The Direct Claim Argument Should Overcome Section 4617(b)(2).
Courts and the parties agree that FIRREA’s provisions regarding the powers of conservators, including the succession clause, are materially identical to those of HERA.
The Court has already accepted the Eleventh Circuit’s position construed FIRREA’s successor clause while reviewing an order from the United States Bankruptcy Court for the Southern District of Florida.
Relying on Lubin, the Court succinctly found: “Therefore, all derivative claims in the Appellant’s proposed complaint belong to [FDIC], and all direct claims belong to [Stockholder].” Consistent with Lubin, “[n]o federal court has read” Section 4617(b)(2) or the analogous provision of FIRREA to transfer direct shareholder claims to the conservator or receiver.
HERA Does Not Strip Plaintiffs of Their Rights in Their Stock.
- First, HERA does not bar Plaintiffs from asserting direct claims that relate to their ownership of stock, and all of the claims at issue here are direct.
- Second, even if Plaintiffs’ claims were derivative, courts repeatedly have recognized that shareholders may bring derivative claims during conservatorship where, as here, the conservator has a manifest (and therefore disqualifying) conflict of interest.
Plaintiffs May Bring Direct Claims.
HERA provides that FHFA as conservator succeeds to “all rights, titles, powers, and privileges of . . . any stockholder . . . of the regulated entity [i.e., Fannie] with respect to the regulated entity and the assets of the regulated entity.” 12 U.S.C. § 4617(b)(2)(A)(i) (emphasis added). Whatever implications this succession clause may have for shareholders seeking to bring derivative claims on behalf of Fannie, it does nothing to divest shareholders of their own, independent and personal economic rights in Fannie and, therefore, does nothing to prevent shareholders from maintaining direct claims on behalf of themselves to protect their own rights against any culpable party. This is why, upon imposition of the conservatorship, FHFA correctly insisted that Fannie’s shares would “continue to trade” and that its shareholders would “retain all rights in the stock’s financial worth.”
FHFA Fact Sheet, Questions and Answers on Conservatorship 3, https://goo.gl/Gl9z04. If FHFA’s current litigating position were correct, these public assurances would have been demonstrably false.
[Adopting FHFA’s position would also render numerous conservatorship decisions nonsensical. For example, FHFA expressly suspended payment of dividends to private shareholders like Plaintiffs during conservatorship. But if FHFA had in fact succeeded to the shareholders’ contractual dividend rights, any payment of dividends would have been to FHFA itself, not to shareholders. FHFA then would have had no need to announce to itself that it was halting the payment of dividends. Moreover, FHFA entered into contractual agreements with Treasury—a shareholder in the Companies—that provided Treasury with dividend and liquidation rights, and FHFA has paid tens of billions of dollars in dividends under those agreements. If FHFA’s assertion were correct, Treasury’s dividend rights would belong to FHFA, and these payments should have been retained by FHFA rather than given to Treasury. ]
Under Delaware law, shares of stock and interests in non-corporate business entities “carry with them particular rights that a holder of the [interest] can exercise by virtue of being the owner.” Direct claims for breach of fiduciary duty arise when those rights are infringed. Moreover, even in cases involving derivative claims, the same claims can have direct aspects when the allegedly faithless transaction involves an extraction from one group of stockholders, and a redistribution to another, of “a portion of the economic value and voting power embodied in the minority interest.”
Plaintiffs must prove a breach of an underlying fiduciary duty, such as the duty belonging to FHFA. If FHFA took over Plaintiffs’ claims, it would need to prove that it breached its fiduciary duty. FHFA would have to attack its own records and depose its own officers to effectively pursue Plaintiffs’ claims. An obvious manifest conflict of interest prevents FHFA from proving Plaintiffs’ claims
Plaintiffs May Bring Derivative Claims Where the Conservator Has a Manifest Conflict of Interest.
Plaintiffs must prove a breach of an underlying fiduciary duty, such as the duty belonging to FHFA. If FHFA took over Plaintiffs’ claims, it would need to prove that it breached its fiduciary duty. FHFA would have to attack its own records and depose its own officers to effectively pursue Plaintiffs’ claims. An obvious manifest conflict of interest prevents FHFA from proving Plaintiffs’ claims.
While Section 4617(b)(2)(A) generally has been interpreted to bar derivative (but not direct) suits by shareholders during conservatorship or receivership, it does not follow that all shareholder derivative suits are barred without exception, including derivative suits involving misconduct by the conservator or receiver itself.
Two federal courts of appeals have squarely addressed this question, both in the context of 12 U.S.C. § 1821(d)(2)(A)(i), the provision of FIRREA on which Section 4617(b)(2)(A) was modeled. And both of those courts held that shareholders may maintain a derivative suit when the conservator or receiver has a manifest conflict of interest. See First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279, 1283 (Fed. Cir. 1999) (finding standing to sue “because of the FDIC’s conflict of interest by which it is both alleged to have caused the breach and controls the depository institution”); Delta Sav. Bank v. United States, 265 F.3d 1017, 1024 (9th Cir. 2001) (adopting “a common-sense, conflict of interest exception to the commands of FIRREA” and permitting a shareholder to bring a derivative suit against one of the FDIC’s “closely-related, sister agencies”).
JUDGE GINSBURG: Well, they had a preexisting right to bring the lawsuit, the succession clause takes away something.
STERN: Yes, it takes away.
JUDGE GINSBURG: But does it take away a direct claim? It doesn’t take away a, just because a shareholder is a shareholder doesn’t mean that his loss of rights as a shareholder means his loss of rights in any other capacity. If he were also a tradesman he’d still retain his trade account.
STERN: I think it’s a derivative claim, Your Honor.
JUDGE GINSBURG: Insofar as they want their liquidation preference they don’t get, Fannie Mae doesn’t get anything.
