GSE Shareholders Floored, Again

The United States Court of Appeals for the Eighth Circuit issued an opinion in Saxton v. FHFA (No. 17-1727, Aug. 23, 2018). The Eighth Circuit joins the Fifth, Sixth, Seventh and D.C. Circuits in rejecting the arguments of Fannie and Freddie shareholders that the Federal Housing Finance Agency exceeded its authority as conservator of Fannie Mae and Freddie Mac and acted arbitrarily and capriciously. The Court provides the following overview:

     The financial crisis of 2008 prompted Congress to take several actions to fend off economic disaster. One of those measures propped up Fannie Mae and Freddie Mac. Fannie and Freddie, which were founded by Congress back in 1938 and 1970, buy home mortgages from lenders, thereby freeing lenders to make more loans. See generally 12 U.S.C. § 4501. Although established by Congress, Fannie and Freddie operate like private companies: they have shareholders, boards of directors, and executives appointed by those boards. But Fannie and Freddie also have something most private businesses do not: the backing of the United States Treasury. 

     In 2008, with the mortgage meltdown at full tilt, Congress enacted the Housing and Economic Recovery Act (HERA or the Act). HERA created the Federal Housing Finance Agency (FHFA), and gave it the power to appoint itself either conservator or receiver of Fannie or Freddie should either company become critically undercapitalized. 12 U.S.C. § 4617(a)(2), (4). The Act includes a provision limiting judicial review: “Except as  provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.” Id. § 4617(f). 

     Shortly after the Act’s passage, FHFA determined that both Fannie and Freddie were critically undercapitalized and appointed itself conservator. FHFA then entered an agreement with the U.S. Department of the Treasury whereby Treasury would acquire specially-created preferred stock and, in exchange, would make hundreds of billions of dollars in capital available to Fannie and Freddie. The idea was that Fannie and Freddie would exit conservatorship when they reimbursed the Treasury.

     But Fannie and Freddie remain under FHFA’s conservatorship today. Since the conservatorship began, FHFA and Treasury have amended their agreement several times. In the most recent amendment, FHFA agreed that, each quarter, Fannie and Freddie would pay to Treasury their entire net worth, minus a small buffer. This so-called “net worth sweep” is the basis of this litigation. 

     Three owners of Fannie and Freddie common stock sued FHFA and Treasury, claiming they had exceeded their powers under HERA and acted arbitrarily and capriciously by agreeing to the net worth sweep. The shareholders sought only an injunction setting aside the net worth sweep; they dismissed a claim seeking money damages. Relying on the D.C. Circuit’s opinion in Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017), the district court dismissed the suit.

What amazes me as a longtime watcher of the GSE litigation is how supposedly dispassionate investors lose their heads when it comes to the GSE lawsuits. They cannot seem to fathom that judges will come to a different conclusion regarding HERA’s limitation on judicial review.

While I do not rule out that the Supreme Court could find otherwise, particularly if Judge Kavanaugh is confirmed, it seems like this unbroken string of losses should provide some sort of wake up call for GSE shareholders. But somehow, I doubt that it will.

Supreme Take on Truth in Lending

The United States Supreme Court issued its ruling in Jesinoski v. Countrywide Home Loans, Inc., No. 13-684 (Jan. 13, 2015).  Jesinoski resolved a circuit split regarding notice requirements under the Truth in Lending Act (TILA) that apply when a homeowner is rescinding certain types of home mortgage loans.

Justice Scalia wrote the short opinion for a unanimous Court. The Court held that a “borrower exercising his right to rescind under the Act need only provide written notice to his lender within the 3-year period, not file suit within that period.” (syllabus at 1) Countrywide had argued that the borrower had to file suit within that 3-year period. In finding for the borrowers, the Court found that the language of the statute was “unequivocal.”

While some have said that this result will lead to borrowers walking away from their loans, that is unlikely to occur in all but a handful of cases. That is because in order to rescind the loan, a borrower would need to tender back the original loan proceeds. Hard to imagine too many borrowers being able to do that.

The opinion is important because it resolves a significant circuit split, but its unanimity reflects that this case was perceived by the members of the Court as a straightforward question of statutory interpretation. As such, it does not appear to be signaling much about the Court’s approach to consumer protection jurisprudence more generally.

Reiss on GSE Transfer Taxes

Law360 quoted me in Fannie, Freddie Look Unstoppable In Transfer Tax Fight (behind a paywall).  It reads in part,

Class actions against Fannie Mae and Freddie Mac over hundreds of millions of dollars in unpaid transfer taxes in states and cities around the country continue to pile up, but experts say any attempt to challenge the housing giants’ exempt status is likely futile as court after court rules in their favor.

