Regulators
have accused the former chief executives of the mortgage giants Fannie Mae and Freddie
Mac of misleading investors about
their firms’ exposure to risky mortgages, one of the most significant federal
actions taken against those at the center of the housing bust.
The
lawsuits filed Friday against the two chief executives and four other top
executives are an aggressive move by the Securities
and Exchange Commission, and come after a three-year investigation.
The
agency has come under fire for not pursuing top Wall Street and mortgage
industry executives who contributed to the financial crisis. In cases
contending the deceptive marketing of securities tied to mortgages, the S.E.C.
has been criticized for citing only midlevel bankers while settling with the
Wall Street firms themselves. Recently, the agency drew criticism from a
federal judge after allowing Citigroup to settle a fraud case without
conceding wrongdoing.
On
Friday, S.E.C. officials trumpeted their actions in the Fannie and Freddie case
as part of a renewed effort to crack down on wrongdoing at the highest levels
of Wall Street and corporate America
“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,” said Robert S. Khuzami,
the agency’s enforcement chief. “Investors were robbed of the opportunity to make
informed investment decisions.”
He
noted that the agency had now filed 38 separate actions stemming from the 2008
financial crisis.
The
former Fannie Mae and Freddie Mac executives have vowed to challenge the
government, saying that the companies repeatedly disclosed the breakdowns of
their loan portfolios.
As
companies that fed both the housing bubble and Wall Street’s appetite for risk,
Fannie Mae and Freddie Mac came under investigation quickly by federal agencies
amid the financial crisis in 2008. But Freddie Mac disclosed this summer that
the Justice Department’s inquiry into the company had ended without any
charges. And the S.E.C stopped short of bringing actions against the two
companies.
Instead,
agreements with Fannie and Freddie will allow the now government-controlled
companies to evade prosecution and fines so long as they cooperate with
authorities. The deal does not require approval from a federal court, unlike
the proposed settlement with Citigroup.
The
case against the former executives, including Daniel H. Mudd, the former chief
executive of Fannie Mae, and Richard F. Syron, the former chief of Freddie Mac,
centers on a series of disclosures the firms made to investors at the height of
the mortgage boom. The government contends that the firms played down the
extent of their exposure to subprime mortgages, loans doled out to the riskiest
of borrowers.
One
S.E.C. complaint contends that Freddie Mac executives falsely proclaimed that
the company had virtually no exposure to ultra-risky loans, despite internal
warnings admonishing against such claims.
A
separate complaint contends that Fannie Mae executives described subprime loans
as those made to individuals “with weaker credit histories” while only
reporting one-tenth of the loans that met that criteria in 2007. Both
complaints were filed in the United States District Court in Manhattan
Mr.
Mudd, who was chief executive of Fannie Mae from 2005 until the government took
control of the company in 2008, said that there had been no deception.
“The
government reviewed and approved the company’s disclosures during my tenure,
and through the present,” he said in a statement. “Now it appears that the
government has negotiated a deal to hold the government, and
government-appointed executives who have signed the same disclosures since my
departure, blameless — so that it can sue individuals it fired years ago.”
The
S.E.C.’s commitment to the long-running investigation — more than 100
depositions were produced over its course — highlights the major roles that
Fannie Mae and Freddie Mac played in the financial crisis and subsequent
government bailout. The Bush administration took over the teetering mortgage
giants in September 2008, and taxpayers have since pumped more than $150
billion into the two companies. The Obama administration has vowed to wind them
down, although the timeline remains unclear.
The
case against the former mortgage executives resembles an earlier action against
one of the nation’s biggest lenders to risky, or subprime, borrowers. Angelo Mozilo, the former chief
executive and founder of Countrywide
Financial, agreed to pay $22.5 million to settle federal charges along the same
lines. The settlement was the largest ever levied against a senior executive of
a public company, though Mr. Mozilo, who also agreed to forfeit $45 million in
gains, neither admitted to nor denied wrongdoing.
Success
for the S.E.C. in the Fannie and Freddie case will largely hinge on the meaning
of the word subprime, which the government itself has never fully defined.
While the term often refers to borrowers with low credit scores, Fannie and Freddie
decided to classify loans as prime or subprime based on the lender type, not
the borrower’s credit score. A Wall Street
But
the government’s complaint contends that this kind of disclosure masked risk.
Loans not considered subprime often defaulted at higher rates than those
classified as subprime.
The
government contends that the executives were less than forthcoming about that
extra layer of risk. Mr. Syron told an investor conference in May 2007 that the
company had “basically no subprime business.”
But
a lower-level executive at the firm, who reviewed Mr. Syron’s speech in
advance, warned that such a statement could be misleading.
“We
need to be careful how we word this. Certainly our portfolio includes loans
that under some definitions would be considered subprime,” the employee said,
according to the complaint. “We should reconsider making as sweeping a
statement.”
Mr.
Mudd, meanwhile, testifying before Congress in April 2007, broadly defined
subprime as “the description of a borrower who doesn’t have perfect credit.”
But at the same hearing, he told lawmakers that “less than 2.5 percent of our
book of business can be defined as subprime,” which the complaint says greatly
understated the firm’s exposure based on his definition that day. Mr. Mudd’s
estimate omitted some $50 billion in subprimelike loans, according to the
complaint.
Lawyers
for the executives, however, plan to argue that the firms did in fact disclose
minute details of their loan portfolios, suggesting a potential weakness in the
case. During the period under scrutiny, the companies produced “monster charts”
breaking down their loan portfolios by borrowers’ credit scores and how much
equity they had in their homes, among other information.
Lawyers
for Mr. Syron called the S.E.C.’s case “fatally flawed” and “without merit.”
“Simply
stated, there was no shortage of meaningful disclosures, all of which permitted
the reader to assess the degree of risk in Freddie Mac’s guaranteed portfolio,”
Thomas C. Green and Mark D. Hopson, partners at Sidley Austin, said in the statement.
The
lawyers note that even the federal government never settled on a definitive
meaning for subprime. Indeed, in a 2007 document, multiple federal agencies
declined to define it.
Lawyers
for two of the other executives named in the suit have also promised to fight
the allegations.
The
complaints also name Fannie’s former risk officer, Enrico Dallavecchia; an
executive vice president for Fannie, Thomas A. Lund
Still,
Mr. Mudd and Mr. Syron are the two most prominent subjects of the complaint.
Since
August 2009, Mr. Mudd has been chief executive of the Fortress Investment Group, the large
publicly traded private equity and hedge fund company.
Mr.
Syron is a former president of the American
Stock Exchange and currently an
adjunct professor and trustee at Boston College
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