Dodd-Frank Forces Early Call in SEC Probe of Fannie Mae’s Mudd

Former Head of Fannie Mae Daniel Mudd
Daniel Mudd, former president and chief executive officer of Fannie Mae. Photographer: Brendan Hoffman/Bloomberg

Last March the U.S. Securities and Exchange Commission told Daniel Mudd, former head of Fannie Mae, that he could face claims for his role in the firm’s collapse. He may be the first chief executive officer to benefit from a rule that regulators sue or drop such cases within six months.

The 180-day deadline set out in last year’s Dodd-Frank regulatory overhaul expires today for Mudd. SEC lawyers can only get an extension if they formally justify it to their bosses.

Mudd’s situation highlights a dilemma for the agency, which has been faulted both for letting probe targets languish and for shutting investigations too quickly, causing the SEC to miss frauds including Bernard L. Madoff’s Ponzi scheme.

“The government does have a role in giving respondents peace of mind if an investigation isn’t going to continue,” said James Cox, a securities law professor at Duke University in Durham, North Carolina. “At the same time, there’s a natural reluctance. Nobody wants to be the one who closes the file on the next Bernie Madoff.”

The Dodd-Frank time limit applies to cases in which the SEC has sent so-called Wells notices telling individuals they may face a lawsuit. An unintended consequence may be that fewer people will learn they’re being probed. Since the agency isn’t required to make such notifications, some SEC lawyers have been postponing sending the notices to avoid starting the 180-day clock, according to a person familiar with the process who spoke on condition of anonymity.

Fannie and Freddie

Mudd, now chief executive officer of Fortress Investment Group LLC, received a Wells notice on March 11. Under the SEC’s rules investigators aren’t required to notify him if the inquiry is closed or extended.

Mudd, who hasn’t been accused of wrongdoing, declined to comment yesterday. John Nester, a spokesman for the SEC, declined to comment on notification procedures or the Mudd matter.

The SEC’s investigation of Mudd, Fannie Mae and its smaller sibling, Freddie Mac, centers on whether the government-sponsored mortgage finance firms told investors enough about the risky loans they loaded into their portfolios as the housing market cratered in 2007 and 2008, according to people with direct knowledge of the matter who spoke on condition of anonymity because the probe isn’t public.

During Mudd’s tenure as Fannie Mae CEO, from 2004 through the government takeover in 2008, the mortgage company ramped up its business with lower-quality mortgages. Mudd told Congress in April 2007 that the firm’s exposure to subprime loans was “less than 2.5 percent of our book.” Regulators are examining whether he downplayed the risks.

Fannie Disclosures

After receiving the Wells notice, Mudd said that Fannie Mae’s disclosures had been previewed by federal regulators. He said the firm reported on its loan portfolio when he was in charge the same way it does now -- by breaking down the mortgages it holds by credit score, loans made to borrowers with less documentation and loan-to-value ratio.

Under the new Dodd-Frank rules, the SEC’s director of enforcement, Robert Khuzami, can grant investigators an extra 180 days to work a case, and beyond that, SEC commissioners have the power to extend the life of a probe indefinitely.

Khuzami requires the staff to explain in writing why a case involving a Wells notice is sufficiently complex to justify an extension, said the person with direct knowledge of the matter.

Novel Issues

An SEC internal form states that reasons for an extension may include the application of novel legal or policy issues, difficulty getting evidence from foreign jurisdictions or the need to coordinate with criminal authorities, the person said.

Khuzami has sent his staff the message that he won’t rubber-stamp the requests, the person said.

When Dodd-Frank was enacted in July 2010, the SEC started the 180-day clock for Wells notices that had been already been sent, meaning that the agency has since decided whether to close or extend those inquiries, the person said. Wells deadlines and extensions are tracked on a chart that is circulated regularly to senior enforcement staff, according to the person.

Investigators have likely made decisions about whether to extend related probes against former Freddie Mac executives, though they aren’t required to notify them. Donald Bisenius, the firm’s former executive vice president for single-family credit guarantee, and Anthony “Buddy” Piszel, who was Freddie Mac’s chief financial officer from November 2006 to September 2008, both received Wells notices before Mudd, according to public filings. Richard Syron, Freddie Mac’s former CEO, has also received a Wells notice, according to two people briefed on the matter. Bisenius, Piszel and Syron haven’t been accused of wrongdoing.

Litigation Costs

For individuals the price of uncertainty can be high because not everyone’s legal costs are covered by their firms. In Mudd’s case, Fannie Mae is footing the bills, spokeswoman Amy Bonitatibus said in an e-mail.

Registered brokers are also required to disclose if they’ve received a Wells notice. That stays in the broker’s public filings indefinitely if the probe isn’t formally closed, even if the case is no longer being actively pursued.

While the Dodd-Frank provision applies to individuals who have been notified -- not to firms that receive Wells notices -- the SEC’s April 2010 claims against Goldman Sachs Group Inc. gave political traction to the measure.

Goldman Case

The company’s executives said they were blindsided by the SEC lawsuit, which said Goldman Sachs misled investors in a mortgage-linked product known as Abacus. After receiving a Wells notice in July 2009, the firm submitted a response in September 2009 and employees were interviewed in the following months. Goldman Sachs executives said they thought the case went inactive. They said they were stunned nine months later when the SEC filed the suit, which the firm settled for $550 million in July 2010.

SEC Inspector General H. David Kotz said in a report that the agency didn’t notify Goldman Sachs prior to filing the lawsuit. According to the report, Goldman Sachs’s counsel called Khuzami and complained about not having had an opportunity to settle the claims. Khuzami responded that the SEC had no reason to believe that the firm was interested in settling, according to the report.

In testimony for the report, Goldman Sachs’s counsel said it was “contrary to decades of SEC experience” that the agency would file a lawsuit without giving the respondent a chance to propose a settlement.

In 2009, before Dodd-Frank, Khuzami took steps to overhaul the management of investigations, including hiring the division’s first chief operating officer to improve case flow. In a March speech at a securities law event in Phoenix, Khuzami said the time it takes to file an action fell by 11 percent in the past two years.

“This trend translates into more timely cases with greater deterrent impact, and a decrease in the uncertainty for the subjects of our investigations about their status,” he said.

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