Fairholme Funds, Inc. v. Fed. Hous. Fin. Agency

Decision Date28 September 2018
Docket NumberCivil No. 13-1439 (RCL),Miscellaneous No. 13-1288 (RCL),Civil No. 13-1053 (RCL)
PartiesFAIRHOLME FUNDS, INC., et al., Plaintiffs, v. FEDERAL HOUSING FINANCE AGENCY, et al., Defendants. ARROWOOD INDEMNITY COMPANY, et al., Plaintiffs, v. FEDERAL NATIONAL MORTGAGE ASSOCATION, et al., Defendants. In re Fannie Mae/Freddie Mac Senior Preferred Stock Purchase Agreement Class Action Litigations This Memorandum Opinion relates to: ALL CASES
CourtU.S. District Court — District of Columbia



Before the Court is a motion to dismiss filed by the defendants Federal Housing Finance Agency ("FHFA"), as Conservator for the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac," and together with Fannie Mae, the "GSEs,"); Melvin L. Watt, in his official capacity as Director of FHFA; and the GSEs (collectively, "Defendants"). The motion applies to all three of the above-captioned cases [ECF No. 68 for Civil No. 13-1053; ECF No. 77 for Civil No. 13-1439; ECF No. 66 for Miscellaneous No. 13-1288]. Upon consideration, Defendants' motion is GRANTED IN PART and DENIED IN PART. Additionally, because the Court considered the various plaintiffs' sur-replies in coming to this decision, the motions for leave to file sur-reply [ECF No. 79 for Civil No. 13-1053, ECF No. 87 for Civil No. 13-1439, and ECF No. 78 for Miscellaneous No. 13-1288] will be GRANTED.


This matter is brought before the Court by a class action law suit and two individual lawsuits. Following this Court's prior opinion, see generally Perry Capital LLC v. Lew, 70 F. Supp. 3d 208 (D.D.C. 2014) ("Perry I"), and the D.C. Circuit's opinion, see generally Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017) ("Perry II"), these lawsuits contain substantially identical claims.2 The class action law suit was brought by a purported class of private individual and institutional investors (the "Class Plaintiffs") who own either preferred or common stock in the Fannie Mae or Freddie Mac. Second Am. Consolidated Class Action Compl. at ¶¶ 18-33, In re Fannie Mae/Freddie Mac Senior Preferred Stock Purchase Agreement ClassAction Litigs., Misc. No. 13-1288 (D.D.C. Feb. 1, 2018), ECF No. 71 ("Class SAC"). The individual lawsuits were brought by separate institutional investors owning junior preferred stock in the GSEs. First Am. Compl. at ¶¶ 5-20, Fairholme Funds, Inc. v. FHFA, Civ. No. 13-1053 (D.D.C. Feb. 1, 2018), ECF No. 75 ("Fairholme FAC"); First Am. Compl. at ¶¶ 6-18, Arrowood Indem. Co. v. Fannie Mae, Civ. No. 13-1439 (D.D.C. Feb. 1, 2018), ECF No. 83 ("Arrowood FAC").

A. The GSEs

Fannie Mae and Freddie Mac are government-sponsored enterprises, born from statutory charters issued by Congress. See Federal National Mortgage Association Charter Act, 12 U.S.C. §§ 1716-1723; Federal Home Loan Mortgage Corporation Act, 12 U.S.C. §§ 1451-1459. Congress created the GSEs in order to, among other goals, "promote access to mortgage credit throughout the Nation . . . by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing." 12 U.S.C. § 1716(3). The GSEs accomplish this objective by purchasing mortgages from lenders, thereby relieving the lenders of default risk and clearing up funds to be used to make more loans. To finance these purchases, the GSEs pool the many mortgage loans they purchase into various mortgage-backed securities and sell these securities to investors.

Fannie Mae and Freddie Mac are considered government-sponsored, rather than government-owned, because both congressionally chartered entities were eventually converted, by statute, into publicly traded corporations. In 1968, Congress made Fannie Mae a publicly traded, stockholder-owned corporation. Housing and Urban Development Act, Pub. L. No. 90-448, § 802, 82 Stat. 536-538 (1968). And in 1989, Freddie Mac followed suit. Financial Institutions Reform, Recovery and Enforcement Act, Pub. L. No. 101-73, § 731, 103 Stat. 432-433 (1989). To provideguidance to the GSEs on corporate governance issues not specifically addressed by federal law, the Office of Federal Housing Enterprise Oversight directed the GSEs to follow a chosen state's corporate laws as a gap-filling measure. See 67 Fed. Reg. 38361 (Jun. 4, 2002). The GSEs hence enacted bylaws in which they elected to follow a chosen state's law—Delaware law for Fannie Mae and Virginia law for Freddie Mac.