HUME: Our contract claims are direct claims.
HUME: They have always been direct claims.
HUME: We litigated them as direct claims, they were analyzed as direct claims, and —
HUME: — a contract between me the shareholder and you the company. I’m the shareholder; I get to enforce the contract. It is a direct claim, look at page six of our reply brief; those kinds of claims are always analyzed under state law as direct claims. They didn’t even argue this in the District Court, or in any other case, in Kellmer, in the Barnes case, see footnote –
HUME: Let me try to be very clear. Our breach of contract claims are direct claims. I don’t mean to suggest there’s some other amorphous direct claim. Our breach of contract claims are all direct, breach of contract, breach of implied covenant. The only issue was whether we said enough for a direct fiduciary breach claim. And on that, I’ll rest on what I said before, which is we think we said enough, if not, we ask the right to amend. But on breach of contract there’s no ambiguity at all, those claims were brought –
HUME: — directly to the shareholders, directly, nothing new is through the companies. And that — just to — in the Barnes case, the Leven case, the Kellmer case, the FHFA or the FDIC, whichever it was didn’t even try to intervene on behalf of the direct claims. They admitted through their conduct that direct claims belong to the shareholders. They never even took the position in any of those cases; please see the cases in footnote six on page four of our reply, and also what happened in Kellmer. And it does, to what we discussed earlier, it does raise a serious issue of constitutional doubt to even suggest the shareholders, whom they admit have economic rights and interests, don’t have the ability to come to court to protect them, that raises serious constitutional issues as recognized by Judge Easterbrook in the Leven case, and the Plaintiffs in all Winstar case, and by Judge Edwards in the Waterview case, and in the, which is cited in the Pershing Square Amicus brief, which I —
Newly Unsealed Documents Show How Treasury Violated HERA
Tuesday, August 2nd, 2016
The more that is known about the thinking and discussions in the inner sanctums of government during the course of the conservatorship of Fannie Mae and Freddie Mac, the more obvious it is that Treasury officials exceeded their legal authority in order to hasten the dismantlement of the enterprises.
The latest evidence has come to light in unsealed documents produced in the discovery process in the U.S. Court of Federal Claims, which were cited in a complaint filed by investors in Chicago.
In addition to setting up a process by which the assets of Fannie and Freddie would be conserved and preserved, the Housing and Economic Recovery Act (HERA) explicitly delineated the powers and duties of the Federal Housing Finance Agency (FHFA) as conservator and constricted Treasury’s powers. Top government officials intimately involved with the drafting of the statute have detailed how Congress made it a point to reinforce the independence of FHFA as the conservator, consistent laws dealing with distressed institutions going back decades. But this seemed to have little bearing on Treasury’s determination to dictate Fannie and Freddie’s fate, which ultimately led to the Net Worth Sweep in 2012 and the depletion of their capital.
For example, Jim Parrott, who was a top housing policy advisory at the White House at the time of Sweep, was asked in a deposition whether there had been outreach to Congress about the Sweep. He replied that he had not done so and commented “…this was a Treasury-driven process. So to the degree there was outreach to the Hill, it would have come from Treasury, and not from, from me.”
Parrott’s name has surfaced in several documents unsealed this spring. Recall one of them was his email to senior officials at Treasury the day the Sweep was announced, boasting that diverting Fannie’s and Freddie’s profits would eliminate “the possibility that they ever go (pretend) private again.”
Treasury’s assertion of de facto control came early in the conservatorship. A heavily-redacted presentation prepared by PriceWaterhouseCoopers for Freddie to FHFA in October 2008, explained that the Preferred Stock Purchase Agreement terms “restrict the business activities” of Freddie and prevents the company from taking various steps in its own management “without prior written consent of Treasury.” Thus, the designated conservator was told early on that the buck stops with Treasury, regardless of what the statute said.
This interest by Treasury to keep Fannie and Freddie on a short leash is also evident in a draft document spelling out the terms of the PSPA s prepared for Treasury in August 2008 by the law firm of Wachtel, Lipton, Rosen and Katz and Morgan Stanley, in their capacity as independent consultants. In the section of that document titled “Transfers of Assets” the ability of the GSEs to sell assets without Treasury’s consent is restricted. The document also reveals Treasury’s long-term calculations on the value of the warrants the government received for Fannie and Freddie’s stock. Ultimately, these terms would make it impossible for Fannie and Freddie to pay back public funds made available to them at the start of the conservatorship.
Other documents from the early months of the conservatorship provide yet more information that Ed DeMarco had been on a quest to assist Treasury in using the conservatorship to dismantle Fannie and Freddie practically from the outset. In a presentation in November 2008 to other government officials, DeMarco, then a deputy director at FHFA, said “…conservatorship is a legal process to stabilize a troubled institution with the objective of returning the GSEs to normal business operations. Structure was flawed.” Thus he knew the statute said one thing (restore their financial footing) but he believed it was better policy to do something else (wind them down.)
On top of these documents is a March 2012 memo from Deloitte that observes that with Fannie and Freddie in conservatorship, “…the US government, and the US Treasury continue to be able to direct the Company’s business.” Interestingly, a September 2008 memo from Freddie’s auditor, PriceWaterHouseCoopers, says “Treasury’s authority to purchase GSE debt obligations and securities will expire on December 31, 2009.” As we now know, that deadline meant nothing as Treasury engineered the Sweep in the summer of 2012.
All this serves to underscore an important claim by shareholders who have challenged the Net Worth Sweep: Treasury controls the GSEs and FHFA’s role as independent conservator was rendered meaningless from the start of the conservatorship. As the discovery process yields more information it is a safe bet that more violations of HERA will come to light. When they do, the rationale for the Sweep will crumble and the injustice suffered by shareholders will be glaringly apparent.