Fannie Mae, Freddie Mac: Ted Olson’s Appeal Filed by Todd Sullivan, ValuePlays
Ted Olson filed his appeal in the Perry v FHFA/Treasury yesterday. It is 104 pages and goes into stunning detail but below is the cliff note argument for those who do not wish to read the whole thing (Perry Appeal). District Court Judge Lamberth’s decision was slovenly. He simply punted on the decision knowing full well discovery was happening before DC Court of Claims Judge Sweeney and that the Appeals Court, should it disagree with him, would send the case back to him at which time discovery would be done before Sweeney and that could be incorporated into his court. If the appeals court agrees with him, then the case is off his plate. Either way it is off his desk while the other courts do the heavy lifting in these cases…..slovenly
Olson requests: “This Court should reverse the judgment below and remand with instructions to vacate the Net Worth Sweep.”
I’m skeptical the appeals Court orders Lamberth to vacate the NWS. My guess would be they remand it back to him with instructions to “do your goddamn job” and actually hear the case. You know, like, be a Judge.
1. HERA requires FHFA as conservator to “preserve and conserve the assets and property of the regulated entity,” to “put the regulated entity in a sound and solvent condition,” and to “rehabilitat[e]” it. 12 U.S.C. § 4617(a)(2), (b)(2)(D). These statutory requirements are consistent with the well-established understanding that a conservator is a fiduciary to the entity in conservatorship. The Net Worth Sweep flouts FHFA’s obligations as conservator.
The Net Worth Sweep does not put the Companies in a “sound and solvent condition.” Soundness and solvency requires financial institutions—subject to both interest rate and underwriting risk—to build capital sufficient to operate independently and withstand financial downturns. The Net Worth Sweep makes that impossible. Nor does the Net Worth Sweep “preserve and conserve” the Companies’ “assets and property,” as the Net Worth Sweep has transferred to Treasury over $128 billion more than the Companies’ pre-Net Worth Sweep obligations with no corresponding benefit to the Companies. And instead of “rehabilitating” the Companies, the stated purpose of the Net Worth Sweep is to wind them down—and until they are wound down, to operate them for the exclusive benefit of Treasury. That FHFA’s purpose was to wind down the Companies, rather than to rehabilitate them, requires the conclusion that FHFA acted far outside of its statutorily authorized role of conservator.
Rather than address these arguments, the district court began its analysis by declaring FHFA’s purposes or rationale to be irrelevant to the question whether FHFA exceeded its statutory authority. That analysis was erroneous because FHFA’s rationales inform whether a challenged action can be characterized as rehabilitating a conservatee to a sound and solvent condition. And rather than analyze whether the Net Worth Sweep had preserved and conserved the Companies assets, or placed them in a sound and solvent condition, the district court instead concluded that a conservator fulfills its statutory mission so long as its ward is not in “de facto” liquidation. This construction is flatly contrary to the governing statute and would vest conservators with literally boundless authority— authority even to transfer wards’ assets as gifts. No authority supports this conception and, indeed, not even the government has advocated a position so extreme. That the Companies currently are producing profits—for Treasury and Treasury only—does not mean FHFA, in acquiescing to the Net Worth Sweep, has acted within its statutory authority to operate as a conservator, an independent fiduciary for the Companies.
2. Treasury similarly exceeded its statutory authority under HERA and violated the APA. After December 31, 2009, HERA limited Treasury’s authority to holding Treasury’s Stock, exercising rights received in connection with its purchases of Treasury’s Stock, and selling Treasury’s Stock. See 12 U.S.C. § 1719(g)(2)(D), (g)(4). That limited grant of authority does not include authority to engage in “other non-security-purchasing activities.” Op. 17. Treasury therefore lacked authority to amend the compensation structure of its investment to the detriment of every other shareholder. Indeed, that amendment was so transformative—and the exchange for value so plain—that it can only be regarded as the purchase of a brand-new security expressly prohibited by HERA.
