Tag Archives: HERA

GSE Shareholders Taking Discovery

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Judge Sweeney of the Court of Federal Claims issued an Opinion and Order regarding jurisdictional discovery as well as a related Protective Order in the GSE Takings Case brought by Fairholme against the United States.  I had previously discussed the possibility of a protective order here.

By way of background, and as explained in the Opinion and Order,

Defendant [the U.S.] has filed a motion to dismiss, contending that the court lacks jurisdiction to hear this case, that plaintiffs’ claims are not ripe, and that plaintiffs [Fairholme et al.] have failed to state a claim for a regulatory taking. Plaintiffs respond that defendant’s motion relies upon factual assertions that go well beyond, and in many respects, conflict with, their complaint. The court thus entered an order on February 26, 2014, allowing the parties to engage in jurisdictional discovery. (1-2)

Judge Sweeney discussed the likely scope of jurisdictional discovery in a hearing on June 4th. She suggested that the big issue would be the extent to which she was going to defer to the federal government as to its request the discovery be limited in order to allow the government discretion in its operational and policy roles in the housing finance system. The judge indicated that she might be open to a limited protective order that allowed the plaintiffs to examine documents under certain restrictions so that they are not made public.The judge also made clear that she was not going to authorize a fishing expedition.

The Opinion and Order is pretty consistent with what she had suggested in June, but I would characterize it as a tactical win for the plaintiffs. Judge Sweeney signaled that she was not going to be overly deferential to the federal government.  This was clear throughout the Opinion and Order, regarding the scope of the Court’s jurisdiction over matters involving the FHFA, regarding the scope of the deliberative process privilege and regarding the overall scope of jurisdictional discovery that the Court will allow.  The plaintiffs should very happy with this result.

Running CERCLA around FIRREA

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Law360 quoted me in High Court Environmental Ruling Could Clear Air For Banks (behind a paywall). The article reads in part,

A recent U.S. Supreme Court ruling that a federal environmental law does not preempt state statutes of repose has inspired banks and other targets of Wall Street enforcers to test the decision’s power to finally fend off lingering financial crisis-era cases on timeliness grounds.

The high court on June 9 found that the Comprehensive Environmental Response, Compensation and Liability Act could not extend the 10-year statute of repose in a North Carolina environmental cleanup suit in the in CTS Corp. v. Waldburger case. Although the decision pertained to a case outside of the financial realm, attorneys say it could limit the ability of federal financial regulators to bring claims on behalf of failed financial institutions under two of their favored tools: the Financial Institutions Reform, Recovery and Enforcement Act and the Housing and Economic Recovery Act.

That’s because the defendants in those cases, including banks but others as well, will now be able to argue that regulators like the National Credit Union Administration, the Federal Housing Finance Agency and the Federal Deposit Insurance Corp. missed their chance to bring claims on behalf of institutions in receivership.

Given the Supreme Court’s interpretation, the regulators may be on shaky ground.

“The government is going to have a much more difficult time sustaining the arguments it’s been making after CTS,” said Jeffrey B. Wall, a partner with Sullivan & Cromwell LLP and a former assistant solicitor general.

In its CTS ruling, the Supreme Court found that CERCLA does not preempt state statutes of repose like the one in North Carolina, citing CERCLA’s exclusive use of the phrase “statute of limitations.”

Statutes of repose and statutes of limitations are distinct enough terms in their usage that it’s proper to conclude that Congress didn’t intend to preempt statutes of repose when it crafted CERCLA, Justice Anthony M. Kennedy said in the majority opinion. The justice cited a 1982 congressional report on CERCLA that recommended repealing state statutes of limitations and statutes of repose but acknowledged that they were not equivalent.

According to a memo released June 10 by Sullivan & Cromwell, both FIRREA and HERA are susceptible to similar readings by courts.

Both statutes include extenders that allow government agencies suing on behalf of failed financial institutions to move beyond statutes of limitations on state law claims. However, much like CERCLA, both say nothing about extending statutes of repose, the memo said.

And that could make a major difference for a large number of defendants trying to fend off claims from the FDIC, NCUA and FHFA, Wall said.

