Fannie Suit Vexes Regulator, May Pay Shareholders

Oct 2008 // The Wall Street Journal


NEW YORK — Fannie Mae shareholders, battered by the federal takeover of the mortgage finance giant, may yet have checks coming their way.

A class-action lawsuit alleging securities fraud by the company could yield a hefty payment to shareholders. That suit, now in U.S. District Court in Washington, puts the regulator running the company in an awkward position.

A similar securities-fraud case against Freddie Mac was settled in April 2006 for $410 million. At the time, the settlement was the eighth-largest in a securities-fraud case in U.S. history.

But since the Fannie suit was filed, the government in early September seized control of Fannie and Freddie, citing the risk that growing losses on mortgage defaults would wipe out their capital. The government’s control of Fannie puts taxpayers potentially on the hook for hundreds of millions of dollars in damages stemming from the lawsuit.

Moreover, Exhibit A in the suit is a highly critical report about Fannie, written a few years ago by the regulator that now runs the company. A vigorous defense on Fannie’s part would require rebutting the agency’s own report. An acknowledgment of the report’s veracity could mean admitting wrongdoing and an even bigger payout. “The regulator is between a rock and a hard place,” said Tom Ajamie, a securities lawyer at Ajamie LLP in Houston. Mr. Ajamie isn’t involved with the Fannie case.

The Federal Housing Finance Agency, Fannie and Freddie’s regulator, is the new, more powerful incarnation of the companies’ former overseer, the Office of Federal Housing Enterprise Oversight. James Lockhart, who oversaw Ofheo, is the director of the new agency.

The regulator grabbed control of the two companies — the main providers of funding for U.S. home mortgages — under a legal process known as conservatorship last month. Under the takeover, in which the government can buy nearly 80% of both companies at a nominal price, shareholders have suffered crushing losses. Fannie and Freddie shares have lost more than 95% of their value this year.

Former Ohio Attorney General Jim Petro filed a class-action securities-fraud lawsuit against Fannie and its top executives in November 2004, accusing the company of manipulating its accounting to artificially inflate its stock price. The lawsuit is filed on behalf of the Ohio Public Employees Retirement System, State Teachers Retirement System of Ohio and other investors who bought or sold Fannie shares from April 2001 through December 2004. This period may be extended to investors who bought or sold Fannie shares to September 2005 or even February 2006.

On average, affected Freddie shareholders got back about $1.20 per share minus litigation-related expenses. While any Fannie award is likely to be different in size than the Freddie award, it is noteworthy that the $1.20 award now exceeds the current stock price of Fannie, which early Friday afternoon was trading at $1, up 1%.

A so-called status conference, or a progress report, on the Fannie case is being held Oct. 20.

The regulator’s 340-page report found Fannie’s board and management responsible for a corporate culture that allowed managers to manipulate accounting in order to alter earnings and trigger millions of dollars in bonuses. Former executives have denied that they sought to inflate their bonuses through improper accounting.

“The image of Fannie Mae as one of the lowest-risk and ‘best-in-class’ institutions was a facade,” Mr. Lockhart said in a statement related to the report in May 2006. “Our examination found an environment where the ends justified the means.”

The regulator’s predicament may work to the advantage of shareholders, securities lawyer Mr. Ajamie said. “The report so strongly describes the misbehavior and supports the case. It’s hard to get a better piece of evidence than this,” he said. “A settlement would be the best resolution.”

The original article may be found here.