Good News For Fannie And Freddie Shareholders?


The plaintiffs in one of the lawsuits involving Fannie Mae and Freddie Mac received some good news in July – and people involved in related lawsuits might benefit, as well.

In Fairholme Funds Inc. et al. v. United States, the plaintiffs, which include the mutual fund and several insurance companies, argue that the Federal Housing Finance Administration (FHFA) took the plaintiffs' property without just compensation under the Fifth Amendment of the U.S. Constitution. The property was stock in the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which have been under conservatorship since 2008.

The case challenges the ‘net worth sweep,’ which was an action the U.S. Treasury took in August 2012. The sweep was the result of a ‘third amendment’ to the bailout agreement between the companies and the Treasury (i.e., this was a change in conservatorship rules as opposed to a change to the Third Amendment of the U.S. Constitution). As a result of the change, the U.S. Treasury took the profits the GSEs generated to repay the 2008 bailout of $188 billion. The case is related to other cases with similar claims.

The Fairholme case was filed on July 9, 2013, in the U.S. Court of Federal Claims. ‘When you are suing the government and you go for damages, you go to the Court of Federal Claims,’ says Charles Cooper, the lead attorney for Fairholme. ‘We are seeking injunctive relief.’
Fairholme also filed a lawsuit in the U.S. District Court for the District of Columbia, and that case is on appeal in the U.S. District Court of Appeals. In July, Judge Margaret Sweeney, presiding over the case in the Court of Federal Claims, granted the motion that Fairholme may file the materials found during discovery in the Court of Federal Claims case and use it in the related District Court case. This means the lawyers can read the more than 10,000 documents that the government claims is protected information and that may offer insight into whether the government broke the law when it changed the rules.

‘We have been allowed to take discovery of the government over its objection,’ says Cooper, who is with Cooper & Kirk in Washington, D.C. ‘We asked Judge Sweeney to permit us to share some of the documents that we believe are important and relevant, and she has granted it.’

The documents are under seal and not available to the public. ‘It's not even available to my clients,’ Cooper says. ‘It is only available to the lawyers representing the client, to me and my colleagues in my firm.’

The original complaint explained that in 2008, when the FHFA placed the GSEs into conservatorship, the U.S. Treasury exercised its temporary authority to provide them with capital. Meanwhile, public trading of Fannie and Freddie's stock continued. The U.S. Treasury entered into purchase agreements in which the Treasury invested in a newly created class of securities: Preferred Stock or Government Stock. The stock helped the GSEs remedy the book losses that had resulted from the financial crisis, and the Treasury earned a 10% dividend.

By 2012, the complaint noted, Fannie and Freddie had regained profitability and no longer had to draw on capital from the Treasury. The Treasury was earning dividends.

‘But Treasury was not content,’ Cooper wrote in the complaint. ‘It wanted to cut out the preferred shareholders entirely, and it wanted all the profits.’ The Treasury implemented changes, including the Third Amendment ‘sweep’ that changed the 10% dividend to a dividend of 100% of all future profits of the two companies, in perpetuity. The government did not pay the holders of preferred stock any compensation.

In fact, wrote Cooper, the government could have ended the conservatorship because it had been successful. Instead, he says, ‘the government nationalized the companies and expropriated their entire net worth and all future net profits.’ Holders of the companies' stock expected a return to normal business and that they could redeem stock the way they might with any publicly traded company.

Other shareholders have filed separate lawsuits. Some of these are Cacciapalle, et al. v. United States; Fisher v. United States; Reid v. United States; Washington Federal, et al. v. United States; Rafter v. United States; and Arrowood Indemnity Company, et al. v. United States.

The discovery decision will help attorneys in other cases, too. ‘Judge Sweeney's order allows attorneys in the Fisher and Reid cases access to the government's document production and the right to attend and receive transcripts of any depositions,’ explains Noah M. Schubert, an attorney with Schubert Jonckheer & Kolbe, which represents Fisher and Reid in the two shareholder derivative cases against Fannie and Freddie. ‘The amended protective order in Fairholme now includes our cases. We are in the process of coordinating with the government to begin receiving the document production.’

Other suits include shareholders in Iowa who filed a case in May. The New York Times filed a motion to release information so that media outlets can report on it.
According to the complaint, Fairholme Funds is a mutual fund with more than 171,000 shareholders who have an average of $43,000 in their accounts. The fund performed well in the first quarter, according to its Portfolio Manager's Report for the first half. If someone had invested $10,000 in Fairholme at the fund's inception in December 1999, the investment would have been worth $53,107 on June 30. Meanwhile, the S&P total return for that time period would have totaled $18,952. The fund's biggest winners, the report indicated, were AIG, at 29.6% of the portfolio, and Bank of America at 20.6%.

Cooper says the next step is to collect the information and prepare documents for filing in the U.S. Court of Appeals. There is no timeline on that, but Cooper hopes the government will mediate. ‘We reached our hand out to the government,’ Cooper says. ‘We would like to do that, [but] so far to no avail. I still hold out some hope the government may agree to resolve this dispute amicably.’

Another case is Perry Capital v. Lew. In that case, Investors Unite, a coalition of investors, filed an amicus curiae, or friend of the court brief, in July. Michael H. Krimminger, partner with Cleary Gottlieb Steen & Hamilton, who is retained by Investors Unite, says the point of the brief is that the Third Amendment sweep violates the Housing and Economic Recovery Act (HERA) of 2008. Specifically, the sweep violates the requirement that a conservatorship be conducted with the goal of restoring the companies to a ‘sound and solvent condition.’

‘The model for the HERA statute was clearly the Federal Deposit Insurance Act,’ says Krimminger, who previously held executive positions with the Federal Deposit Insurance Corp. ‘When you are interpreting HERA you should look back, and you would see that FHFA conservatorship is completely at odds and completely contrary to how the FDIC would do conservatorship.’

Krimminger does not predict how the Perry case or the related cases will conclude, but he hopes the FHFA will set aside a trust to pay damages if the government is found liable. ‘That's interesting from a public policy perspective, too,’ he says. ‘Right now with the way the Third Amendment works, they are stripping currently earned value, also decreasing bit by bit the cushion they had held, so it will be zero by 2018.’

Some onlookers say the lawsuits go beyond taking money from stockholders. In the Perry Capital case, The National Black Chamber of Commerce filed an amicus brief in July. The brief noted that the case involves the federal government's attempt to liquidate and nationalize Fannie Mae and Freddie Mac. That will negatively impact African Americans who are trying to buy homes. ‘Under the FHFA's conservatorship, African Americans have been disproportionately unable to get conventional mortgages, and the 'homeownership gap' between whites and blacks has exacerbated,’ wrote Pierre H. Bergeron, an attorney with Squire Patton Boggs.

‘Fannie Mae and Freddie Mac are the keys to middle-class homeownership,’ says Harry C. Alford, president and CEO of the National Black Chamber of Commerce. ‘What we want is a return to the days of stewardship, of government-sponsored enterprises. That's important to our constituents. Without those mortgage tools, it's going to be difficult to get loans.’

Alford is not optimistic about an amicable outcome. ‘My experience with this government is they don't mediate,’ he says. ‘It's a fight. We've won before.’

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