In re Federal Nat. Mortg. Ass'n Securities

• Decision Date: 31 May 2007
• Docket Number: Civil Action No. 04-1783(RJL).,MDL No. 1688.
• Citation: 503 F.Supp.2d 9
• Court: U.S. District Court — District of Columbia
• Parties: In re FEDERAL NATIONAL MORTGAGE ASSOCIATION SECURITIES, DERIVATIVE, and "ERISA" LITIGATION. In re Fannie Mae Derivative Litigation.

503 F.Supp.2d 9

In re FEDERAL NATIONAL MORTGAGE ASSOCIATION SECURITIES, DERIVATIVE, and "ERISA" LITIGATION.

In re Fannie Mae Derivative Litigation.

MDL No. 1688.

Civil Action No. 04-1783(RJL).

United States District Court, District of Columbia.

May 31, 2007.

Alex Giscard Romain, Williams & Connolly, LLP, Arlington, VA, Joseph Marshall

Terry, Jr., Michelle D. Schwartz, Williams & Connolly, LLP, Daryl Andrew Libow, Sullivan & Cromwell, LLP, James. D. Wareham, Carolyn Elizabeth Morris, James Edward Anklam, Paul, Hastings, Janofsky & Walker LLP, Michael J. Walsh, Jr., Jeffrey William Kilduff, O'Melveny & Myers LLP, Jonathan Michael Stern, Schnader Harrison Segal & Lewis, LLP, Cristen E. Sikes, DLA Piper U.S. LLP, Everett Clifford Johnson, Jr., Latham & Watkins, Carolyn Marie Welshhans, Dechert, LLP, Barbara Ann Van Gelder, Wiley Rein LLP, David I. Ackerman, Bingham McCutchen, LLP, Rhonda D. Orin, Anderson Kill & Olick, LLP, James Hamilton, Swidler, Berlin, Shereff & Friedman, L.L.P., Andrew Santo Tulumello, Gibson, Dunn & Crutcher, L.L.P., Julia Evans Guttman, Baker Botts, LLP, Eric R. Delinsky, Carole J. Yanofsky, Ellen D. Marcus, Richard Miles Clark, Steven Mark Salky, Tammy Gershon, Holly Ann Pal, Zuckerman Spaeder, LLP, Glenn B. Manishin, Stephanie Ann Joyce, Kelley, Drye & Warren, L.L.P., Washington, DC, Seth Alben Aronson, O'Melveny & Myers, LLP, Los Angeles, CA, John J. Clarke, Jr., Dla Piper Rudnick Gray Cary U.S. LLP, Neil A. Steiner, William K. Dodds, Dechert, L.L.P., John H. Doyle, III, Anderson Kill & Olick, P.C., Christopher Coyne Palermo, David Earl Barry, William Andrew Krohley, Kelley Drye & Warren LLP, Jeremy C. Bates, Michael T. Tomaino, Patrice A. Rouse, Richard H. Klapper, Sullivan & Cromwell LLP, New York, NY, David Smith, Jonathan S. Liss, Theresa E. Loscalzo, Schnader Harrison Segal & Lewis LLP, Philadelphia, PA, for Defendants.

Carlotta Poter Wells, U.S. Department of Justice, Washington, DC, for Movant.

MEMORANDUM OPINION

LEON, District Judge.

Before the Court are multiple motions to dismiss the claims in the First Amended Consolidated Verified Shareholders' Derivative Complaint ("Amended Complaint") filed in this action. The Amended Complaint names as defendants: (1) certain outside directors of the. Federal National Mortgage Association ("Fannie Mae") (i.e. Stephen, B. Ashley, Kenneth M. Duberstein, Thomas P. Gerrity, Ann Korologos, Frederic V. Malek, Donald B. Marron, Anne M. Mulcahy, Joe K. Pickett, Leslie Rahl, H. Patrick Swygert, and John K. Wulff); (2) two former senior executives (i.e. Franklin D. Raines and J. Timothy Howard); (3) the current President and. Chief Executive Officer of Fannie Mae, Daniel H. Mudd; and (4) Fannie Mae itself. All defendants seek to dismiss the Amended Complaint for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6) and for failure to make a demand pursuant to Federal Rule of Civil Procedure 23.1. After reviewing the parties' submissions, oral argument, and the applicable law, the Court GRANTS the defendants' motions to dismiss for failure to make a demand pursuant to Federal Rule of Civil Procedure 23.1.¹

BACKGROUND

Fannie Mae is one of two (the other being Freddie Mac) federally-chartered government sponsored enterprises that serve the public policy of expanding home ownership to moderate and low-income families, in part, by supplying capital and liquidity for residential mortgages. The additional capital and liquidity provided by Fannie Mae, in turn, increases the market for 30-year fixed-rate mortgages and frees up banks' limited capital, allowing them to make more loans. Fannie Mae was established in 1938 by the federal government as a public entity. In 1968, Congress amended Fannie Mae's charter to make it a shareholder-owned company that operates on a self-sustaining basis. Indeed, its Board of Directors is composed principally of outside directors who are elected by the shareholders. The Chairman and officers of the company have neither the power to dismiss the outside directors, nor set their compensation. To the contrary, it is the Board of Directors who set the compensation of the officers and have the authority to remove them from office.

