Sources: SEC Heading Toward Charging Fannie & Freddie Execs with Violations

According to sources familiar with the matter, the Washington Post is reporting that the Securities and Exchange Commission (SEC) is moving toward charging former and current Fannie Mae and Freddie Mac executives with violations related to the financial crisis, setting up a clash with the housing regulator that oversees the companies.

Source: Source: Washington Post | Published on March 18, 2011

Responsible for enforcing securities laws, the SEC is alleging that at least four senior executives failed to provide necessary information to investors about the companies’ mortgage holdings as the U.S. housing market collapsed.

But the agency that most closely regulates Fannie and Freddie, the Federal Housing Finance Agency, disagrees with that assessment, according to sources familiar with the matter.

FHFA officials think Fannie and Freddie’s financial disclosures, which agency staff members had reviewed before the documents were released to the public, were sufficient, the sources said. One source added that FHFA has sent a letter to the SEC opposing the filing of charges.

An FHFA spokesman declined to comment.

Over the past eight weeks, the SEC sent notices to the executives saying they may face civil charges. The SEC has not yet formally filed such charges and ultimately may choose not to.

The agency alleged that executives at both companies misled investors about their exposure to dangerous mortgage products, such as subprime loans, sources familiar with the matter said.

The executives include former Fannie chief executive Daniel Mudd, former Freddie chief executive Richard Syron, former Freddie chief financial officer Anthony “Buddy” Piszel and current Freddie executive Donald Bisenius, who recently announced that he would leave the company after he received his notice.

The allegations are slightly different for both the companies. One of the chief allegations against Fannie executives is that it characterized mortgage loans as “prime” — meaning high-quality — when they should have been classified in a more risky category of loans.

Meanwhile, Freddie executives are accused of not fully warning investors about the risks associated with subprime loans.

Fannie and Freddie, on the verge of collapse as the financial markets imploded in the fall of 2008, were seized by the federal government. The companies, now owned by taxpayers, have needed $150 billion in aid to stay afloat.

The SEC case may also add to a brouhaha on Capitol Hill over federal expenditures by Fannie and Freddie for former executives. The companies are spending tens of millions of dollars to cover the legal costs of a different set of former executives who face private class-action lawsuits. FHFA officials say the former executives are legally entitled to that coverage.

The SEC case will add to those taxpayer bills because the executives facing allegations are also indemnified.

In the years relevant to the SEC case, Fannie and Freddie routinely submitted their financial disclosures to FHFA’s predecessor agency before releasing them to the public.

“The disclosures and procedures that are the subject of the [SEC] investigation were accurate and complete,” Mudd, now chief executive of Fortress Investment Group, said in a statement released to Bloomberg News this month.

He added, “These disclosures were previewed by federal regulators, and have been issued in the same form since the company went into government conservatorship.”

One person familiar with the matter pointed out that the SEC itself reviewed Freddie’s disclosures in 2008 as part of the company’s application to become officially registered with that agency.

An attorney for Syron said Freddie made accurate disclosures. Attorneys for Bisenius and Piszel could not be reached.

Approval by a federal regulator is not a defense for a misleading securities filing, said Donald C. Langevoort, a Georgetown law professor. It could make it harder for the SEC to prove fraud, but the agency can file other kinds of charges, he said.

Even in charging fraud, “the SEC enforcement staff is well within bounds in proceeding if it believes that the regulators who approved did not have all the relevant facts, and the subject in question knew or recklessly disregarded such facts,” Langevoort said by e-mail.

If the SEC were to take enforcement action against Fannie Mae, Freddie Mac or any of their executives, it would not be the first time. In the past, the fact that other regulators had overseen the companies did not shield them from SEC action.

Before they were taken over by the government, the companies went through twin accounting scandals. Each firm paid a fine to settle SEC fraud charges and was forced to correct past financial reports.

Although the Office of Federal Housing Enterprise Oversight, predecessor of the FHFA, had previously given both companies a clean bill of health, in 2003 and 2004 the regulator accused them of accounting irregularities, and the SEC later agreed.

Mudd and Syron were placed in charge of the companies with mandates to clean up the accounting and organizational problems left by their predecessors.