GSEs: Government’s Position in Delaware Case Upended by Ruling in 9th Circuit

Updated on


By Investors Unite

A decision by the Ninth Circuit Court of Appeals yesterday has bolstered the case of Fannie and Freddie shareholders David Jacobs and Gary Hindes, who are arguing in court that the Net Worth Sweep violates Delaware state law.

The Ninth Circuit upheld a lower court’s decision in the case of United States of America ex rel. Adams v. Aurora Loan Serv., Inc. The Court agreed with the government that the conservatorship of the GSEs does not “transform Fannie Mae and Freddie Mac into federal instrumentalities.”  The ruling said the conservatorship “places FHFA in the shoes of Fannie Mae and Freddie Mac, and gives the FHFA their rights and duties, not the other way around.”

In other words, the conservatorship notwithstanding, Fannie and Freddie remain, effectively, private companies and not federal government entities. Specifically, with regard to the Delaware suit, the GSEs follow Delaware corporate law. And because Delaware law does not permit the sweep of their profits into the Treasury, the Net Worth Sweep is illegal.


On behalf of Hindes and Jacobs,  Myron Steele, a former chief justice of the Delaware Supreme Court, wasted no time in responding to this development and notified the judge in the Delaware case, stating, “This holding is contrary to Defendants’ arguments that federal law, not state law, governs the conservator’s power to implement the Net Worth Sweep as a term of preferred stock, and that FHFA has authority under HERA (the Housing and Economic Recovery Act) to act as it sees fit without regard to whether Fannie Mae and Freddie Mac themselves have power under state law to issue preferred stock having the terms of the Net Worth Sweep.”

The case before the Ninth Circuit Court was a False Claims Act suit. It was originally brought about by a group of realtors in the U.S. District Court in Nevada against various mortgage lenders and loan servicers. The plaintiffs claimed that the defendants wrongly certified that loans purchased by Fannie Mae and Freddie Mac were free of homeowner association fees and other liens. Importantly, the realtors’ suit also alleged that the false certifications were made to the GSEs as instrumentalities of the United States.

In that case, the district court in Nevada, and now the federal appeals court, was persuaded that Fannie and Freddie were not really instrumentalities of the U.S., their government charters notwithstanding. In a blog on ValuePlays, Todd Sullivan summed up the government’s situation well. He wrote, “The government here is between a rock and a hard place. They can’t appeal the decision because they won and they won because the lower court and the appeals court bought their argument, the GSE’s are not Federal Instrumentalities.”

Clearly, the Ninth Circuit court ruling has important ramifications for the Delaware suit and gives FHFA and Treasury even less room to maneuver – not that they had much room to begin with. As we pointed out recently, briefs filed by lawyers for the government aimed at preventing the state Supreme Court of Delaware from taking up the shareholder suit rely on the “Nixonian” assertion that the government can interpret the law as it likes simply because it is the government.

In November, we detailed the reasons why the government’s motion to dismiss should itself be  dismissed and the flaws in the government’s assertion that it needed to act as savior of Fannie Mae and Freddie Mac – and the farcical argument that the Sweep was in any way saving them.

With the ruling in the Ninth Circuit, it will be interesting to see how the government will seek to define itself and Fannie and Freddie going forward. If they are private companies, then assertions of executive privilege, which is exclusive to the government, would seem inapplicable to the piles of documents the government wants to conceal in the litigation brought by Fairholme Funds, which is explored in an analysis today by University of Virginia Law Professor Saikrishna Prakash posted today at the National Review Online. And if state law, rather than HERA, prevails in the Delaware case, then Hindes and Jacobs could be on the way to victory and a light could be visible at the end of the tunnel for all shareholders.



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