Bill Ackman made big headlines today by speaking at the Ira Sohn Conference about his investment in Fannie Mae and Freddie Mac shares. Ackman being the largest shareholder of the common shares and speaking at the one of the most famous investment conference got the lion’s share of the Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) coverage. However, there was another big story on this front. The Government issued a new response to Perry Capital and Fairholme Capital. Todd Sullivan has the details and a nice summary. Both documents can be found below, following a short excerpt.
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Providing further proof that no good deed goes unpunished, the plaintiffs in these actions seek judicial relief as a result of the Department of Treasury’s and the Federal Housing Finance Agency’s (“FHFA”) unparalleled actions to rescue and stabilize the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (collectively, “the GSEs”). In September 2008, Treasury committed massive taxpayer funds to the GSEs, ultimately providing over $187 billion in taxpayer funds (and committing over $258 billion more) to cure their insolvency. Without this capital infusion, both enterprises would have been placed in mandatory receivership. Their failure and subsequent liquidation in receivership would have had dire consequences for mortgage markets and the larger economy.
In return for its investment, Treasury received valuable rights, including senior preferred stock, the right to collect dividends equal to ten percent annually of the funds that it had provided, and a periodic commitment fee “determined with reference to the market value of the Commitment as then in effect.” Fannie Mae Senior Preferred Stock Purchase Agreement (“PSPA”) § 3.2 (AR 22); Freddie Mac PSPA § 3.2 (AR 56).1 Six years later, the GSEs have returned to a stable footing, thanks exclusively to the infusion of government capital since 2008. The plaintiffs, shareholders in the GSEs, appear to have forgotten the unprecedented extent and nature of the record amount of government funds the GSEs received. They now bring these lawsuits to demand an even better deal for themselves, a windfall at the expense of the taxpayers.
In entering into the Third Amendment, Treasury acted to address a new threat to the GSEs’ viability. Treasury’s unprecedented commitment of funds to the GSEs had succeeded in
addressing the immediate threat to the GSEs’ solvency. By 2012, however, the dividend structure under the PSPAs posed a new problem; it had become apparent that the GSEs were at great risk of being unable to pay their future dividend obligations to Treasury under the PSPAs, which by that point had grown to $19 billion per year, without taking further draws from the funds that Treasury had committed under the PSPAs. The potential that the GSEs would exhaust that finite funding capacity posed a serious threat to those entities’ viability. Accordingly, in August 2012, Treasury and FHFA, the conservator of the GSEs, agreed to a “Third Amendment” to the PSPAs, which resolved this threat to the GSE’s viability by eliminating the circular arrangement whereby the GSEs drew on Treasury’s capital commitment under the PSPAs in order to pay a dividend to Treasury.
The plaintiffs challenge the validity of the Third Amendment, asserting a variety of theories under the APA, state common-law principles, or the Takings Clause. All four suits should be dismissed on jurisdictional grounds. The three individual suits (the Perry, Fairholme, and Arrowood actions) run afoul of the anti-injunction provision of the Housing and Economic Recovery Act of 2008 (“HERA”), 12 U.S.C. § 4617(f), which precludes courts from ordering equitable relief that would interfere with FHFA’s exercise of its powers as conservator of the GSEs. The plaintiffs attempt in their opposition briefs to evade this jurisdictional bar by disputing whether FHFA properly exercised its conservatorship powers to reduce the size of the GSEs’ operations, but this attempt fails. Under law that is well-established under HERA and a materially identical provision in the Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”), the anti-injunction bar does not depend on whether the plaintiffs agree with the manner in which FHFA has exercised its conservatorship powers. Nor may the plaintiffs evade the anti-injunction bar by suing FHFA’s counter-party, Treasury.
In addition, all four suits are derivative suits that are precluded under HERA’s prohibition against shareholder suits, 12 U.S.C. § 4617(b)(2)(B)(i). That prohibition has been authoritatively construed by the D.C. Circuit to bar claims like those that the plaintiffs seek to bring here. The plaintiffs attempt in their opposition briefs to circumvent this independent barrier against their claims by characterizing their shareholder claims as “direct,” not “derivative.” This argument is doubly misconceived: their claims are plainly derivative, in that the plaintiffs do not allege any injury independent of the injury that they claim the GSEs have suffered, and, in any event, the distinction does not matter for the purposes of HERA. The plaintiffs also attempt to invoke a “manifest conflict of interest” exception to justify a suit against the conservator. That exception, however, appears nowhere in the text of HERA, and could make no sense in the context of a suit, like this one, in which the plaintiffs challenge a decision of the conservator itself. All four suits likewise fail on additional threshold grounds, such as improper third-party standing, lack of ripeness, and, as to the putative class action, the jurisdictional limits of the Little Tucker Act.
