Ex-Fannie Mae Executives Have to Defend Against SEC Lawsuit Over Their Alleged Involvement in Understating Mortgage Company’s Exposure Risk

The U.S. District Court for the Southern District of New York has decided that ex-Federal National Mortgage Association executives do have to contend with a Securities Exchange Commission enforcement lawsuit over their alleged role in underplaying just how exposed the company was to high risk loans. Ex-Fannie Mae (FNM) CEO Daniel Mudd, former single family mortgage business EVP Thomas Lund, and ex-chief risk officer Enrico Dallavecchia had sought to have the lawsuit dismissed because they said that the Commission failed to make its case against them. Judge Paul Crotty has denied their motion.

The SEC claims that former Fannie Mae executives misled investors about the actual degree to which the company was exposed to “Alt-A” loans and subprime loans when they failed to reveal this information in the mortgage firm’s public disclosures. As a result, Fannie Mae understated its mortgage exposure risk by hundreds of billions of dollars.

The defendants had countered that because Fannie Mae is an independent establishment of this country, per the 1934 Securities Exchange Act’s Section 3(c), government agencies are protected from liability. Crotty, however, did not agree Fannie Mae did not fall under the “independent establishment” category seeing that it is a private corporation, run by a board, did not get federal funding, and traded stock in public.

The court also disagreed with the defendants’ contention that the SEC did not succeed in alleging that an “actionable” omission or representation occurred, instead finding that the Commission did an adequate job of pleading that Fannie Mae’s “quantitative subprime and Alt-A disclosures” failed to include all the loans that fell under these two loan categories. The court also found that the Commission did a sufficient job of alleging that Fannie Mae did not make sure the subprime loans it obtained via certain loans it acquired from Countrywide Home Loans were factored into its calculations. As for the Alt-A loans, the court said that the SEC also did an adequate job of pleading that Fannie Mae did not disclose that it had “instructed certain lenders” to not label some specific low-documentation loans as Alt-A loans, while leaving these loans out when figuring out its exposure calculations.

The judge dismissed the defendants’ contention that the alleged omissions the SEC accuses them of making/helping to make were immaterial. Crotty said that not factoring in certain loans when making its calculations caused its exposure to subprime loans to be understated by over $100 billion and its exposure to Alt-A loans to be understated by $341 billion. Considering that the secured-transaction and housing market were so volatile, Crotty said that it had been important for investors to know the true exposure risk involved.

“The public should note that the SEC and prosecutors will not pursue case against MF Global CEO John Corzine after over a billion dollars of his clients’ money disappeared, and financial firm heavyweights such as Goldman Sachs (GS), Deutsch Bank (DB), and Merrill Lynch (MER) are getting off unscathed,” said securities lawyer William Shepherd. “Meanwhile, salaried employees at Fannie Mae and Freddy Mac (FMCC) will apparently be sued for doing what their boss, Congress, told them to do.”

Read the Complaint (PDF)

Ex-Fannie Mae CEO Mudd Must Defend SEC Suit, Judge Rules, Bloomberg, August 10, 2012

More Blog Posts:
Freddie Mac and Fannie May Drop After They Delist Their Shares from New York Stock Exchange, Stockbroker Fraud Blog, June 25, 2010

Goldman Sachs Settles SEC Subprime Mortgage-CDO Related Charges for $550 Million, Stockbroker Fraud Blog, July 30, 2010

Ex-Bank of America Employee Pleads Guilty to Mortgage Fraud Scam Using Stolen Identities to Buy Homes Not For Sale, Institutional Investor Securities Blog, August 30, 2011