Opinion

Alison Frankel

New ruling puts Fannie, Freddie in line for windfall MBS recovery

Alison Frankel
Dec 17, 2013 20:24 UTC

Has there ever been a more lopsided multibillion-dollar case than the Federal Housing Finance Agency’s fraud litigation against the banks that sold mortgage-backed securities to Fannie Mae and Freddie Mac? I don’t think U.S. District Judge Denise Cote of Manhattan, who is overseeing securities fraud suits against 11 banks that haven’t already settled with the conservator for Fannie and Freddie, has sided with the banks on any major issue, from the timeliness of FHFA’s suits to how deeply the defendants can probe Fannie and Freddie’s knowledge of MBS underwriting standards in the late stages of the housing bubble. But even in that context, Judge Cote’s summary judgment ruling Monday – gutting the banks’ defenses against FHFA’s state-law securities claims – is a doozy.

In effect, Cote’s decision will permit FHFA to recover more from MBS issuers than Fannie Mae and Freddie Mac would have made if their MBS investments had paid as promised. Of course, FHFA and its lawyers at Quinn Emanuel Urquhart & Sullivan and Kasowitz, Benson, Torres & Friedman still have to show that the banks knew or had reason to know that their offering documents misrepresented the mortgage-backed securities they were peddling to Fannie Mae and Freddie Mac. But if FHFA meets that burden, the banks can’t ward off claims under the state securities laws of Virginia and the District of Columbia by blaming Fannie and Freddie’s MBS losses on broad declines in the economy and the housing market.

What’s more, those state securities laws give FHFA the right to rescission – or restitution of the entire purchase price of the MBS Fannie and Freddie bought – plus fees, costs and, most importantly, interest. The Virginia statute mandates that securities fraudsters chip up 6 percent interest – more than the scheduled interest rate in many of the MBS trusts in which Fannie and Freddie invested. The banks, in other words, are now exposed to liability far beyond the actual losses Fannie Mae and Freddie Mac suffered – and even beyond what FHFA’s wards would have earned if the MBS trusts had performed exactly as the banks said they would at the time of sale. That extra interest would be a true windfall for FHFA.

Cote rejected the banks’ motion to ask the Virginia Supreme Court for a ruling on whether the state’s securities fraud law permits a so-called loss causation defense. As the judge explains in her ruling, when Congress passed the Private Securities Litigation Reform Act in 1995, it amended Section 12 of the Securities Act of 1933 to permit defendants to limit their liability by showing that a supposed fraud victim’s losses were not attributable to the defendant’s misrepresentations. In the FHFA cases, the banks’ lawyers – led by James Rouhandeh of Davis Polk & Wardwell, for Morgan Stanley, and Thomas Rice of Simpson, Thacher & Bartlett, for Deutsche Bank – tried to persuade Cote that because state securities laws were based on the federal Securities Act, she should look to the amended federal statute to interpret Virginia and D.C. law. Cote rejected the argument, holding that the federal law did not include a loss causation defense until it was amended in 1995. The Virginia and D.C. laws predate that amendment, Cote said, so loss causation cannot be inferred from their texts.

“As defendants concede, no federal court interpreted the ’33 Act as incorporating a loss causation defense before one was added by the PSLRA,” Cote wrote, so “there is no reason to think the Virginia Supreme Court would read a loss causation defense into the Virginia Securities Act if confronted with the question now.”

UBS ‘likely’ to settle with FHFA before January trial: bank co-defendants

Alison Frankel
Jul 17, 2013 19:03 UTC

Remember UBS’s attempt to play what it considered a get-out-of-jail-free card in the megabillions litigation over mortgage-backed securities UBS and more than a dozen other banks sold to Fannie Mae and Freddie Mac? UBS’s lawyers at Skadden, Arps, Slate, Meagher & Flom came up with an argument that could have decimated claims against all of the banks: When Congress passed the Housing and Economic Recovery Act of 2008 and established the Federal Housing Finance Agency as a conservator for Fannie Mae and Freddie Mac, UBS said, lawmakers explicitly extended the one-year statute of limitations on federal securities claims – but neglected to extend, or even mention, the three-year statute of repose. UBS argued that FHFA’s suits, which in the aggregate asserted claims on more than $300 billion in MBS, were untimely because they were filed after the statute of repose expired.