Even if these suits could clear HERA’s barriers against judicial review, the plaintiffs’ claims would still fail. The plaintiffs allege that Treasury violated HERA by engaging in a “purchase” of securities through the Third Amendment after its purchase authority in that statute expired. But, as the plaintiffs are unable to dispute, Treasury neither committed any additional funds to the GSEs in the Third Amendment nor received any additional securities from the GSEs. Unable to plausibly allege that the Third Amendment amounted to a “purchase” of securities under any ordinary sense of that term, the plaintiffs seek instead to invoke one side of a circuit split under a disputed, judge-made doctrine, under a separate statute, concerning “fundamental changes” in securities. There is no reason to believe that Congress had that
inapposite statute in mind, let alone that it endorsed one side or other of the circuit split regarding that statute, when it enacted HERA.
The plaintiffs also invent a fiduciary duty that Treasury purportedly owed to the GSEs’ shareholders, and they claim that Treasury violated the APA by failing to consider that duty, or, alternatively, that Treasury should be held directly liable for damages for a breach of that duty. Federal law would preempt the sort of fiduciary obligation that the plaintiffs assert. When Treasury entered into the PSPAs, and when it entered into the Third Amendment, Treasury sought to achieve a number of goals, including the protection of the taxpayers’ interest in the government’s investment. The plaintiffs contend that it would not be “impossible” for Treasury to perform the functions assigned to it under HERA while at the same time acting as their fiduciary, but this misstates the inquiry. The imposition of a state-law fiduciary obligation on Treasury would upset the balance of policy considerations that Congress took into account when it enacted HERA, and for that reason such an obligation would be preempted by federal law. In any event, state law would not impose any fiduciary obligation on Treasury, as it is not a controlling shareholder, and it does not exercise actual control over the GSEs.
The plaintiffs further question, under the APA, the reasonableness of Treasury’s decision to enter into the Third Amendment. But the evidence is plain – and substantial evidence in the record indicates – that the Third Amendment was an appropriate response to the circularity of the dividend structure under the PSPAs, an arrangement that, according to Treasury’s financial projections, presented a threat to the long-term solvency of the GSEs. Indeed, even the plaintiffs concede that Treasury’s contemporaneous projections showed that the GSEs would exhaust their PSPA funding if they continued to draw on those funds to pay dividends to Treasury. See Mem. of Law of Pls. Perry Capital LLC, et al., in Opp’n to Defs.’ Mots. to Dismiss and Mots. for S.J.
and in Supp. of Pls.’ Cross-Mot. for S.J. on Administrative Procedure Act Claims (“Perry Br.”) 75-76. The plaintiffs’ briefs are replete with rhetoric insinuating that Treasury entered into the Third Amendment to extract profits from the GSEs; that rhetoric is considerably deflated, however, by the plaintiffs’ recognition that Treasury did not expect that the Third Amendment would produce any greater return for it than that to which it was entitled under the PSPA’s existing dividend structure. See Perry Br. 72. Far from a “naked money grab,” as the plaintiffs melodramatically put it, the Third Amendment solved a threat to the GSEs’ viability. The plaintiffs posit several alternative solutions to that threat, all of which would have involved Treasury voluntarily foregoing its right to dividend payments. Treasury lacks the authority, however, to waive the government’s vested contractual rights without receipt of a corresponding benefits. Treasury was under no obligation, first, to funnel an unprecedented amount of funds to the GSEs to save those entities from insolvency and mandatory receivership, and then, second, to forgo the return to which it was entitled under the agreements that had kept those entities afloat.
The putative class plaintiffs fare no better when they attempt to recast the same claims under the Takings Clause. Treasury did not invade any of the plaintiffs’ legally cognizable property interests. As shareholders in entities that are highly-regulated (indeed, that exist only as creatures of federal law), the plaintiffs acquired their shares with the recognition that the GSEs’ federal regulator could place (or already had placed) those entities into conservatorship, and could operate the affairs of the GSEs during the period of conservatorship. The plaintiffs lacked any ability to exclude the federal government from exercising these powers, and that fact alone is dispositive of the takings claim. In any event, the takings claim fails under the Penn Central balancing test, given, in particular, the absence of any plausible assertion that the plaintiffs are entitled to impose the costs of their investment decisions on to the federal taxpayer.