SEC charges former Fannie Mae, Freddie Mac executives with fraud
The SEC charged six former executives of Fannie Mae and Freddie Mac with securities fraud Friday, saying they misled the public about the companies’ exposure to subprime loans during the mortgage meltdown.
The executives charged in the civil suits include Daniel H. Mudd, former chief executive of Fannie Mae, and Richard F. Syron, who was chairman and chief executive at Freddie Mac.
The executives are among the most prominent individuals the Securities and Exchange Commission has accused of wrongdoing related to the financial crisis, and the legal action comes at a time when the SEC and the Justice Department are facing criticism for not doing more to hold executives accountable.
The SEC accused the companies of understating their vulnerability to the housing downturn by concealing the amount of risky mortgages on their books, robbing investors of the chance to make informed decisions about whether to stake their money on the firms.
In 2007, when Fannie Mae began reporting its exposure to subprime loans, or loans “made to borrowers with weaker credit histories,” it disclosed less than one-tenth of the total volume that met that description, the government said.
Fannie Mae and Freddie Mac, which came to symbolize the housing bubble and its painful aftermath, were taken over by the federal government in September 2008 and have received billions of taxpayer dollars to keep operating.
None of the six defendants agreed to settle with the SEC, and attorneys for some of them issued statements Friday vowing to fight the charges.
The SEC said it was not prosecuting the companies themselves, because they are essentially wards of the government. Both firms entered agreements accepting responsibility for their conduct and promising to help the SEC sue the former executives, the agency said.
The repercussions from the case, which was three years in the making, reach beyond the six former executives. The charges cast a harsh new light on the role of the government-chartered companies — which provide funding for mortgage lenders and play a central role in housing finance — as extensions of federal housing policy. The case also reflects poorly on a federal regulatory agency dedicated to overseeing the companies. Then known as the Office of Federal Housing Enterprise Oversight, it was responsible for reviewing the companies’ financial disclosures.
A spokeswoman for the agency, now called the Federal Housing Finance Agency, declined to comment.
The SEC said it is trying to force the former executives to pay fines and give up “ill-gotten gains,” and to bar them from serving as officers or directors of public companies. The SEC, which polices Wall Street and corporate financial disclosures, does not have the authority to pursue criminal charges or prison sentences.
At a time when anxious investors were focusing on the hazards of subprime loans, Fannie and Freddie made public statements and filed regulatory disclosures sharply understating the extent to which they owned or guaranteed those mortgages, the SEC said.
Fannie and Freddie plunged into the market for what turned out to be toxic loans to avoid being left behind by an increasingly reckless lending industry and in response to government mandates that they assist low-income borrowers.
Even as they were taking on risky loans to increase their market share, the companies and their executives “sought to maintain the illusion that the business involved minimal and manageable credit risk,” SEC enforcement director Robert Khuzami said at a news briefing.
The pursuit of high-risk loans contributed to the companies’ implosion and to the broader housing debacle.
The misleading statements allegedly began in December 2006 at Fannie Mae and in March 2007 at Freddie Mac and continued until August 2008, the SEC said.
Also charged with various violations were Enrico Dallavecchia, Fannie’s former chief risk officer; Thomas A. Lund, former executive vice president of Fannie’s single-family mortgage business; Patricia L. Cook, former chief business officer of Freddie Mac; and Donald J. Bisenius, former executive vice president for Freddie’s single-family guarantee business.
Fannie allegedly omitted from its subprime disclosures entire categories of risky loans, including one group that had a higher rate of serious delinquency than the loans the company publicly counted as subprime.
At the time, Fannie’s executives were trying to expand the company’s market share by buying more subprime and Alt-A loans, the SEC said. Alt-A loans allowed borrowers to avoid fully documenting their income, assets or employment.
Mudd testified falsely at a congressional hearing on the subprime turmoil in early 2007 when he said the firm’s exposure to subprime loans “remains relatively minimal — less than 2.5 percent of our book of business,” the SEC lawsuit said. The agency alleged that his statement “was knowingly false and misleading.”