HERA’s limitation on judicial review does not bar Appellants’ arbitrary- and-capricious APA claim against Treasury. Both the presumption in favor of judicial review and case law interpreting the FDIC’s analogous jurisdictional provision confirm that such limitation does not block claims against third parties, like Treasury, that contract with FHFA. Moreover, the agency action plainly fails the APA’s standards. Treasury’s action was predicated on a false notion of a “downward spiral” that was based on outdated and selective data. And Treasury’s deficient administrative record shows no consideration of obvious alternatives— such as paying dividends in kind rather than in cash—or explanations for their rejection.
3. Finally, the district court erred by resolving factual disputes at the motion to dismiss phase, even though the administrative records were patently incomplete. And contrary to the district court’s conclusion, FHFA’s administrative record is not “irrelevant.” At the very least, this case must be remanded to require the agencies to supplement the administrative records.
Yet in the proceedings below, the district court, FHFA, and Treasury asserted several reasons why the Net Worth Sweep makes the Companies “sound and solvent.” Op. 24-25; Dkt. 32 at 21-26; Dkt. 31-1 at 27-28.
a. The district court incorrectly concluded that FHFA acted as a conservator simply because the Companies are operating and currently profitable. Op. 24-25. The statute does not require conservators to establish “profitability,” but to take necessary action to “put the [Companies] in a sound and solvent condition.” 12 U.S.C. § 4617(b)(2)(D)(i). Even if the Companies remain profitable, FHFA’s decision to sweep those profits—and any additional net worth—to Treasury nullifies any benefit to the Companies of their renewed profitability, contrary to the goals of soundness and solvency.
b. The district court suggested that the Net Worth Sweep could be part of “a fluid progression from conservatorship to receivership” permissible under HERA. Op. 25 n.20. But in HERA Congress authorized FHFA to act “as conservator or receiver,” 12 U.S.C. § 4617(a); whichever choice FHFA made had corresponding limits and obligations imposed by Congress. If FHFA distributed the Companies’ assets to Treasury as part of a “progression” towards liquidation, FHFA was statutorily required to formally become a receiver and comply with the statutory notice and priority requirements, neither of which FHFA has done. See 12 U.S.C. § 4617(a)(4)(D), (b)(2)(E), (b)(3), (c).
That FHFA can “be appointed conservator or receiver for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated entity,” 12 U.S.C. § 4617(a)(2), does not imbue FHFA with power as conservator to wind up the Companies’ affairs. HERA assigns that function only to a properly designated receiver. Id. § 4617(b)(3)(B) (“The receiver, in any case involving the liquidation or winding up of the affairs of a closed regulated entity . . . .” (emphasis added)).
Indeed, FHFA has acknowledged that “a conservator’s goal” is not to liquidate, but rather “to continue the operations of a regulated entity, rehabilitate it and return it to a safe, sound and solvent condition.” 76 Fed. Reg. at 35,730-31. Allowing a conservator to wind up the affairs of its charge is at war with its obligation to “rehabilitate” and would chart a path for a faithless conservator to avoid the procedural protections for claimants set forth in HERA’s receivership provisions.
And this reading conversely would allow FHFA as receiver to take up a mission of “rehabilitation,” notwithstanding the receiver’s obligation to liquidate the entity. Receivership is distinct from conservatorship, but the district court’s truncated analysis improperly conflates the two roles. FHFA is indisputably a conservator here and cannot override Congress’s mandate by assuming a receiver’s different
c. FHFA and Treasury argued below—and the district court accepted— that by giving away the Companies’ net worth in perpetuity, the Net Worth Sweep supported the Companies’ soundness and solvency because it prevented a “downward spiral.” Dkt. 32 at 3-4, 21-25; Dkt. 31-1 at 5, 27-28. According to the agencies, the Companies could not afford to pay Treasury’s 10% cash dividend in the future and therefore would need to draw on Treasury’s limited Commitment to pay the dividend. Because those draws would increase Treasury’s liquidation preference, they would in turn increase the purportedly unaffordable cash dividend and hasten the exhaustion of Treasury’s Commitment. This argument fails.