*    *    *

The CTS ruling is likely to play out in cases brought by financial regulators in smaller cases over losses incurred by failed financial institutions using FIRREA and HERA. But FIRREA has also become a favored tool in the U.S. Department of Justice’s big game hunts against ratings agency Standard & Poor’s and Bank of America.

Because those cases are largely predicated on federal claims, the CTS case is unlikely to be a help for those institutions, according to Brooklyn Law School professor David Reiss.

“I don’t read it as having an extension on the higher-profile FIRREA cases,” he said.

But even if CTS is limited to state law claims brought by financial regulators, that could have a major impact given the sheer number of cases the FDIC, NCUA and FHFA bring.

G-Fee Entreaty

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The FHFA has issued a Request for Input about Fannie Mae and Freddie Mac Guarantee Fees. The Request both provides a good explanation of g-fees and poses important questions about their appropriate role in the functioning of the housing finance system. The Request opens,

On December 9, 2013, the Federal Housing Finance Agency (FHFA) announced proposed increases to guarantee fees (g-fees) that Fannie Mae and Freddie Mac (the Enterprises) charge lenders. The Enterprises receive these fees in return for providing a credit guarantee to ensure the timely payment of principal and interest to investors in Mortgage Backed Securities (MBS) if the borrower fails to pay. The MBS, in turn, are backed by mortgages that lenders sell to the Enterprises.

 The proposed changes included an across-the-board 10 basis point increase, an adjustment of up-front fees charged to borrowers in different risk categories and elimination of the 25 basis point Adverse Market Charge for all but four states. On January 8, 2014, Director Melvin L. Watt suspended implementation of these changes pending further review. (1)

The Request asks for responses to 12 questions. The most important, as far as I am concerned, is the first: “Are there factors other than those described in section III – expected losses, unexpected losses, and general and administrative expenses that FHFA and the Enterprises should consider in setting g-fees? What goals should FHFA further in setting g-fees?” (7)

Setting the g-fee has far-reaching consequences not just for the financial health of the two companies, but also for the health of the overall housing market and the mortgage industry. It will also have predictable effects on the litigation over the conservatorships of the two companies. For instance, a high g-fee will make the two companies appear to be more valuable than a low one. The size of the g-fee may also impact the scope of federal affordable housing initiatives.

While this Request for Input is pretty technical (particularly the parts of it that I didn’t blog about), it touches on some of the most fundamental aspects of our system of housing finance. As such, it invites responses from more than just industry insiders. Input is due by August 4th.

Discovery War in GSE Litigation

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The United States filed a motion for a protective order in the Fairholme Funds case in the Court of Federal Claims (the Fairholme Takings case). You may not be familiar with protective orders. By way of background, Federal Rule of Civil Procedure 26(c) states that “The court may, for good cause, issue an order to protect a party or person from annoyance, embarrassment, oppression, or undue burden or expense . . ..”

The federal government can request a protective order, like any other party.  But there may be some unique policies at issue when the federal government makes such a request.  For instance, the federal government may assert a variety of privileges to limit discovery.  These may include the deliberative process qualified privilege.  This privilege is asserted to protect communications about the government’s decisions.  Another example would be the qualified government privilege for official information.  This privilege would be asserted to maintain the confidentiality of official government records.  These are just two examples – there are a whole other range of privileges that the government might assert.  A court’s protective order analysis involving the federal government thus might take into account a variety of legitimate objectives that would not apply in a dispute between two private parties.

Here, the United States is seeking to limit discovery requests that “seek documents that relate in their entirety to the future termination of the conservatorships, with no end date” and “documents that relate (in part) to the future profitability of the Enterprises, again with no end date.” (2) The government argues that

Disclosure of these documents is contrary to the strictures of the Housing and Economic Recovery Act of 2008 (HERA), which bars a court from taking “any action to restrain or affect the exercise of powers or functions” of the Federal Housing Finance Agency (FHFA) as conservator. 12 U.S.C. § 4617(f). The declaration of FHFA Director Melvin Watt explains that disclosure would “have extraordinarily deleterious  consequences on the Conservator’s conduct of the ongoing and future operations of the conservatorships.”  Decisions about when and how to terminate the conservatorships and the future profitability of the Enterprises are at the heart of FHFA’s responsibilities as conservator, and Court-mandated disclosure of information bearing on such matters would jeopardize the stewardship of the Enterprises. (2, footnotes and some citations omitted)

While some of the government’s language in the motion seems hyperbolic, the court should certainly focus on the deliberative process privilege that the government asserts. Defining its scope will have implications far beyond this case, no matter that this case is incredibly important itself.

