U.S. Sec. & Exch. Comm'n v. Syron

• Decision Date: 28 March 2013
• Docket Number: No. 11 Civ. 9201(RJS).,11 Civ. 9201(RJS).
• Citation: 934 F.Supp.2d 609
• Parties: U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Richard F. SYRON, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

934 F.Supp.2d 609

U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.Richard F. SYRON, et al., Defendants.

No. 11 Civ. 9201(RJS).

United States District Court,

S.D. New York.

March 28, 2013.

Suzanne Romajas, Christian D.H. Schultz, Giles T. Cohen, David S. Karp, Kevin P. O'Rourke, and Matthew A. Rossi, Washington, DC, for The U.S. Securities and Exchange Commission.

Thomas C. Green, Mark D. Hopson, Frank R. Volpe, Matthew D. Krueger, Katie M. Durick, and Judith C. Gallagher of Sidley Austin LLP, Washington, DC, Steven M. Bierman and Andrew D. Hart of Sidley Austin LLP, New York, NY, for Richard F. Syron.

Daniel J. Beller, Walter G. Ricciardi, and David W. Brown of Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY; and by Charles E. Davidow and John H. Longwell of Paul, Weiss, Rifkind, Wharton & Garrison LLP, Washington, DC, for Donald J. Bisenius.

Memorandum and Order

RICHARD J. SULLIVAN, District Judge.

Plaintiff, the U.S. Securities and Exchange Commission (“SEC”), brings this action against Defendants Richard F. Syron, Patricia L. Cook, and Donald J. Bisenius (collectively, “Defendants”), former senior executives of the Federal Home Loan Mortgage Corporation (“Freddie Mac”), for violations of anti-fraud provisions of the federal securities laws. The SEC's claims arise from statements regarding the extent of Freddie Mac's subprime portfolio that allegedly misled investors into believing that Freddie Mac's exposure to subprime loans was significantly less than it actually was.

Before the Court is Defendants' motion to dismiss the Complaint (“Compl.”) with prejudice for failure to state a claim, pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. For the reasons set forth below, the Court grants Defendants' motion to dismiss the claim against Syron and Cook under Section 17(a)(2) of the Securities Act of 1933, but denies Defendants' motion as to each of the SEC's other claims.

I. Background

A. Facts

1. Freddie Mac

In 1970, Congress established Freddie Mac as a shareholder-owned Government Sponsored Entity (“GSE”).¹ (Compl. ¶ 9.) Freddie Mac's purpose was to promote residential mortgage lending by providing liquidity to that industry through the purchase and guarantee of residential mortgage loans and mortgage-related securities. ( Id.) At all times relevant to this action, Freddie Mac's common stock traded on the New York Stock Exchange. ( Id.) Also at all relevant times, Freddie Mac issued annual and quarterly reports of its financial condition, initially in the form of Information Statements and Information Statement Supplements, and later—after July 2008, when Freddie Mac voluntarily registered its stock under Section 12(g) of the Exchange Act—in the form of Form 10–Ks and Form–10Qs. ( Id.) Although Freddie Mac was exempt from the registration and disclosure requirements of federal securities laws until its voluntary registration in July 2008, the Information Statements and Information Statement Supplements were virtually identical to the typical reports of registered entities. ( Id.)

Freddie Mac's business is organized into three main segments: Single Family Guarantee (“Single Family”), Investments, and Multifamily. ( Id. ¶ 10.) Single Family represents Freddie Mac's primary business segment and is responsible for fulfilling the company's mission by purchasing residential mortgages and mortgage-related securities in the secondary market and securitizing them as Freddie Mac mortgage-backed securities, known as Participation Certificates (“PCs”). ( Id. ¶¶ 11–12.) During the period between March 2007 and August 2008 (the “Relevant Period”), the reported size of Single Family's portfolio grew from $1.4 trillion to $1.8 trillion. ( Id. ¶ 11.)

Single Family also included what Freddie Mac refers to as Structured Securities, which are securities issued by Freddie Mac that represent beneficial interests in pools of PCs and certain other mortgage-related assets. (Defs.' Mem. 9; see Decl. of Daniel J. Beller, dated Apr. 30, 2012, Doc. No. 53 (“Beller Decl.”), Ex. 5 at 4–5.) A subset of Structured Securities, in turn, were known as Structured Transactions, in which Freddie Mac purchased senior interests in a trust holding mortgage-related collateral and then issued guaranteed Structured Securities backed by those senior interests. (Defs.' Mem. 9; see Beller Decl. Ex. 2 at 68–69; id. Ex. 5 at 5.) The collateral in those trusts typically consisted of mortgage-backed securities issued by private issuers rather than GSEs, which Freddie Mac's disclosures referred to as “non-agency mortgage-backed securities.” (Defs.' Mem. 9; see Beller Decl. Ex. 2 at 68–69; id. Ex. 5 at 5.) During the Relevant Period, Structured Transactions amounted to approximately $20.4 billion to $29.4 billion, or 1% to 2%, of the Single Family portfolio. ( See Beller Decl. Ex. 2 at 68; id. Ex. 7 at 76, tbl. 48.)

