9:30 p.m. | Update
Regulators have accused former CEOs of mortgage giants Fannie Mae and Freddie mac investors deceiving their companies’ exposure to risky mortgages, one of the most important federal measures taken against those at the center of the housing crisis.
The lawsuits against the two chief executives and four other top executives on Friday are an aggressive move Security and Trade Commission, and come after a three-year investigation.
The agency has come under fire for failing to prosecute senior Wall Street and mortgage industry executives who contributed to the financial crisis. In cases challenging the deceptive marketing of mortgage-related securities, the SEC has been criticized for citing only mid-level bankers while settling with the Wall Street companies themselves. Recently, the agency was criticized by a federal judge after allowing Citigroup to settle a fraud case without acknowledging wrongdoing.
SEC officials on Friday proclaimed their actions in the Fannie and Freddie case as part of a renewed effort to crack down on wrongdoing at the highest levels of Wall Street and U.S. businesses.
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“All individuals, regardless of rank or position, will be held responsible for perpetuating half-truths or false statements on matters materially important to the interests of our country’s investors,” said Robert S. Khuzami , responsible for the agency’s law enforcement. “Investors have been denied the opportunity to make informed investment decisions.”
He noted that the agency had now filed 38 separate actions arising from the 2008 financial crisis.
Former executives Fannie Mae and Freddie Mac have vowed to challenge the government, saying companies have repeatedly disclosed their loan portfolio breakdowns.
As companies fueled both the housing bubble and Wall Street’s risk appetite, Fannie Mae and Freddie Mac were quickly investigated by federal agencies amid the financial crisis of 2008. But Freddie Mac revealed this summer that the Justice Department’s investigation into the company was over. at no cost. And the SEC shut down before bringing lawsuits against the two companies.
Instead, deals with Fannie and Freddie will allow companies now controlled by the government to escape prosecution and fines as long as they cooperate with authorities. The deal does not require federal court approval, unlike the proposed settlement with Citigroup.
The case against former executives, including Daniel H. Mudd, the former CEO of Fannie Mae, and Richard F. Syron, the former CEO of Freddie Mac, centers on a series of disclosures the companies have made to investors at the height of the crisis. mortgage boom. The government maintains that companies have minimized the extent of their exposure to subprime mortgages, loans granted to the riskiest borrowers.
An SEC complaint argues that executives at Freddie Mac falsely claimed the company had virtually no exposure to ultra-risky loans, despite internal warnings berating such claims.
Another complaint argues that Fannie Mae executives described subprime loans as those made to people “with weaker credit histories,” while reporting only a tenth of loans that met these criteria in 2007. two complaints were filed in United States District Court in Manhattan. .
Mr Mudd, who was managing director of Fannie Mae from 2005 until the government took over the company in 2008, said there had been no deception.
“The government has reviewed and approved the company’s disclosures during my tenure and until today,” he said in a statement. “Now it appears the government has negotiated a deal to hold the government and government-appointed leaders who have signed the same disclosures since I left, blameless – so that he can prosecute the people he fired there.” years ago. ”
The SEC’s long-standing engagement in the investigation – more than 100 depositions were produced during its course – highlights the major roles Fannie Mae and Freddie Mac played in the financial crisis and the government bailout that followed. The Bush administration took over the faltering mortgage giants in September 2008, and taxpayers have since pumped more than $ 150 billion into the two companies. The Obama administration has promised to dissolve them, although the timeline remains unclear.
The case against the former mortgage executives resembles an earlier action against one of the country’s largest lenders to subprime or subprime borrowers. Angelo Mozilo, the former managing director and founder of National financial, agreed to pay $ 22.5 million to settle federal charges in the same direction. The settlement was the largest ever imposed on a senior public company executive, although Mr. Mozilo, who had also agreed to forgo $ 45 million in earnings, neither admitted nor denied wrongdoing.
The success of the SEC in the Fannie and Freddie case will largely depend on the meaning of the word subprime, which the government itself has never fully defined. Although the term often refers to borrowers with low
credit scores, Fannie and Freddie decided to classify loans as prime or subprime based on the type of lender and not the credit rating of the borrower. A Wall Street bank, for example, was generally viewed as a blue chip lender, despite granting subprime loans.
But the government’s complaint argues that this type of disclosure masked the risk. Loans not classified as subprime have often defaulted at higher rates than those classified as subprime.
The government maintains that executives have been far from open about this extra layer of risk. Mr Syron told an investor conference in May 2007 that the company had “basically no subprime business”.
But a lower cabinet official, who revised Mr Syron’s speech in advance, warned that such a statement could be misleading.
“We have to be careful how we phrase this. Our portfolio certainly includes loans which, by some definitions, would be considered subprime, ”said the employee, according to the complaint. “We should reconsider making a radical statement.”
Mudd, meanwhile, during his testimony before Congress in April 2007, broadly defined subprime as “the description of a borrower who does not have perfect credit.” But at the same hearing, he told lawmakers that “less than 2.5% of our business book can be defined as subprime,” which the complaint said significantly underestimated the company’s exposure. according to his definition of that day. Mr Mudd’s estimate omitted some $ 50 billion in substandard loans, according to the complaint.
However, lawyers for the executives plan to argue that the firms have in fact disclosed painstaking details about their loan portfolios, suggesting a potential weakness in the case. During the period under review, companies produced “monster charts” breaking down their loan portfolios by borrowers’ credit ratings and home equity, among other information.
Lawyers for Mr. Syron have called the SEC case “irrecoverable” and “baseless”.
“Simply put, there is no shortage of significant information, all of which have enabled the reader to assess the degree of risk in Freddie Mac’s guaranteed portfolio,” said Thomas C. Green and Mark D. Hopson, partners at Sidley Austin, in the press release. .
Lawyers note that even the federal government has never ruled on a definitive meaning for subprime mortgages. Indeed, in a 2007 document, several federal agencies refused to define it.
Lawyers for two of the other leaders named in the lawsuit have also vowed to fight the allegations.
The complaints also name Fannie’s former risk manager, Enrico Dallavecchia; an executive vice president of Fannie, Thomas A. Lund; Patricia L. Cook, former business manager of Freddie; and its executive vice-president, Donald J. Bisenius.
Yet Mr. Mudd and Mr. Syron are the two main subjects of the complaint.