The judge overseeing almost all of the FHFA MBS suits, U.S. District Judge Denise Cote, denied UBS’s motion to dismiss in 2012. The bank, she said, was splitting hairs: Congress clearly intended to give FHFA a chance to evaluate its potential causes of action and believed it was doing so when it extended the statute of limitations. The judge subsequently applied the same reasoning to other banks’ motions to dismiss FHFA suits on timeliness grounds, but she also granted UBS permission to take the issue to the 2nd Circuit Court of Appeals. Cote said that whichever way the appeals court ruled, its decision would help resolve the FHFA litigation. If she were reversed, FHFA’s claims would be drastically narrowed; if she were upheld, the banks would be more inclined to settle.

In April, as you probably recall, a three-judge 2nd Circuit panel affirmed Judge Cote. In the appeal, UBS stood alone among the FHFA bank defendants as a party, though the other banks filed an amicus brief endorsing UBS’s position that Congress failed to extend the statute of repose. Since the 2nd Circuit’s ruling, UBS and FHFA have been engaged in whirlwind discovery, which is scheduled to close in September. Judge Cote has set an inviolable January trial date for FHFA’s case against UBS.

Fannie, Freddie shareholders demand lost dividends from U.S. in new class action

Alison Frankel
Jul 10, 2013 21:29 UTC

In August of 2012, the U.S. Treasury and the Federal Housing Finance Agency announced that they had amended the terms of Treasury’s investment in Fannie Mae and Freddie Mac, the government-sponsored mortgage lenders under FHFA’s conservatorship. After Fannie and Freddie went into conservatorship in the economic crisis of 2008, Treasury invested more than $100 billion in a new class of senior preferred stock that guaranteed the government first dibs on a percentage of Fannie or Freddie profits. Those seemed like a distant hope in 2008, but by 2012, Fannie and Freddie were, in fact, making money. Preferred shareholders junior to the government believed the mortgage lenders were generating enough profits to pay Treasury’s dividend and leave something for them as well. But in August, FHFA and the government – without consulting Fannie and Freddie junior preferred shareholders – disclosed that under a newly executed “net worth sweep,” Treasury would be receiving all of the profits kicked out by Fannie Mae and Freddie Mac, then and in the future.

On Wednesday, junior preferred shareholders filed a class action in the U.S. Court of Federal Claims, asserting that the August 2012 agreement between FHFA and the Treasury amounted to an illegal seizure of their property in violation of the Takings Clause of the Fifth Amendment of the U.S. Constitution. The preferred shareholders, represented by Boies, Schiller & Flexner and Kessler Topaz Meltzer & Check, point to the $66.3 billion dividend Fannie and Freddie paid to the government in the second quarter of 2013, arguing that more than $60 billion of that money was misappropriated from them.

The new shareholder class action follows an injunction suit filed Sunday in federal court in Washington by Perry Capital and its lawyers at Gibson, Dunn & Crutcher. The Perry suit, which claims that the August 2012 agreement between Treasury and FHFA “enriches the federal government through a self-dealing pact, and destroys tens of billions (of dollars) of value in the companies’ preferred stock,” seeks a declaratory judgment that the amended agreement violates the Administrative Procedures Act, as well as an injunction against implementing the new agreement. In addition, the mutual fund Fairholme Funds and several insurance companies that own Fannie Mae and Freddie Mac junior preferred shares filed a Takings Clause case on Tuesday night in the Court of Federal Claims. Cooper & Kirk, which represents the Fairholme plaintiffs, raises allegations that parallel those in the new class action but brought the case only on behalf of the named shareholders.

Banks should fear ominous new rulings in Fannie/Freddie MBS cases

Alison Frankel
Nov 9, 2012 23:19 UTC

JPMorgan Chase filed quite a remarkable quarterly report with the Securities and Exchange Commission on Thursday, crammed with far more details about its exposure to litigation and mortgage repurchase demands than the earnings report the bank issued in mid-October. Among the revelations: JPMorgan has reached an agreement in principle to settle two SEC investigations, one involving a single unidentified JPMorgan securitization, the other involving Bear Stearns’s crafty (alleged) trick of keeping put-back recoveries from mortgage originators for itself instead of passing them on to investors in mortgage-backed securities trusts. The SEC deal has been long rumored, and though we still don’t know any of its terms, the bank’s filing confirms it.

JPMorgan also disclosed that it is now facing put-back claims, in one form or another, on $140 billion in mortgage-backed notes. Yes, you read that right: $140 billion. That doesn’t mean there are $140 billion in claims, but it means that holders of $140 billion in MBS notes have asserted, in litigation or through contractual demands, that the bank must buy back deficient mortgages in their trusts. Given that MBS investors generally claim breach rates in excess of 50 percent, JPMorgan’s exposure to mortgage put-backs is tens of billions of dollars.

