Fannie Mae Conservator Sued by Pension Funds Over Recovery Limit

A pension fund investors group sued Fannie Mae’s conservator over a rule that could limit their recovery for damages stemming from securities fraud.

The Ohio Public Employees Retirement System and the State Teachers Retirement System of Ohio asked a federal judge in Washington yesterday to throw out the Federal Housing Finance Agency rule, which sets the priority for payment of unsecured claims against Fannie Mae and Freddie Mac, the home mortgage finance companies now under government control.

The pension funds argue that the rule, which took effect July 20, violates the Appointments Clause of the U.S. Constitution and the Housing and Economic Recovery Act because Edward DeMarco, FHFA’s acting director, who imposed it, has been in his position for almost two years without Senate confirmation.

“If Fannie Mae’s officers -- the very individuals responsible for the fraud -- sued the company to recover their attorney’s fees, their claims would receive priority over plaintiffs’ valid securities fraud claims,” the shareholders allege in the lawsuit.

Stefanie Johnson, an FHFA spokeswoman, declined to comment on the filing.

Safety and Soundness

The FHFA is charged with protecting the safety and soundness of the two companies while they are reliant on government aid.

Paying damages on securities lawsuits could leave fewer resources to pay higher priority claims, the FHFA wrote when it proposed the rule a year ago.

“Indeed, paying such claims on a first-come, first-served basis during conservatorship could induce a ‘run on the conservatorship’ with severe adverse repercussions” on efforts to rehabilitate the companies, the FHFA wrote.

The pension funds are the lead plaintiffs in a lawsuit filed in 2004 related to a $6.3 billion overstatement of earnings. The defendants include Fannie Mae, its former Chairman Franklin Raines, two other former executives and KPMG, a former company auditor.

Federal investigators in 2006 accused Raines and other executives of overstating profit from 2001 until June 2004 to meet targets and trigger bonuses. Raines denies the accusation.

Stock Purchase

In 2008, the U.S. Treasury Department took control of Fannie Mae and Freddie Mac through a stock purchase that promised government aid to the companies to keep them solvent.

The stock purchase, made possible by the Housing and Economic Recovery Act of 2008, allowed Fannie Mae and Freddie Mac to draw funds to maintain a positive net worth.

In the rule, FHFA subordinated certain claims, including damages arising from shareholder lawsuits. Richard Cordray, then Ohio’s attorney general, raised objections to that design as it was being considered last year.

The rule “would have a devastating impact on millions of beneficiaries of public, union and private pension plans and taxpayers in Ohio and other states who suffered substantial damages as a result of the fraud at Fannie Mae and Freddie Mac,” Cordray wrote in an August 2010 letter to FHFA.

Cordray is now the nominee to head the U.S. Consumer Financial Protection Bureau.

When it issued its final rule in June, the FHFA called shareholder plaintiff concerns “unfounded.”

The case is Ohio Public Employees Retirement System v. Federal Housing Finance Agency, 11-cv-01543, U.S. District Court, District of Columbia (Washington).

To contact the reporters on this story: Tom Schoenberg in Washington at tschoenberg@bloomberg.net; Lorraine Woellert in Washington at lwoellert@bloomberg.net.

To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net; Lawrence Roberts at lroberts13@bloomberg.net

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