former top executives of Fannie Mae and Freddie Mac were charged with securities
fraud Friday morning in connection with mortgage backed securities issued by
the firms. The Securities and Exchange
Commission filed separate suits against each of the government sponsored
enterprises (GSEs) in the U.S.
District Court for the Southern District of New York while at the same time
revealing non-prosecution agreements with Fannie Mae and Freddie Mac in return
for the cooperation of the GSEs in the upcoming litigation.
Named in the Fannie Mae suit were former
Fannie Mae Chief Executive Officer Daniel H.
Mudd, its former Chief Risk Officer Enrico Dallavecchia, and the former
Executive Vice President of Fannie Mae’s Single Family Mortgage business, Thomas
A. Lund. The three former Freddie Mac executives are Chairman of the Board and CEO Richard F. Syron, Executive Vice
President and Chief Business Officer Patricia L. Cook, and former Executive
Vice President for the Single Family Guarantee business Donald J. Bisenius. The
irony of the suits is that most if not all of the executives were hired by the
companies to clean house following accounting scandals that cost their
predecessors their jobs.
The lawsuits allege that the former
executives caused their respective companies to materially misstate their
holdings of risky loans, including subprime loans, in periodic and other
filings with the SEC and in public statements, investor calls, and media
interviews. The Fannie Mae suit contains
similar allegations about Alt-A mortgage loans.
The time period covered by the Fannie Mae suit is December 2006 to
August 2008 and the Freddie Mac suit covers the period between March 2007 and
According to the complaint against
Fannie Mae’s executives, Fannie Mae reported its exposure to subprime loans in
2007 but described the loans as those “made to borrowers with weaker credit
histories” and claimed that less than one-tenth of its loans met that
description. This, the suit alleges, was
done with the “knowledge, support, and approval” of the three executives. At the end of 2006 the company reported its
exposure to subprime loans was 0.2 percent of its single family portfolio or
approximately a $4.8 billion share.
Investors were not told, according to the SEC, that Fannie Mae did not
include in this calculation loan products specifically targeted toward
borrowers with weaker credit histories including more than $43 billion of
Expanded Approval loans.
Similar claims were allegedly made
by Fannie Mae officers about the company’s exposure to Alt-A loans which was
disclosed on March 31, 2007 as 11 percent of its portfolio. In reality at that juncture the exposure was
approximately 18 percent of all single family loan holdings.
The suit against the former Freddie
Mac executive alleges that they and the company used a narrow definition of
subprime loans when they publicly proclaimed that the company had basically no
subprime exposure when the single family part of the business was, at the end
of 2006, actually exposed to $141 billion of loans which the company referred
to internally as subprime or subprime-like which was 10 percent of the
portfolio at that time. This eventually
grew to $244 billion or 14 percent of the portfolio.
“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.
All individuals, regardless of their rank or position, will be held accountable
for perpetuating half-truths or misrepresentations about matters materially
important to the interest of our country’s investors.”
Under the Non-Prosecution Agreements
entered into by Fannie Mae and Freddie Mac each company agreed to accept
responsibility for its conduct and not dispute a Statement of Facts but did not
have to admit or deny liability. Each
GSE also agreed to cooperate with SEC’s investigation against the company’s
former executives. SEC said it entered into the Agreements in light of the
companies’ current status and considering that any damages the court levied
against the companies would be paid by taxpayer funds.
The SEC is seeking financial
penalties, disgorgement of ill-gotten gains with interest, permanent injunctive
relief and officer and director bars against Mudd, Dallavecchia, Lund, Syron,
Cook, and Bisenius.