The bank, of course, thinks the put-back demands are meritless and its entire litigation exposure is a trifling matter. The SEC filing’s 10-page discussion of the various litigation headaches facing JPMorgan — which include really serious matters, such as the securities class action over its CIO losses, various Libor suits and the Federal Energy Commission’s market manipulation case – begins with the brash assertion that the bank’s “reasonable possible losses” in all of this litigation (aside from its litigation reserves) range from zero dollars to $6 billion.

The megabillions tax claims facing Fannie Mae and Freddie Mac

Alison Frankel
Aug 1, 2012 00:02 UTC

We all know that the foreclosure crisis has been a disaster for state and county governments. When homeowners lose their houses, they stop paying property taxes, which is one of the reasons why municipal governments have been driven to consider ideas like seizing underwater mortgages through the use of eminent domain. We’ve also seen state and local officials file lawsuits against the Mortgage Electronic Registration Systems, claiming that MERS and its member banks have cheated governments out of mortgage recording fees in the securitization process. MERS has had mixed results in shutting down those cases but so far hasn’t been found liable.

There’s another tranche of litigation that’s gotten much less attention but could result in billions of dollars for state and county governments, courtesy of Fannie Mae and Freddie Mac, the government-sponsored mortgage guarantors that have taken ownership of thousands and thousands of foreclosed homes. The Judicial Panel on Multidistrict Litigation is weighing a motion to consolidate 23 suits from around the country that claim Fannie and Freddie owe real estate transfer taxes on foreclosed homes they resold. The total exposure for Fannie and Freddie, which are now in federal conservatorship, hasn’t been publicly tabulated, but in the two cases that sparked the MDL motion, the Michigan attorney general and the county government of Oakland, Michigan, claimed that Fannie and Freddie owe millions in transfer taxes just to Oakland County. Class actions already on the dockets have asserted claims on behalf of 13 states, but according to a consolidation motion filed by Genesee County, Michigan, 35 states have real estate transfer tax statutes that could be asserted against Fannie and Freddie. I’d be surprised if most of them (including California and Nevada, which haven’t yet brought cases) don’t end up filing claims.

Fannie and Freddie, which are represented at the JPMDL by King & SpaldingFoley & Lardner and Arnold & Porter, argued in the Michigan litigation that they are exempt from all state taxes by the federal charters that created them. But in a summary judgment ruling in March, U.S. District Judge Victoria Roberts of Detroit said the transfer tax is an excise fee that’s not covered by the charter exemption. She also said Fannie and Freddie are not “federal instrumentalities,” so they’re not shielded by a Michigan law exempting government entities from taxation. The judge granted the county and state summary judgment on Fannie and Freddie’s excise tax liability. (Lawyers for Fannie and Freddie have asked the 6th Circuit Court of Appeals to take an interlocutory appeal of the ruling.)

Previewing the defense in SEC cases v. Fannie and Freddie execs

Alison Frankel
Dec 19, 2011 21:17 UTC

For the last three years, since the housing bubble burst, the Securities and Exchange Commission has been investigating the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Association (Freddie Mac). Fannie and Freddie, after all, were the biggest players in the mortgage lending and securitization business, and there’s a lot of sentiment that they deserve a hefty share of blame for encouraging the financial industry’s voracious appetite for mortgage loans, no matter how deficiently underwritten. The problem for regulators hoping to hold Fannie and Freddie accountable, though, is that the previously quasi-private agencies went into public receivership conservatorship in 2008. Any SEC suit against Fannie and Freddie would essentially be one wing of the U.S. government seeking damages against another.

But the people who ran Fannie and Freddie in the run-up to the mortgage meltdown were another story. About nine months ago the SEC issued Wells notices to top Fannie and Freddie executives. I’ve heard there was virtually no give-and-take between regulators and defense lawyers for the executives after initial defense responses. So it was a disappointment but not a big surprise to the defendants when, on Friday, the SEC sued three former top officials from both Fannie and Freddie. (Here’s the SEC’s complaint against Richard Syron, Patricia Cook, and Donald Bisenius of Freddie Mac; and here’s the complaint against former Fannie Mae execs Daniel Mudd, Enrico Dallavecchia, and Thomas Lund.) The SEC complaints charge two defendants in each case with full-on securities fraud (the third official in each complaint faces aiding and abetting claims) for allegedly misleading investors about their agencies’ exposure to subprime mortgages. In the Freddie complaint, the SEC asserts that the agency claimed only $2 to $6 billion of its single-family guaranteed mortgages were considered subprime loans, when, in fact, $140 billion to $244 billion in loans fit that classification. Fannie allegedly reported $4.8 billion in exposure when its subprime lending exceeded $40 billion.

