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From Banking and Finance Law Daily, October 2, 2014

HERA protects Fannie Mae and Freddie Mac conservator

By R. Jason Howard, J.D.

The U.S. District Court for the District of Columbia has granted the Treasury Department and Federal Housing Finance Agency’s (FHFA) motions to dismiss and denied the individual plaintiffs’ cross-motion for summary judgment based on the authority granted to FHFA through the Housing and Economic Recovery Act (HERA) (Perry Capital LLC v. Lew, et al., Sept. 30, 2014, Lamberth, R.).

Background. The litigation began as a class action lawsuit and a set of three individual lawsuits, all containing overlapping claims. The purported class plaintiff consisted of private individuals and institutional investors who owned either preferred or common stock in the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac). The individual lawsuits consisted of private investment funds and insurance companies.

Fannie Mae and Freddie Mac are considered government-sponsored enterprises (GSEs) whose shared purpose was to make it easier for local banks and other lenders to offer mortgages to prospective home buyers. With the onset of the 2008 market decline, due in large part to the decline in the national housing market, the value of the assets of the two companies deteriorated significantly.

The potential for their collapse and the inevitable effect that a collapse would have had on the economy caused Congress to enact the Housing and Economic Recovery Act (HERA) on July 30, 2008 and with that HERA established FHFA as an independent agency to supervise and regulate the GSEs. In addition, HERA further granted FHFA’s director the authority to appoint the agency as conservator or receiver.

Fannie and Freddie attempted to raise capital in the private market but when that failed, FHFA placed them into conservatorship in September 2008. Thereafter Treasury entered into Preferred Stock Purchase Agreements (PSPAs) with both Fannie and Freddie. As of August 8, 2012, Treasury had provided $187.5 billion in funding. The PSPAs were subject to three amendments.

The subject of the litigation was the third amendment and it “require[d] Fannie Mae and Freddie Mac to pay a quarterly dividend to Treasury equal to the entire net worth of each Enterprise, minus a small reserve that shrinks to zero over time.”

It was the plaintiffs’ contention that by 2012 Fannie and Freddie were once again profitable and able to pay the 10 percent dividend to shareholders without drawing money from Treasury.

Claims. The plaintiffs’ brought claims of breach of contract, regarding allegedly promised dividends and liquidation preferences, breach of the implied covenant of good faith and fair dealing, and an unconstitutional taking, as well as derivative claims of breach of fiduciary duty.

Analysis. At every step of the Court’s analysis it simply reverted to HERA's unambiguous statutory provisions, coupled with the unequivocal language of the plaintiffs' original Fannie and Freddie stock certificates in support of granting the defendants motion to dismiss.

The court noted that the HERA statute and its empowering of FHFA as conservator or receiver, to “immediately succeed to—(i) all rights, titles, powers, and privileges of the [GSE], and of any stockholder, officer, or director of such [GSE] with respect to the [GSE] and the assets of the [GSE],” and its establishment on limitations to court action such that, “[e]xcept 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 [FHFA] as a conservator or a receiver,” gave the FHFA broad power to do what was necessary to prevent a collapse. Both Fannie and Freddie’s charters were also amended by HERA to temporarily authorize Treasury to “purchase any obligations and other securities issued by the [GSEs].”

With the statute as ammunition, the court quickly but thoroughly, worked through each of the plaintiffs’ arguments and dismissed them in turn. The common theme across the opinion can be summed up by the court’s analysis of the plaintiffs’ argument that, despite the general bar against derivative suits, they had standing to sue derivatively because FHFA, due to a conflict of interest, would be unwilling to sue itself or Treasury. To that the court quoted Professor Frankfurter's "timeless advice: ‘(1) Read the statute; (2) read the statute; (3) read the statute!’”

In the end, the plaintiffs simply did not have enough in their corner to overcome the powers inherent in the HERA provisions that Congress authorized. The court noted that the “plaintiffs' grievance is really with Congress itself. It was Congress, after all, that parted the legal seas so that FHFA and Treasury could effectively do whatever they thought was needed to stabilize and, if necessary, liquidate, the GSEs.”

The case is No. 13-1025 (RCL).

(Perry Capital v. Lew, et al.)

Attorneys: Theodore B. Olson (Gibson Dunn & Crutcher LLP) for Perry Capital LLC. Joel L. McElvain, U.S. Department of Justice, for Jacob J. Lew in his official capacity as the Secretary of the Department of the Treasury and the Department of the Treasury. Asim Varma (Arnold & Porter LLP) for Edward DeMarco in his official capacity as Acting Director of the Federal Housing Finance Agency and the Federal Housing Finance Agency.

(Fairholme Funds, Inc., et al., v. Federal Housing Finance Agency, et al.)

Attorneys: Peter A. Patterson (Cooper & Kirk PLLC) for Fairholme Funds, Inc., Fairholme Fund, Berkley Insurance Co., Acadia Insurance Co., Admiral Indemnity Co., Berkley Regional Insurance Co., Carolina Casualty Insurance Co., Midwest Employers Casualty Insurance Co., Nautilus Insurance Co. and Preferred Employers Insurance Co. Asim Varma (Arnold & Porter LLP) for in its capacity as Conservator of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. and Edward DeMarco in his official capacity as Acting Director of the Federal Housing Finance Agency. Joel L. McElvain, U.S. Department of Justice for the Department Of Treasury.

Companies: Fairholme Funds, Inc.; Fairholme Fund; Berkley Insurance Co.; Acadia Insurance Co.; Admiral Indemnity Co.; Berkley Regional Insurance Co.; Carolina Casualty Insurance Co.; Midwest Employers Casualty Insurance Co.; Nautilus Insurance Co. and Preferred Employers Insurance Co.

(Arrowood Indemnity Company, et al., v. Federal National Mortgage Association, et al.)

Attorneys: Michael H. Barr (Dentons US LLP) for Arrowood Indemnity Co., Arrowood Surplus Lines Insurance Co. and Financial Structures Ltd. Paul Clement (Bancroft PLLC) for Federal National Mortgage Association. Graciela Maria Rodriguez (King & Spalding LLP) for Federal Home Loan Mortgage Corp. Asim Varma (Arnold & Porter LLP) for Federal Housing Finance Agency and Edward DeMarco. Joel L. McElvain, U.S. Department of Justice for the Department Of Treasury and Jacob J. Lew.

Companies: Arrowood Indemnity Co.; Arrowood Surplus Lines Insurance Co.; Financial Structures Ltd.; Federal National Mortgage Association; Federal Home Loan Mortgage Corp.; Federal Housing Finance Agency; Department Of Treasury

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