As to this case itself, it is interesting to see how even procedural disputes in the GSE lawsuits implicate the current operations of the GSEs as well as their post-conservatorship future. There is no question that the plaintiffs are very aware of their effect on the broader debates about the housing finance system as they press their individual claims in court. It is not yet clear to me how much the Court will weigh those considerations in its decision regarding the reach of the deliberative process privilege.

More on GSE Litigation

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Inside Mortgage Finance did a longer story on the GSE litigation that profiled my take on it, Expert: GSE Shareholder Suits at ‘Early Stage’ of a Long Process; Litigation No Barrier to Dissolution, Says Group.

Look for the various lawsuits filed by private owners of Fannie Mae and Freddie Mac stock against the federal government to take a “very long time to be decided,” as the courts may take up to a year to resolve just the introductory motions, according to a legal expert. Beyond that, the litigation over shares in the two government-sponsored enterprises could stretch out to the U.S. Supreme Court.

Brooklyn Law School Professor David Reiss, speaking during a Bloomberg Industries webinar last week, noted that lawsuits stemming from the savings and loan debacle of 20 years ago give a sense of the possible timeframe, but litigation brought by disenfranchised Fannie and Freddie investors against the government offers an entirely different and deeper set of legal complexities.

“These are factually and legally complex cases and don’t trust anyone who thinks this is a slam dunk for any one of the parties,” said Reiss. He added that neither the government nor shareholders of the two government-sponsored enterprises can cut a deal and settle for anything short of total victory.

“I think we have plaintiffs that are going to go all the way on this because they have a lot at stake and they have a lot of resources to pursue their claims. You have a government that doesn’t have an incentive to settle like a normal private party does. They’re not worried about litigation costs or time, so I foresee this going on for a very, very long time,” said Reiss.

More than a dozen lawsuits filed against the government – led by 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 shareholder plaintiffs allege that the Treasury’s 2012 change in the dividend structure of its preferred stock leaves no funds to pay dividends to junior shareholders.

The government in its pending motion to dismiss gives some clear indication as to the tactics it will take to derail the various shareholder suits, Reiss explained. The government’s brief states that not a single plaintiff is entitled to recover anything – either on their individual or derivative claims – in light of the extensive powers that the Housing and Economic Recovery Act vests in the Federal Housing Finance Agency in its capacity as conservator to the GSEs.

“Until we have some motions to dismiss decided, we’re not really going to know how wide a scope these cases will have,” he said. “Only when we having a ruling on a summary judgment motion, will we have a sense of the real issues in contention. I will say that we are at an absolutely early stage.”

With the “entire range of private, administrative and constitutional principles” due to be called into question through the litigation, Reiss said there’s a great deal of uncertainty how the courts will decide the issue, including whether the Supreme Court will hear the inevitable appeal by plaintiffs or the defendant.

Although the pending shareholder litigation and investors’ claims of a government taking “must be taken seriously,” there’s no barrier – either from a legal or safety and soundness standpoint – preventing Fannie and Freddie from being dissolved, the Heritage Foundation argued in an issue brief.

“Protecting property rights, however, does not mean that taxpayers and consumers must continue to be put at risk by these government-sponsored housing giants,” said Heritage. “The ongoing lawsuits need not impede and should not distract Congress from the critical task of dissolving these economically dangerous institutions.”

Each of the GSE charters explicitly grants Congress the power to dissolve the corporations free of any conditions. After dissolution, Heritage notes that creditors would be paid off, with any remaining assets divided among shareholders, taking into account the priorities of different classes of shares.

“Because the United States is a defendant in the lawsuits, the litigation can proceed independently of the GSEs’ dissolution,” said Heritage. “If shareholders prevail on their takings claim, or any other monetary claim, they would still be able to receive full restitution for any legitimate claims.”