First, the Companies had no obligation to pay the cash dividends. At the outset, Treasury’s Stock entitled Treasury to a cash dividend only “if declared by the [Companies’] Board of Directors.” T0032 (§ 2(a)). And, even if declared, Treasury’s Stock allowed the Companies to choose indefinitely whether to pay a 10% cash dividend or a 12% “in-kind” dividend by increasing Treasury’s liquidation preference. See T0033 (§ 2(b)-(c)). Exercising this in-kind option would have resolved any purported “downward spiral”—in-kind dividends would not have required the Companies to draw from Treasury, and Treasury would have been compensated by an increased liquidation preference.
The district court erroneously concluded that the Companies were not free to pay Treasury’s dividend in kind. See Op. 6 n.7. Noting that the in-kind dividend arises if the Companies “shall have for any reason failed to pay dividends in cash in a timely manner as required by this Certificate,” Op. 7 n.7 (quoting T0033) (emphasis added by district court), the district court stated that the 12% in-kind payment was a “penalty” rather than a “right,” and thus not “merely a matter of
Whether the in-kind payment is a “penalty” or a “right” is irrelevant. The stock agreements granted the Companies exceptionally broad license to pay dividends in kind without limiting how many times, or for how long. That is why, a week before Treasury and FHFA agreed to the Net Worth Sweep, the Congressional Research Service explicitly noted that a “Fannie Mae and Freddie Mac lacking the funds to pay the [10%] cash dividend could pay the 12% dividend in additional senior preferred stock.” N. Eric Weiss, Cong. Research Serv., RL34661, Fannie Mae’s and Freddie Mac’s Financial Problems 5-6 (2012), available at http://www.fas.org/sgp/crs/misc/RL34661.pdf. Indeed, Treasury’s presentations explaining the Net Worth Sweep characterize the pre-Net-Worth-Sweep dividend rate as “Cash 10%; if elected to be paid in kind (‘PIK’) 12%.” T3780, T3841.
FHFA thus could have solved the purported “downward spiral” without changing Treasury’s Stock at all. Payments in kind would not have harmed the Companies: they would conserve cash and the remainder of Treasury’s Commitment.
Second, extending the lifespan of Treasury’s Commitment cannot contribute to soundness and solvency because the Commitment is a mere commitment to inject preferred equity, it is not an asset nor does it qualify as capital. The Purchase Agreements themselves make clear that the remaining amount of Treasury’s Commitment cannot be counted among the Companies’ assets. See F0129 (“total assets” defined to “exclud[e] the Commitment and any unfunded amounts thereof”). Neither federal capital requirements nor the Companies’ “core capital” levels required by HERA qualify Treasury’s Commitment as capital. See supra 34-35; see also 12 C.F.R. § 217.20(b) (defining “common equity tier 1 capital” without reference to capital commitments); 12 U.S.C. § 4502(7) (HERA). This treatment is consistent with the Congressional Budget Office’s view that capital allows companies “to absorb losses and pay off creditors without external assistance,” 2008 CBO Estimate at 3, which Treasury’s Commitment.
Third, the “downward spiral” narrative also is wrong because Treasury’s Commitment was not in danger of exhaustion when FHFA adopted the Net Worth Sweep. By 2012, the Companies had stanched their losses and posted profits well in excess of Treasury’s 10% cash dividend. Indeed, the agencies’ internal presentations demonstrated that Freddie Mac was never expected to come close to depleting Treasury’s Commitment—even under the government’s most pessimistic projections. See T3850 ($102.6 billion in Treasury Commitment remaining in 2023 under “Downside Case”). And Fannie Mae would never exhaust funding under Treasury’s base case, and even under the pessimistic scenario it would exhaust funding only in 2021 (and even then only assuming neither company ever elected to pay dividends in kind). See T3847-T3848. The agencies’ own data thus demonstrated that there was no real chance of a “downward spiral” even if the Companies opted to pay cash dividends, which they had no obligation to do.