There are a few points to keep in mind about the Fannie and Freddie suits. First, the allegations all center on disclosures. There’s no accusation of accounting manipulation or more obvious fraudulent acts. Yet four of the defendants are accused of intentionally defrauding investors — partly because Fannie and Freddie were not registered entities during the entire period of alleged wrongdoing, which means the execs couldn’t be accused of negligence. That’s a high bar, in which the agency has to show the defense acted with fraudulent intent. Second, the former Fannie and Freddie executives — unlike the Citigroup executives who agreed to an administrative settlement in the bank’s 2010 subprime exposure agreement with the SEC — had no leverage because the SEC wasn’t also negotiating with their employer. There was little reason for financial regulators to reign in aggressive allegations, especially because there’s a strong public-relations incentive for the SEC to charge senior executives of agencies that ended up in such severe straits that they had to be placed in receivership, with taxpayers bearing the burden of management’s overly risky strategy.

Why FHFA IG report doesn’t mean big new liability for banks

Alison Frankel
Sep 27, 2011 21:44 UTC

When I first read the Federal Housing Finance Agency Inspector General’s report criticizing Freddie Mac’s $1.35 billion MBS put-back settlement with Bank of America, I wondered if the FHFA IG had just exposed billions of dollars in untapped bank liability. The IG report notes, after all, that Freddie’s deal with BofA (unlike Fannie Mae’s simultaneous $1.52 billion BofA settlement) resolves not only pending breach of contract claims, but also any future claims that Countrywide breached representations and warranties on the mortgages it sold Freddie. Those are exactly the kinds of global settlements banks are going to have to reach if they have any hope of resolving their MBS put-back liability.

So if the FHFA Inspector General is castigating Freddie for overlooking BofA’s liability for mortgages that defaulted four or five years after they were issued — and FHFA is generally reckoned to be the most experienced evaluator of reps and warranties claims there is — have other put-back claimants underestimated potential bank liability? Are bond insurers and MBS investors making the same supposed mistake as Freddie Mac?

The short answer is no.

The IG report faults Freddie for failing to account for the exotic mortgage loans that proliferated in the housing bubble. Homeowners with interest-only or adjustable-rate mortgages often made it through the early teaser-rate years, only to default when they had to begin making higher payments. The FHFA IG report indicates that Freddie Mac has seen tens of thousands of these mortgages go into default three to five years after they were issued.

What are Fannie and Freddie’s MBS cases really worth?

Alison Frankel
Sep 6, 2011 23:03 UTC

Last Friday evening, after the Federal Housing Finance Agency filed 17 blockbuster suits against just about every major issuer of mortgage-backed securities, the buzz was about the staggering size of Fannie Mae and Freddie Mac’s investments in mortgage-backed notes and certificates. The suits, 13 filed by Quinn Emanuel Urquhart & Sullivan and four by Kasowitz Benson Torres & Friedman, cite about $196 billion in MBS holdings by Fannie and Freddie. Under both state and federal damages theories, the suits demand rescission, or a buyback of the notes by their issuers. Does that mean we should we assume that FHFA has $196 billion in claims?

Nope. Not even close. FHFA doesn’t specify any damages numbers in the complaints filed Friday, but in the agency’s previously-filed $4.5 billion MBS suit against UBS, FHFA asserted that Fannie and Freddie had “lost in excess of 20 percent” of their investment in UBS notes, including unrealized losses. Apply that rough logic to the FHFA’s new suits, and the agency’s claims are knocked down to $40 billion — a huge number, to be sure, but not a heart-stopping one. The banks, meanwhile, are cranking up defenses to shrink even that reduced estimate of FHFA losses. One bank defense lawyer told me Tuesday that by his firm’s calculation, which I’ll explain later, Fannie and Freddie have actually realized losses of no more than about $50 million on their $4.5 billion investment in UBS mortgage-backed certificates. Do the math: if FHFA’s losses are similar across the board, that would put Fannie and Freddie’s recoverable damages on MBS securities claims in the universe of a few billion dollars.

That is, of course, a lot of supposition. But any estimate of banks’ MBS liability, by necessity, involves supposition. MBS investor litigation is so new that there’s not much precedent to guide predictions of how FHFA’s suits, or those of any other MBS investor, will fare in court or in settlement talks. So far, there’s only been one public settlement of an MBS securities case — Wells Fargo’s $125 million deal in a class action involving investors in 28 MBS offerings. Lots of other MBS investors have filed federal court cases, including several class actions, but the litigation hasn’t progressed very far. (Late Tuesday FHFA put out a press release that clarified its damages theories and claims, spelling out some of the same points I make below.)

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