Reiss on GSE Litigation

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Inside Mortgage Finance profiled me in Legal Expert: GSE Shareholder Plaintiffs, U.S. Want ‘Total’ Victory (behind a paywall). It reads,

Look for the various GSE shareholder lawsuits against the federal government to take a “very long time to be decided” with the courts taking up to a year to resolve just the introductory motions and an ultimate appeal to the U.S. Supreme Court.

That’s the view of one legal expert speaking during a recent Bloomberg Industries webinar on Fannie Mae and Freddie Mac litigation. Brooklyn Law School Professor David Reiss noted there are some parallels to the savings and loan lawsuits brought by owners against the federal government 20 years ago. But the attorney stressed that the litigation from the Fannie and Freddie investors against the government offers an entirely different and deeper set of legal complexities.

“These are factually and legally complex cases and don’t trust anyone that thinks this is a slam dunk for any one of the parties,” predicted Reiss. He added that neither the government nor GSE shareholders can cut a deal and settle for anything short of total victory.

In its motion to dismiss, the government argues that the plaintiffs – hedge funds that have speculated in the junior preferred – are not entitled to recover anything, either on their individual or derivative claims, in light of the extensive powers that the Housing and Economic Recovery Act granted to the Federal Housing Finance Agency in its capacity as conservator.

With the “entire range of private, administrative and constitutional principles” due to be called into question in this litigation, Reiss said there’s a great deal of uncertainty over how the courts will decide the issue, including whether the Supreme Court will hear the inevitable appeal by plaintiffs or defendant.

Reiss in Bloomberg Industries Q&A on Frannie Litigation

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Bloomberg Industries Litigation Analyst Emily Hamburger interviewed me about The Government as Defendant: Breaking Down Fannie-Freddie Lawsuits (link to audio of the call). The blurb for the interview is as follows:

As investors engage in jurisdictional discovery and the government pleads for dismissals in several federal cases over Fannie Mae and Freddie Mac stock, Professor David Reiss of Brooklyn Law School will provide his insights on the dynamics of the lawsuits and possible outcomes for Wall Street, the U.S. government and GSEs. Reiss is the author of a recent article, An Overview of the Fannie and Freddie Conservatorship Litigation.

Emily questioned me for the first half of the one hour call and some of the 200+ participants asked questions in the second half.

Emily’s questions included the following (paraphrased below)

  • You’re tracking several cases that deal with the government’s role in Fannie Mae and Freddie Mac, and I’d like to go through about 3 of the major assertions made by investors – investors that own junior preferred and common stock in the GSEs – against the government and hear your thoughts:
    • The first is the accusation that the Treasury and FHFA’s Conduct in the execution of the Third Amendment was arbitrary and capricious. What do you think of this?
    •  Another claim made by the plaintiffs is that the government’s actions constitute a taking of property without just compensation, which would be seen as a violation of the 5th Amendment – do you think this is a stronger or weaker claim?
    • And finally – what about plaintiffs asserting breach of contract against the government? Plaintiffs have said that the Net Worth Sweep in the Third Amendment to the Preferred Stock Purchase Agreement nullified Fannie and Freddie’s ability to pay dividends, and that the two companies can’t unilaterally change terms of preferred stock, and that the FHFA is guilty of causing this breach.
  • Is the government correct when they say that the section 4617 of the Housing and Economic Recovery Act barred plaintiff’s right to sue over the conservator’s decisions?
  • Former Solicitor General Theodore Olson, an attorney for Perry Capital, has said that the government’s powers with respect to the interventions in Fannie and Freddie “expired” – is he correct?
  • Can you explain what exactly jurisdictional discovery is and why it’s important?
  • Do we know anything about what might happen if one judge rules for the plaintiffs and another judge rules for the government?
  • Is there an estimate that you can provide as to timing?
  • Are there any precedents that you know of from prior crises? Prior interventions by the government that private plaintiffs brought suit against?
  • How do you foresee Congress and policymakers changing outcomes?
  • What do we need to be looking out for now in the litigation?
  • How does this end?

You have to listen to the audiotape to hear my answers, but my bottom line is this — these are factually and legally complex cases and don’t trust anyone who thinks that this is a slam dunk for any of the parties.