2. Defendants

Defendant Richard F. Syron was Chairman of the Board and Chief Executive Officer (“CEO”) of Freddie Mac from December 2003 until September 2008. (Compl. ¶ 15.) As part of his responsibility for overseeing Freddie Mac, Syron chaired the Senior Executive Team (“SET”), which managed the company's strategic direction, and regularly attended Board of Directors (“Board”) meetings, meetings of the Board's Mission, Sourcing, and Technology Committee (“MSTC”), and meetings of the Enterprise Risk Management Committee (“ERMC”), a committee of executives and senior management from Freddie Mac's three business segments that considered the credit, market, and operations risks to Freddie Mac. ( Id. ¶ 16.) Prior to joining Freddie Mac, Syron served in senior positions at the Federal Reserve Bank of Boston and the Federal Home Loan Bank of Boston. ( Id. ¶ 17.)

Defendant Patricia L. Cook was Freddie Mac's Executive Vice President (“EVP”) of Investments and Capital Markets and Chief Business Officer from August 2004 through September 26, 2008. ( Id. ¶ 19.) In those positions, Cook directly oversaw the Single Family business. ( Id. ¶ 78.) Cook also served on the SET and attended meetings of the ERMC and MSTC. ( Id. ¶ 20.)

Defendant Donald J. Bisenius held a number of senior positions at Freddie Mac during his nearly two-decade tenure there. He served as Senior Vice President (“SVP”) of Credit Policy and Portfolio Management from November 2003 to April 2008, SVP of Single Family Credit Guarantee from May 2008 to May 2009, and EVP of Single Family Credit Guarantee from May 2009 to April 2011, when he left Freddie Mac. ( Id. ¶ 24.) In those positions, Bisenius had direct responsibility for the credit risks associated with the Single Family business segment. ( Id. ¶ 79.) Bisenius also served on the Disclosure Committee that reviewed Freddie Mac's Information Statement Supplement (“ISS”) for the period ending March 31, 2008 and Form 10–Q for the period ending June 30, 2008. ( Id. ¶ 27.)

3. Single Family's Acquisition of Loans with Greater Credit Risks

As part of the process whereby loans were purchased for Single Family, Freddie Mac began using an automated underwriting system called Loan Prospector in 1995. ( Id. ¶ 31.) Loan Prospector classified loans by credit risk and assigned each loan a score reflecting the loan's risk of default. ( Id. ¶¶ 32–33.) Freddie Mac grouped the scores into six categories corresponding to the level of anticipated risk. ( Id. ¶ 33.) From least risky to riskiest, the categories were: A+, A1, A2, A3, C1, and C2. ( Id.) Loans in the first four categories were designated “Accept Loans,” which Freddie Mac could automatically underwrite. ( Id. ¶¶ 33–34.) Loans with a C1 or C2 rating, on the other hand, were designated “Caution Loans.” ( Id. ¶ 33.) Such loans had multiple risky credit characteristics, including high loan-to-value (“LTV”) ratios, borrowers with low credit scores, unusual property types, and high debt-to-income ratios. ( Id. ¶ 35.) Unlike Accept Loans, Caution Loans generally had to be manually underwritten, and originators needed to produce additional documentation regarding borrowers' creditworthiness and to make particular representations concerning the loan's credit quality. ( Id.)

Beginning in the late 1990s, however, Freddie Mac began to loosen the terms applicable to Caution Loans. In October 1997, it initiated the A–Minus Program, under which Single Family could purchase C1 loans on the same terms as Accept Loans with the payment of an additional fee by the seller. ( Id. ¶ 36.) Single Family's sales and marketing materials for the program's roll-out stated that “A-minus loans account for approximately 50 percent of subprime loans” in the housing market. ( Id. ¶ 37 (internal quotation marks omitted).) In November 1998, Freddie Mac revised its Credit Policy Book to reflect the influence of the A–Minus Program on Single Family's risk profile. The memorandum authorizing those revisions described mortgages eligible for the A–Minus Program as “mortgages generally includ[ing] 54% to 56% of the subprime market.” ( Id. ¶ 38 (internal quotation marks omitted).) It also characterized the credit quality of C2 loans as “subprime.” ( Id. (internal quotation marks omitted).) Bisenius signed and approved the revisions to the Credit Policy Book. ( Id.)

In 1999, Bisenius also directed the creation of Segmentor, an econometric model designed to enhance Loan Prospector's ability to identify subprime loans for acquisition. ( Id. ¶ 39.) Segmentor evaluated loans' credit characteristics and generated a “subprime score” for each loan. ( Id.) Loans with low scores received C1 or C2 ratings. ( Id.)

Between 1999 and 2007, Freddie Mac introduced several other programs to acquire loans with riskier credit characteristics. ( Id. ¶¶ 44–47.) One of the most significant of the new programs was known as Expanded Approval (“EA”). Freddie Mac internally considered EA loans to have credit risk at best equivalent to A-minus loans—equivalent, that is, to C1 loans. ( Id. ¶ 46.) A Freddie Mac policy...