Since their founding, the GSEs have been major players in the United States' housing market. In the lead up to 2008, the GSEs' mortgage portfolios had a combined value of $5 trillion and accounted for nearly half of the United States' mortgage market.

B. The 2008 Recession, the Creating of the FHFA, and the Beginning of Conservatorship

In 2008, the United States' mortgage and housing markets went into crisis, leading in part to a severe recession. Despite the GSEs' comparatively strong financial position amidst the crisis, Congress worried that a potential default by Fannie or Freddie would imperil the already fragile national economy. In response to these concerns, Congress enacted the Housing and Economic Recovery Act ("HERA" or "the Act"). HERA established the FHFA, granting it broad authority to ensure the GSEs remained stable. The Act denominated the GSEs as "regulated entit[ies]" subject to the direct "supervision" of FHFA, 12 U.S.C. § 4511(b)(1), and the "general regulatory authority" of FHFA's director (the "Director"). Id. § 4511(b)(1), (2). The Director was charged by HERA with "over see[ing] the prudential operations" of the GSEs and "ensur[ing] that" they "operate[] in a safe and sound manner," "consistent with the public interest." Id. § 4513(a)(1)(A), (B)(i), (B)(v).

Additionally, HERA authorized the Director to appoint FHFA as either conservator or receiver for the GSEs "for the purpose of reorganizing, rehabilitating, or winding up the[ir] affairs." 12 U.S.C. § 4617(a)(2). If appointed as conservator, the Act granted the FHFA broadpowers and authority over the GSEs. The Act provided that the FHFA "shall, as conservator or receiver, . . . immediately succeed to . . . all rights, titles, powers, and privileges of the regulated entity and of any stockholder, officer, or director of such regulated entity with respect to the regulated entity and the assets of the regulated entity." Id. § 4617(bX2)(B)(i), (iv). It also gave the FHFA general powers to take actions "necessary to put the [GSEs] in a sound and solvent condition" and "appropriate to carry on the business of the [GSEs] and preserve and conserve the assets and property of the [GSEs]." Id. § 4617(b)(2)(D)(i), (ii). And the Act further provides that the FHFA, as conservator, may take any action authorized under the act "which [it] determines is in the best interests of the [GSEs] or the [FHFA]." Id. § 4617(b)(2)(J)(ii).

On September 6, 2008, FHFA placed the GSEs into conservatorship, assuming the powers granted to the conservator by the Act. According to statements by the Director, conservatorship was "designed to stabilize a troubled institution with the objective of returning the entities to normal business operations." Class SAC at ¶ 40 (relying on Press Release, Federal Housing Finance Agency, Statement of FHFA Director James B. Lockhart at News Conference Announcing Conservatorship of Fannie Mae and Freddie Mac (Sept. 7, 2008)). And that the "FHFA [would] act as the conservator to operate the GSEs until they [were] stabilized." Id. Once the FHFA determined that the GSEs were in a safe and solvent condition, the Director would issue an order terminating conservatorship.

Despite the conservatorship, the common and preferred stock remained outstanding. In its Form 8-K filing just days after the beginning of conservatorship, Freddie Mac stated, "The holders of Freddie Mac's existing common and preferred stock . . . will retain all their rights in the financial worth of those instruments, as such worth is determined by the market." Class SAC at ¶ 42 (relying on Federal Home Loan Mortgage Corporation, Current Report (Form 8-K) (Sept. 11, 2008)).

C. The GSEs Enter into a Senior Preferred Stock Purchase Agreement ("PSPA") with Treasury

A day after its appointment as conservator, the FHFA struck a deal with the Treasury Department ("Treasury"), entering into the PSPAs. The state of the market limited access to private capital markets for Freddie and Fannie. To shore up the GSEs' financial positions, Treasury agreed to invest billions of dollars in the GSEs in exchange for one million senior preferred shares ("Government Preferred Stock") in each company. These shares had a principal value equal to the amount invested by Treasury in each company, plus $1 billion to reflect a commitment fee with respect to each GSE. The shares also entitled Treasury to:

• a senior preferred dividend each quarter in an amount equal to 10% of the outstanding principal value of the Government Preferred Stock if the dividend was paid in cash;
• a stock dividend, if the senior preferred dividend was not paid in cash, in the form of additional Government Preferred Stock with a face value equal to 12% of the outstanding principal value of the Government Preferred Stock;
• a priority right above all other stockholders, whether preferred or otherwise, to receive distributions from assets if the GSEs were dissolved;
• warrants allowing Treasury to purchase up to 79.9% of the GSEs' common stock; and
• the possibility of periodic commitment fees over and above dividends.

Additionally, the PSPAs included a variety of covenants. Most relevantly, the GSEs would have to receive Treasury's approval before declaring or paying any dividend or distribution. However, this covenant only applied during conservatorship.

Initially, Treasury's commitment to invest capital was capped at $100 billion per company. But it was determined that this...

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