SEC sues former Fannie Mae, Freddie Mac execs
More than three years ago, the government rescued the nation’s housing finance giants, Fannie Mae and Freddie Mac, from collapse in the wake of the mortgage market meltdown.
On Friday, federal officials went after the executives who led the companies to the brink. In twin lawsuits, the Securities and Exchange Commission accused six former Fannie and Freddie officials of misleading investors and the public about how much money they had sunk into risky subprime mortgages.
Taxpayers have pumped more than $150 billion into Fannie and Freddie in one of the largest bailouts, fueling widespread anger against the firms and accusations that they were the major cause of the subprime market meltdown.
“They could really have a showcase trial,” said James Cox, a professor of securities law at Duke University. “The charges couldn’t be more central to the financial crisis.”
As financing companies, Fannie Mae and Freddie Mac help provide billions of dollars for home mortgages by buying loans made by banks, pooling them into securities and selling them to investors. When the underlying mortgages soured, so did the securities.
“Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” said Robert Khuzami, director of the SEC’s Enforcement Division.
“These material misstatements occurred during a time of acute investor interest in financial institutions’ exposure to subprime loans, and misled the market about the amount of risk on the company’s books,” Khuzami said.
In an 18-month stretch ending in August 2008, for example, Freddie Mac told investors that the exposure of its single-family subprime loans was $2 billion to $6 billion. The SEC alleged the real exposure was $141 billion at the end of 2006, and about $244 billion by mid-2008.
The former chief executives, Daniel H. Mudd at Fannie and Richard F. Syron at Freddie, became two of the highest-ranking figures to face legal action in the wake of the financial crisis. Both were dismissed when the government put the firms into conservatorship.
The executives face financial penalties, repayment with interest of ill-gotten gains and a ban on serving as an officer or a director of a public company. Mudd is chief executive of Fortress Investment Group in New York. Syron is a director at Genzyme Corp. in Cambridge, Mass.
Lawyers for the former executives said that their clients did nothing wrong and that the SEC cases were flawed.
The securities fraud case is similar to those filed by the SEC against two key players in the subprime market — Angelo R. Mozilo, former head of Countrywide Financial Corp. in Calabasas, and Michael W. Perry, former chief executive of failed IndyMac Bancorp in Pasadena. Mozilo agreed to pay a record $22.5-million fine as part of a $73-million settlement last year. The suit against Perry is pending.
John Coffee, a law professor at Columbia University, said a settlement in the Fannie and Freddie suits would not satisfy the public desire to see financial executives pay for their misdeeds if SEC officials fail to recover a large amount. “They would be courting disaster if they settled this for a hollow recovery,” Coffee said.
Friday’s suits came after a lengthy investigation by the SEC, which has faced criticism for not bringing more cases stemming from the financial crisis. Fraud cases typically are difficult to investigate and take more time to develop.
The suits, filed in U.S. District Court in Manhattan, alleged that the Fannie and Freddie executives intentionally and repeatedly misled investors about the exposure of the companies to risky subprime loans.
Executives at both companies were issuing their rosy financial conditions as they tried to increase their share of the housing finance market during the run-up to the 2007-08 mortgage market meltdown, the SEC said.
“Throughout this period, as they were driving up their market share, Fannie, Freddie and their executives sought to maintain the illusion that their business involved minimal and manageable credit risk,” Khuzami said.
The other Fannie Mae executives named in the suits were Enrico Dallavecchia, former chief risk officer, and Thomas A. Lund, former executive vice president of the company’s single-family mortgage business. The other Freddie Mac officials were Patricia L. Cook, former executive vice president and chief business officer, and Donald J. Bisenius, former executive vice president for the single-family guarantee business.
Tom Green, a lawyer for Syron, said that Freddie Mac had made the required disclosures to investors and that “the SEC’s theory and approach are fatally flawed.” Lund’s lawyer, Michael Levy, said his client “did not mislead anyone.” Lawyers for the other executives did not respond to requests for comment.
The Freddie Mac suit quoted Syron as telling an investor conference in New York on May 14, 2007, that “at the end of 2006, Freddie had basically no subprime exposure in our guarantee business.” Three days later, Cook made the same statement to an investor conference in London.
Before the speeches, the head of external reporting for Freddie Mac reviewed a draft of Syron’s comments and warned Bisenius and others about the subprime statement, the suit said.
“We need to be careful how we word this. Certainly our portfolio includes loans that under some definitions would be considered subprime,” the unnamed executive told Bisenius, according to the suit. “We should reconsider making as sweeping a statement as we have ‘basically no subprime exposure.’”
Bisenius did not respond to the warning, the suit alleged.
At Fannie Mae, “Mudd was well aware of the company’s increased acquisition of reduced documentation loans — Indeed, Mudd himself directed the company to pursue that market,” the lawsuit said.
In a Feb. 23, 2007, call with investors, Mudd said Fannie Mae’s “subprime investment constitutes well below 2% of our book,” or about $4.8 billion.
But Fannie Mae was not including “a material number” of subprime loans, including one category called Expanded Approval or EA loans. At the end of 2006, Fannie Mae’s exposure to those loans was $43.3 billion, the SEC said.
“All of the defendants knew that EA loans had higher average serious delinquency rates, a higher level of credit losses and lower average credit scores than the loans Fannie Mae actually included” in its subprime disclosure, said Lorin Reisner, the SEC’s deputy director of enforcement.
“And EA loans were exactly the type of loans that investors would reasonably expect Fannie Mae to include when calculating its exposure to subprime loans,” he said.
Fannie Mae and Freddie Mac, both now run by the government, agreed to accept responsibility for the actions of the former executives. The SEC said it agreed to the deal partly to avoid the potential costs to taxpayers, who now own about 80% of both companies.
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