After Daniel Mudd was forced out as chief executive officer of Fannie Mae (FNMA) when the government seized the company in September 2008, he headed for the river. In the weeks following his dismissal, the 6-foot-4 former Marine, a onetime U.S. Olympic rowing prospect, buzzed his receding gray hair into military style and took a boat out on the Potomac—gathering strength to rebuild his career, according to his friends.
Ten months later, Mudd left Washington, taking the helm of a New York-based hedge fund, Fortress Investment Group (FIG), and putting his mansion up for sale. Yet Mudd didn’t really leave Fannie Mae behind. In December 2011 the Securities and Exchange Commission sued him for allegedly misleading Fannie Mae investors about the company’s stake in subprime loans. Fortress directors offered to let Mudd stay on if he settled the matter quickly, according to two people with direct knowledge of the board’s thinking. Instead, he left Fortress to fight the charges full-time. His stint at Fannie Mae “cost me two jobs,” says Mudd, 53. “I’ve told my legal team, ‘If you use the word “settle,” I will fire you.’ ”
In March, Mudd asked a federal judge to dismiss the SEC complaint on grounds that during his tenure Fannie Mae filed detailed data on risky loans the company held. His lawyers also argued that the SEC failed to show Mudd had a motive, financial or otherwise, to deceive shareholders. No ruling is expected on the motion to dismiss before June.
The stakes are high for both Mudd and the agency. Losing the case could cost him some of the millions he earned during his four years as Fannie Mae’s CEO and make him a symbol of the excesses that blew up the housing market. For the SEC, a failed lawsuit would heighten criticism from lawmakers and others that the agency hasn’t held enough top executives accountable for taking risks that led to the worst recession since the 1930s. “They’ve got to show some scalps,” said Adam Pritchard, a University of Michigan law professor who previously served in the SEC’s Office of the General Counsel. “Anybody can file a case. It’s another thing to win it.”
Mudd is the most prominent of six former executives of Fannie Mae and its smaller cousin, Freddie Mac (FMCC), who are accused in the SEC’s Dec. 16 lawsuit of deceiving investors about Fannie’s and Freddie’s subprime portfolios before souring mortgages sent the companies to the verge of bankruptcy. Shareholders were wiped out, and U.S. taxpayers have so far spent about $190 billion keeping the companies afloat. “Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” Robert Khuzami, director of the SEC’s enforcement division, said when the suit was filed, calling the disclosures “material misstatements.”
Mudd says his reputation and future are on the line in what he considers a witch hunt by an agency responding improperly to outside pressures. “I worked honestly and honorably, and I’m not going to roll over in the face of a baseless, politically motivated work of fiction,” he says.
The son of TV news anchor Roger Mudd, he grew up in Washington and attended Sidwell Friends, a Quaker school where presidents and other members of the capital’s elite send their children. He graduated from the University of Virginia and earned a degree in public administration from Harvard’s Kennedy School of Government.
By the time Mudd joined Fannie Mae as chief operating officer in 2000, then-CEO Franklin Raines and his predecessors had built the company into a dominant force in the market for 30-year fixed-rate mortgages. Fannie Mae and Freddie Mac operated like private businesses, while also benefiting from a congressional charter and implied government backing. They provided liquidity to the home loan market by buying mortgages from lenders and packaging them into securities that they guarantee.
Fannie Mae’s troubles began before Mudd became Raines’s deputy. The company’s accounting practices manipulated earnings statements so executives could maximize their bonuses, its regulator later reported. The regulator, the Office of Federal Enterprise Housing Oversight, also found that Mudd had failed to act on a subordinate’s report when accounting irregularities were brought to his attention in 2003. Mudd told the Senate Banking Committee that he had been “as shocked as anyone” to learn of the manipulation when it surfaced publicly in 2004. Most of the public blame fell on Raines. He was ousted and in 2008 settled a lawsuit filed by Fannie Mae’s overseer saying he wasn’t acknowledging guilt while agreeing to pay back $25 million of the $90 million he had earned as CEO since 1998.
Fannie Mae’s board installed Mudd as CEO in Raines’s place in 2005. Colleagues nicknamed him “Harry Houdini,” according to one former staff member, since he was promoted rather than sanctioned. “Mudd should never have been permitted to be Raines’s successor,” says William K. Black, a professor of economics and law at the University of Missouri at Kansas City and a former bank regulator. “Mudd was part of the Raines regime. It was just an unconscionable mistake.”
Mudd says he saw the move as a call to duty: “I took the job at the request of the board with the approval of the government in the middle of an accounting scandal where, in the middle of the night, the CEO, the CFO, the accountant, the internal auditor, the outside auditor, and the lawyer had all been fired.” From 2006 to 2008, the time at issue in the lawsuit, Mudd earned almost $24 million in taxable compensation, according to the SEC.
At the core of the SEC’s suit is the question of how to define subprime loans and reduced-documentation loans known as Alt-A mortgages. The agency alleges that Mudd and his codefendants failed to disclose the full amount of such mortgages held or guaranteed by Fannie Mae. Mudd and his codefendants say there was no universal definition. In his motion to dismiss the lawsuit, Mudd says Fannie Mae “explicitly defined” subprime and Alt-A loans in its public filings and then “accurately disclosed the amounts” that were in the company’s portfolio.
Part of the SEC’s legal theory against Mudd and the other executives failed last year before U.S. District Court Judge Paul Crotty, who will be hearing the matter in New York. Crotty threw out shareholder claims, based on financial disclosures, that Mudd and other Fannie Mae executives didn’t warn investors about the company’s exposure to subprime mortgages. Ruling in a suit filed on behalf of government pension funds in Massachusetts and Tennessee, and other investors, the judge found that Fannie Mae’s public filings explicitly warned about the risks of subprime and Alt-A loans. Crotty allowed the shareholder suit to move forward with claims based on internal company e-mails—messages that also are part of the SEC suit. They allegedly show that Mudd and other executives knew the company’s risk management was flawed. The SEC suit “will be a very complicated and long case,” says Charles Carberry, a partner at law firm Jones Day, who isn’t representing any of the parties. “It’s going to be a battle of the experts.”
Now that he has his legal team in place, Mudd says he won’t keep his life on hold and he’s begun to think about what his next job might be. He says he would be up for the challenge of managing or restructuring a private company. “At some level,” Mudd says, “I’m not really afraid of messy situations.”