Mudd made a similarly misleading statement at another 2007 hearing when Congress was considering tightening regulation of Fannie and Freddie, the SEC said. In August 2008, Mudd falsely told a radio interviewer that Fannie had “about zero percent” exposure to subprime loans, the SEC said.
At Freddie Mac, Syron and Cook each publicly proclaimed that Freddie’s single-family business had “basically no subprime exposure,” the SEC said. Unbeknownst to investors, the SEC said, Freddie was at risk for about $141 billion in loans that were described internally as “subprime” or “subprime like,” accounting for 10 percent of the portfolio. That figure grew to about $244 billion, which was 14 percent of the portfolio, by mid-2008, the SEC said.
When the government seized the companies in September 2008, it wiped out all shareholders who owned stock in the companies. The Treasury Department received a 79.9 percent ownership stake in the firms.
Since then, taxpayers have pumped more than $130 billion into the firms to keep them solvent. Some of the companies’ costs have included the legal expenses of former executives. Earlier this year, the Federal Housing Finance Agency told Congress that Fannie and Freddie had paid $50.1 million in taxpayer money for document production related to securities lawsuits and government investigations and had advanced $57.5 million in legal fees to executives and board members for securities lawsuits and investigations.
An FHFA spokeswoman confirmed Friday that Fannie and Freddie were continuing to pay the legal fees associated with the SEC case.
Rep. Scott Garrett (R-N.J.), chairman of a House subcommittee that oversees the companies, said Friday, “Today’s news underscores how important it is that Congress work to end the ongoing taxpayer bailout of Fannie and Freddie and replace the government-backed mortgage twins with a private market solution to housing finance.”
Mudd, 53, is now chief executive of Fortress Investment Group, a major hedge fund manager. Mudd said in a statement Friday that he took the advice of independent audit firms and law firms staffed by former SEC lawyers, as well as an independent disclosure committee.
“The government reviewed and approved the company’s disclosures during my tenure, and through the present,” Mudd said. “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.”
Attorneys for Syron, 68, said the SEC’s case was “fatally flawed,” in part because there was no uniform definition of subprime. “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 Green and Mark D. Hopson said in a statement.
Dallavecchia’s attorneys also responded to the charges with a statement Friday. “Fannie Mae’s disclosures were vetted by its lawyers and approved by its regulators. They were truthful, accurate, and far more detailed than those issued by other financial institutions,” Kelly Kramer and Laura Miller said. “While most in the market — including senior government officials — claimed that problems with subprime loans would be ‘contained,’ Mr. Dallavecchia warned that they could infect the entire housing market.”
Lund’s attorney Michael N. Levy said in a statement Friday: “During a period of unprecedented disruption in the housing market, nobody worked more diligently or honestly to serve the best interests of both investors and homeowners. When the truth comes out at trial, it will be abundantly clear that Mr. Lund — who did not sell a single share of Fannie Mae stock during this entire period — acted appropriately at all times.”
Attorneys for the other defendants did not respond to requests for comment.
A spokesman for Freddie Mac declined to comment. A spokesman for Fannie Mae said Friday that the company would not comment on the charges against the former executives. A company statement said: “We are pleased to bring the SEC inquiry to a close. We continue to focus on our priorities of providing critical funding to a fragile housing market, helping distressed homeowners, and helping build a sustainable housing finance system for the future.”
The lawsuits were filed in federal court in Manhattan, where a judge recently refused to accept a settlement between the SEC and Citigroup and challenged the SEC’s standard practice of settling cases without admissions or denials of wrongdoing.
Friday was not the first time the SEC found that violations had occurred at Fannie Mae and Freddie Mac. In 2006 and 2007, respectively, each company settled SEC fraud charges stemming from alleged accounting manipulations.
Amid those scandals, Mudd and Syron were brought in to clean up the companies.