The government's takeover of the mortgage giants Fannie Mae and Freddie Mac in 2008 may turn out to be a very expensive proposition.
The bailouts of the two have already cost taxpayers about $185 billion. And it appears that the legal fees from lawsuits involving former executives from the two companies continue to pile up.
A decision last week by Richard J. Leon of the United States District Court for the District of Columbia to dismiss a shareholder lawsuit against the former Fannie Mae chief executive Franklin D. Raines may provide a little bit of relief from the legal bills.
But more recent cases will require the government to pay to defend executives accused of misleading investors about subprime mortgages on the companies' books that in all likelihood will take years to resolve.
Lawsuits and government investigations involving Mr. Raines and two other former Fannie Mae executives were the result of accounting irregularities at the company. Th is problem surfaced while the company was still profitable â€" that is, before it was crippled by the collapse in the housing market. Mr. Raines and the other executives resigned in 2004 and settled with the government in 2008, but the private litigation has dragged on for another four years.
Like most public companies, Fannie Mae had a broad indemnification policy requiring it to advance the legal fees for executives accused of misconduct based on their work for it. When the government took over the company in September 2008, it affirmed that position and has continued to pay for the lawyers.
A report issued in February by the inspector general of the Federal Housing Finance Administration, which oversees Fannie Mae and Freddie Mac, estimated that the legal fees paid on behalf of Mr. Raines and the other executives totaled $97 million to that point, of which the government had paid approximately $37 million.
In his opinion dismissing the securities fraud claims, Judge Leon concluded that the evidence showed “at best, that Raines acted negligently in his role as the company's chief executive and negligently in his representations about the company's accounting and earnings management practices.†Securities fraud requires proof of intentional conduct or at least recklessness, so Mr. Raines was released from the case.
That does not necessarily spell the end to the government's obligation to pay legal fees.
Judge Leon has not yet decided whether to dismiss the case against the two other Fannie Mae executives. In addition, plaintiffs can appeal his decision on Mr. Raines, so the legal bills can certainly continue to add up.
Legal claims against former executives arising from financial crisis that led to the government's takeover of Fannie Mae and Freddie Mac are just getting started. There is the distinct possibility that costs from those cases will far exceed what was spent defending Mr. Raines and others .
The Securities and Exchange Commission filed civil securities fraud charges in December 2011 against six executives from the two companies, including the former chief executives Daniel H. Mudd of Fannie Mae and Richard F. Syron of Freddie Mac. The S.E.C. has accused the executives of misleading investors about the companies' exposure to subprime mortgages that caused severe financial losses triggering the government's takeover. Private lawsuits have also been filed against the companies and corporate officers making claims that are similar to the S.E.C. charges.
The case against Mr. Mudd and the other Fannie Mae executives cleared its first hurdle in August when Paul A. Crotty, a federal district judge in Manhattan, rejected a motion to dismiss the complaint. The defendants had argued that the company came under an exemption from the federal securities laws because it was a governmental entity, and that their disclosures about subprime loans were not misleadi ng.
The standard for deciding a motion to dismiss at this stage is quite low: all that the S.E.C. has to show is it could prove the charges if the case goes to trial. Judge Crotty found that Fannie Mae was a private company and not an “independent establishment†of the government that would exempt it from the securities laws.
In his assessment, Judge Crotty found that there was a basis for concluding the company's statements were misleading based on how it classified mortgages made to borrowers who were less creditworthy. That is enough to let the case proceed.
The defendants in the Freddie Mac case also filed a motion to dismiss their case with Richard J. Sullivan, a federal district judge in Manhattan, raising similar issues regarding the S.E.C.'s charges. He has not yet ruled, but winning a motion to dismiss at this stage is difficult, so there is a good chance the case will also move forward.
After a judge rejects a defense motion to dismis s, the discovery process commences in earnest, with each side conducting depositions and exchanging documents. In the private litigation involving Mr. Raines, Judge Leon noted that discovery generated 67 million pages of documents and 123 depositions.
The cases against the Fannie Mae and Freddie Mac executives could easily reach those proportions. This is when the meter on the legal bills looks like it is spring loaded because of the legion of lawyers required to gather and analyze the evidence.
Generating that volume of information also takes an enormous amount of time, so discovery is likely to drag on for at least another year or two. On the bright side, once the parties dig into the evidence, the likelihood of a settlement grows because of the toll the process takes on each side.
But even if the S.E.C. settles its case against the Fannie Mae and Freddie Mac executives, the private litigation will march on. The private case against Mr. Raines lasted n ine years, barring a successful appeal that would stretch it out even further. So the government will be paying for lawyers for quite a while yet.
In Re Fannie Mae Securities Litigation Opinion Sept 20 2012
SEC v Mudd District Court Opinion Aug 10 2012
