The U.S. Securities and Exchange Commission today charged six top former executives of Fannie Mae and Freddie Mac with securities fraud, alleging that they knowingly approved misleading statements about the government-sponsored entities' holdings of risky mortgages.
Among those charged are former Fannie Mae CEO Daniel Mudd and ex-Freddie Mac Chairman of the Board and CEO Richard Syron in suits filed in U.S. District Court for the Southern District of New York.
Both Fannie and Freddie entered into non-prosecution agreements with the SEC, agreeing to accept responsibility for their conduct and not to dispute an agreed-upon statement of facts—but also without admitting nor denying liability. Each also agreed to cooperate with the SEC’s litigation against the former executives.
Neither entity will pay a fine to the government, though they face multiple private suits by investors. The SEC is seeking financial penalties, disgorgement of ill-gotten gains with interest, permanent injunctive relief and officer and director bars against the former executives.
According to the complaint, Syron was paid $18.3 million in 2007. Mudd’s salary is not disclosed, but The Washington Post in a 2008 executive compensation survey reported he earned $14.2 million. "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, in a news release. "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."
The SEC explained its decision not to fine Fannie and Freddie, pointing to “the unique circumstances presented by the companies' current status, including the financial support provided to the companies by the U.S. Treasury, the role of the Federal Housing Finance Agency as conservator of each company, and the costs that may be imposed on U.S. taxpayers.”
The complaint against the Fannie Mae executives, which in addition to Mudd include former chief risk officer Enrico Dallavecchia and former single family mortgage executive vice president Thomas Lund, focuses on the period of December 2006 until August 2008.
During that time, each made “materially false and misleading statements” about Fannie Mae’s exposure to subprime loans, according to the complaint. For example, Fannie reported that 0.2 percent, or approximately $4.8 billion, of its single family credit book of business as of December 31, 2006, consisted of subprime mortgage loans.
But Fannie Mae failed to count $43.3 billion worth of loans targeted at borrowers with weak credit in tallying the numbers, according to the complaint. Such loans “were exactly the type of loans that investors would reasonably believe Fannie Mae included when calculating its exposure to subprime loans,” the complaint alleges.
Freddie Mac’s conduct was similar, according to the complaint. Freddie claimed its single family exposure to subprime loans was between $2 billion and $6 billion, or between 0.1 percent and 0.2 percent of its single family portfolio in 2007 and 2008. In reality, the complaint states, the exposure as of December 2006 was $141 billion, or 10 percent of the portfolio, and grew to about $244 billion (or 14 percent of the portfolio) by June 30, 2008.
The other Freddie Mac executives being sued are former chief business officer Patricia Cook and former executive vice president for the single family guarantee business Donald Bisenius.
It’s not clear how the SEC case will affect the 18 suits filed against major investment banks in September by the Federal Housing Finance Agency, which took over as conservator of Fannie and Freddie in September 2008.
FHFA alleges that the banks misrepresented the quality of $200 billion worth of mortgage-backed securities they sold to Fannie and Freddie, but one of the defendants, Bank of America Corp., has countered that the entities knew exactly what they were buying. Still, legal onlookers say the cases may ultimately turn on the wording of the prospectus, and whether the documents accurately described the underlying mortgages.