The Eighth Circuit on Friday joined the Third, Fourth, Sixth and Seventh circuits in ruling that Fannie Mae and Freddie Mac are exempt from local transfer taxes when it ruled in favor of the government-sponsored enterprises, or GSEs, after reviewing a suit brought by Swift County, Minnesota.

Swift County, as with a multitude of counties, municipalities and states before it, sought to dispute Fannie and Freddie’s claim that while they must pay property taxes, they are exempt from additional taxes on transfers of assets. But in what some experts say has come to seem like an inevitable answer, the Eighth Circuit found in favor of Fannie and Freddie.

“The federal statutes that set forth the charters of Fannie and Freddie are pretty clear that the two companies have a variety of regulatory privileges that other companies don’t,” David Reiss, a professor at Brooklyn Law School, said. “One of the privileges is an exemption from nearly all state and local taxation.”

The legal onslaught against the GSEs began in 2012 after U.S. District Judge Victoria A. Roberts ruled in March that they should not be considered federal agencies. In a suit filed by Oakland County, Michigan, over millions in unpaid transfer taxes, Judge Roberts rejected the charter exemption argument and, citing a 1988 U.S. Supreme Court ruling in U.S. v. Wells Fargo, found that “all taxation” refers only to direct taxes and not excise taxes like those imposed on asset transfers.

Counties, municipalities and states across the country were emboldened by the decision. Putative class actions soon followed in West Virginia, Illinois, Minnesota, Florida, Rhode Island, Georgia and elsewhere as plaintiffs rushed to see if they could elicit a similar ruling and recoup millions of dollars allegedly lost thanks to the inability to tax Fannie and Freddie’s mortgage foreclosure operations.

But Judge Roberts’ decision was later overturned by the Sixth Circuit, as were other similar orders, though many district judges found in favor of Fannie and Freddie from the start.

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Many cases remain in the lower courts as well, but experts say the outcomes will likely echo those that played out in the Third, Fourth Sixth, Seventh and Eighth circuits, because the defendants’ chartered exemption defense appears waterproof.

“I find the circuit court decisions unsurprising and consistent with the letter and spirit of the law,” Reiss said. “I am guessing that other federal courts will follow this trend.”

Reiss on Supreme Court Mortgage Case

Law360 quoted me in Supreme Court Takes Up Mortgage Rescission Timing Case (behind a paywall). It reads in part,

The U.S. Supreme Court agreed Monday to weigh in on whether federal law requires borrowers to notify creditors in writing of their intention to rescind their mortgages or file a lawsuit making a similar claim within three years.

The petitioners in the case, Larry and Cheryle Jesinoski of Eagan, Minn., are seeking to overturn a September ruling in the Eighth Circuit that they were required to sue Countrywide Home Loans Inc. to have their mortgage financing rescinded within three years of the transaction closing. The Jesinoskis argue that the Truth In Lending Act only requires that they provide notice of rescission in writing within those three years.

But the case goes beyond a ruling in the Eighth Circuit. A Supreme Court ruling would resolve a circuit split that has seen the Third, Fourth and Eleventh circuits rule that borrowers have three years from closing to notify lenders in writing within three years of their intention to cancel their mortgages, while the First, Sixth, Eighth, Ninth and Tenth circuits have found that a lawsuit must be filed within that three-year period, according to the Jesinoskis’ December petition for certiorari.

“The resulting rule does violence to the statutory text, manufactures legal obstacle for homeowners seeking to vindicate their rights under a law that was enacted to protect them, and risks flooding the federal courts with thousands of needless lawsuits to accomplish rescissions that Congress intended to be completed privately and without litigation,” the petition said.

TILA provides two different rescission rights to borrowers who apply for and receive a mortgage refinancing. The more common process allows such borrowers to rescind their mortgage within three days of closing and before any money is disbursed.

The law also provides a more expanded rescission right in situations where borrowers do not receive mandated disclosures. There, the law provides three years from the closing date to provide such notice, but with proof that the documents were not provided.

Prior to the 2007 financial crisis, such expanded rescission claims were rare, said Reed Smith LLP partner Robert Jaworski.

“A lot more people were in trouble on their mortgages and couldn’t make payments and were subject to foreclosure. That caused a lot of these claims to be made, much more than previously,” he said.

And that has made the need for resolving the circuit split that much more important.

“It’s kind of ambiguous. It’s not stated as a statute of limitations,” said Brooklyn Law School professor David Reiss.