. “It may be a year before the crucial questions can be answered by the courts because the parties are still in the early stages of gathering evidence,” explained Hamburger during a recent webinar.

Brooklyn Law School Professor David Reiss agrees. “The plaintiffs, in the main, argue that the federal government has breached its duties to preferred shareholders, common shareholders, and potential beneficiaries of a housing trust fund authorized by the same statute that authorized their conservatorships. At this early stage, it appears that the plaintiffs have a tough row to hoe,” notes Reiss in a draft paper examining the GSE shareholder lawsuits.

Government attorneys argue that Treasury has authority to purchase Fannie and Freddie stock when it’s determined such actions are necessary to provide stability to the financial markets, prevent disruptions in the availability of mortgage finance and protect the taxpayer. The government also argues that the plaintiffs do not have a legal property interest for purposes of a Fifth Amendment “takings” claim due to the GSEs’ status in conservatorship.

Hamburger predicted that the judges in the various suits won’t be able to ignore the “obvious equitable tensions” involved. “The government is changing the terms years after their bailout, but on the other hand, the timing and motivation of investors is going to be challenged too,” she noted.

While Reiss agrees that the junior shareholders “look like they are receiving a raw deal from the federal government,” it’s a tall order to sue the federal government even under the most favorable of circumstances. The plaintiffs will have to overcome the government’s sovereign immunity, unless it is waived, and the government has additional defenses, including immunity from Administrative Procedures Act claims, under the Housing and Economic Recovery Act of 2008.

Reiss explained that HERA states that except “at the request of the Federal Housing Finance Agency, no court may take any action to restrain or affect the exercise of powers or functions of [FHFA] as conservator or receiver.” It remains to be seen how this language might apply to Treasury’s change in the preferred stock agreement, but Reiss said it could be read to give the government broad authority to address the financial situation of the two companies.

“The litigation surrounding GSE conservatorship raises all sorts of issues about the federal government’s involvement in housing finance,” said Reiss. “These issues are worth setting forth as the proper role of these two companies in the housing finance system is still very much up in the air.”

The full paper, An Overview of the Fannie and Freddie Conservatorship Litigation (SSRN link), can also be found on BePress.

U.S. Dismissive of Frannie Suits

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The Federal Housing Finance Agency filed its motion to dismiss all the claims in Perry Capital v. Lew, D.D.C., No. 13-cv-01025, 1/17/14. I blogged about this case (and similar cases) when they were filed last summer. It is quite interesting to read the government’s side of the story now. Today’s post focuses on the federal government’s alternative narrative. Where the private investors describe an opportunistic and abusive government in their complaints, the FHFA’s brief describes the government as a white knight who rode in to save the day at the depth of the financial crisis:

The national crisis having eased, Plaintiffs now ask the Court to re-write the agreements that FHFA, on behalf of the Enterprises, and Treasury executed to stabilize the Enterprises and the national economy, pursuant to express congressional authority. Plaintiffs want to cherry-pick those aspects of the agreements that they like—namely, the unprecedented financial support from Treasury at a time when the Enterprises required billions of dollars in capital—and discard the parts they do not like—namely, the Third Amended PSPAs—now that over one hundred billion dollars of federal taxpayer capital infusions and commitments have allowed the Enterprises to remain in business and produce positive earnings, rather than being placed into mandatory receivership and then liquidation. Plaintiffs’ attempt to reward themselves, at the expense of federal taxpayers who risked and continue to risk billions of dollars to save the Enterprises from receivership and liquidation, directly contravenes the relevant statutory authorities as implemented by the unambiguous language of the PSPAs.

Plaintiffs’ charges of common law and APA violations have it exactly backwards: FHFA, on behalf of the Enterprises, has acted at all times consistent with the Enterprises’ contractual obligations and FHFA’s powers as Conservator and statutory successor to all rights of the Enterprises and their stockholders. The shareholder-Plaintiffs, on the other hand, are attempting through these cases to convince this Court, during the conservatorships, to give shareholders financial value that they are not owed under the terms of their stock certificates or statutes, and to ignore the rights of the Enterprises’ senior preferred stockholder, the U.S. Treasury. By doing so, Plaintiffs seek not only to undermine the purposes of conservatorship, but also the very statutory mission of the Enterprises in which they chose to invest. (4-5)

While I think that the investors raise some serious legal issues for the court to decide, the federal government’s narrative of the financial crisis jibes a whole lot more with my own than does the investors’. I argued last summer that the side that wins control of the narrative will have an advantage in the battle over the legal issues. I would say that the federal government has won this first round.

Federal Government’s a Fairholme-weather Friend?

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Following up on my posts (here and here) about other suits against the federal government over its amendment of the terms of the distribution of dividends and other payments by Fannie Mae and Freddie Mac, I now look at Fairholme Funds, Inc. et al. v. FHFA et al., filed July 10, 2013.  The suit alleges very similar facts to those found in Fairholme Funds, Inc. v. United States, filed July 9, 2013, but the claims for relief are more similar to those found in Perry Capital, LLC v. Lew et al.

Here are some of the key claims made by the plaintiffs (owners of Fannie and Freddie preferred shares):

  • While the FHFA is the conservator of the two companies, it is acting acting like a receiver by “winding down” Fannie and Freddie’s “affairs and liquidating” their assets, while conservatorship should aim to return a company “to normal operation.” (15) The goal of the conservator, claim the plaintiffs, is to return the company “to a safe, sound and solvent condition.” (15, quoting Conservatorship and Receivership, 76 Fed. Reg. 35, 724, 35, 730(June 20, 2011)) As a result, plaintiffs argue that the Net Worth Sweep (which gives to the federal government substantially all of Fannie and Freddie’s profit) “is squarely contrary to FHFA’s statutory responsibilities as conservator of Fannie and Freddie” because it does not put them in “a sound and solvent condition” and it does not “conserve the assets and property” of the two companies. (25, quoting 12 U.S.C. section 4617(b)(2)(D))
  • “Neither Treasury nor FHFA made any public record of their decision-making processes in agreeing to the Net Worth Sweep.” (29) The plaintiffs argue that the FHFA’s “authority as conservator of” Fannie and Freddie “is strictly limited by statute.” (31, citing 12 U.S.C. section 4617(b)(2)(D)) As a result, the FHFA’s actions were “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” (33, quoting the APA, 5 U.S.C. section 706(2)(A))
  • The plaintiffs’ relationship with Treasury as Fannie and Freddie’s controlling shareholders is governed by state corporate law and thus Treasury owes “fiduciary duties to minority shareholders.” (38)
  • “Implicit in every contract is a covenant of good faith and fair dealing. The implied covenant requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.” (41) Plaintiffs argue that their contractual rights pursuant to their preferred shares have been breached by FHFA’s consent to the Net Worth Sweep.

The validity of these claims should not be assessed superficially. The courts will need to read HERA in the context of the APA and the amendment to the terms of the government’s preferred shares in the context of the contractual obligations found in the private preferred shares. The court will also need to assess the extent to which state corporate law governs the actions of the federal government when it is acting in the multiple capacities of lender, investor, regulator and conservator.  Let the memoranda in support and in opposition to motions to dismiss come forth and enlighten us as to how it should all play out . . ..