Fannie Mae is regulated by various governmental agencies, including the Office of Federal Housing Enterprise Oversight ("OFHEO"), the United States Department of Housing and Urban Development, the United States Department of Treasury, and the General Accounting Office. OFHEO's "mission" is ensuring the safety and soundness of Fannie Mae. (See Federal Housing Enterprises Financial Safety and Soundness Act of 1992, 12 U.S.C. § 4501 et seq.; OFHEO Mission Statement, available at http://www.ofheogov/ Mission.asp (last visited May 31, 2007).) OFHEO's oversight involves reviewing the company's internal controls, corporate structure, financial solvency, capital reserves, and accounting policies. (See generally OFHEO Report to Congress, June 15, 2002 ("2002 OFHEO Report") at 22-42 (detailing OFHEO's examination of Fannie Mae's operations) (attached as Ex. 3 to Stern Decl.).) OFHEO then reports annually to Congress on its findings. (Id.) OFHEO reviews Fannie Mae's executive employment agreements and executive compensation and approves the termination benefits provided under those agreements. See 12 U.S.C. §§ 4518(a), 1723a(d)(3)(B). Pursuant to statute, Fannie Mae officers' compensation must be set where "the board of directors determines [to be] reasonable and comparable with compensation for employment in other similar businesses (including other publicly held financial institutions or major financial service companies) involving similar duties and responsibilities." Id. § 1723a(d)(2). Plaintiffs acknowledge that to ascertain what comparable executives at similar corporations received in compensation, the Board retained Johnson Associates and the Board's Compensation Committee retained Semler Brossy Consulting Group. (Am.Compl.¶ 400.)

On September 22, 2004, OFHEO released an interim report concluding that Fannie Mae had misapplied FAS 91 and FAS 133, which are generally accepted accounting principles ("GAAP"), that Fannie Mae had inadequate internal controls, and that OFHEO no longer had confidence in certain members of Fannie Mae's management. (Am.Compl.¶ 49.) Shortly thereafter, the Board expanded the authority of a Special Review Committee that had previously been created and vested it with the authority to investigate the allegations in the OFHEO Report. (See Fannie Mae, Form 8-K at 99.2 (Dec. 21, 2004) (attached as Ex. 7 to Stern Decl.).) The Committee retained former United States Senator Warren Rudman and his law firm (i.e. Paul, Weiss, Rifldnd, Wharton & Garrison LLP) to carry out this investigation.² (Id.) Within days, putative derivative plaintiffs began filing shareholder derivative suits. In total, ten plaintiffs commenced eleven shareholder derivative actions³ and a books and records action under title 8, section 220 of the Delaware Code.⁴ The first of these shareholder derivative actions was filed on September 28, 2004 in the United States District Court for the Southern District of New York, On that say, the following ten outside directors sat on Fannie Mae's Board: Korologos, Marron, Ashley, Mulcahy, Malek, Pickett, Duberstein, Swygert, Rahl, and Gerrity, and the following three corporate officers, Raines, Howard, and Mudd, were serving as directors. John Wulff, who is also named as a defendant in this action, joined the Board as an outside director on December 9, 2004. (Am.Compl.¶ 85.)

On February 14, 2005, the Court consolidated all of the derivative actions and appointed Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust ("Pirelli") and Wayne. County Employees' Retirement System ("Wayne County") as co-lead Plaintiffs. (See Feb. 12, 2005 Mem. Op. and Order at 3-4.) Plaintiffs filed a consolidated complaint on September 26, 2005. The following Spring, Fannie Mae announced on May 23, 2006 that it had agreed to comprehensive settlements with OFHEO and the SEC. As part of the settlement with OFHEO, the Board agreed to a variety of corporate governance improvements, including the addition of a Compliance Committee and a Risk Policy and Capital Committee. (See In the Matter of The Federal National Mortgage Association ("Fannie Mae"), Consent Order, at 6-8 (dated May 23, 2006) (attached as Ex. 15 to Stern Decl.).)

On September 1, 2006, plaintiffs filed an amended version of the September 2005 Consolidated Complaint (i.e. the Amended Complaint). The Amended Complaint asserts two types of claims: (1) breach of fiduciary duties and gross mismanagement arising out of the company's misapplication of FAS 91 and 133 ("accounting-related claims") (Am. Compl. Counts I-IV); and (2) claims for corporate waste and unjust enrichment relating to the Board's approval of certain executives' compensation ("compensation-related claims") (Am. Compl. Counts V-VIII).

With regard to the demand requirement of Rule 23.1, plaintiffs claim that it would have been futile to make a demand on the Board for the company to pursue these claims. Defendants, not unexpectedly, contend that plaintiffs' Amended Complaint does not set forth facts sufficient to establish futility. To the contrary, they contend that a majority of the Fannie Mae's directors (seven of the thirteen) were not so lacking in independence or disinterest to prevent them from properly evaluating a demand by plaintiffs on the directors that Fannie Mae file suit in this matter. For the following reasons, this Court agrees with the defendants and DISMISSES plaintiffs' claims for failure to make the requisite Rule 23.1 demand upon the Board of Directors of Fannie Mae prior to filing this derivative suit.⁵

ANALYSIS

I. Legal Standard

A complaint in a derivative suit must meet the procedural requirements of Rule 23.1 of the Federal Rules of Civil Procedure. Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96, 111...