Ex-Fannie Chief Girds for Battle With SEC Over Disclosure
After the U.S. government snatched Fannie Mae (FNMA) from the brink of collapse in 2008 and forced out its chief executive officer, Daniel H. Mudd, he headed for the river.
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. Within months, he put his $9.5 million Washington mansion up for sale and took the helm at a New York-based hedge fund, Fortress Investment Group. (FIG)
Mudd didn’t really leave Fannie Mae behind. U.S. regulators sued him in December for allegedly misleading the mortgage company’s investors about its stake in subprime loans. Now Mudd has lost another CEO post and again he’s preparing for battle.
Fortress directors offered to let Mudd stay on if he settled the matter quickly with the Securities and Exchange Commission, according to two people with direct knowledge of the board’s thinking. Instead, he left to work full-time on a case that legal analysts say is far from a slam-dunk for the SEC.
His stint at Fannie Mae “cost me two jobs,” Mudd, 53, said in an interview. “I’ve told my legal team, ‘If you use the word ‘settle,’ I will fire you.’”
Last month he asked a federal judge to dismiss the complaint on the 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 that Mudd had a motive, financial or otherwise, for deceiving shareholders.
The stakes are high for Mudd and the agency. Losing the case could cost Mudd 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.”
While the SEC reports on its website that it has brought claims related to the credit crisis against 55 senior U.S. corporate officers, few have been well-known names from big institutions. SEC lawyers have been publicly lectured by two federal judges about the scope of their efforts.
“When you bring this long complaint and make it sound like there have been all these misdeeds, who’s responsible?” U.S. District Court Ellen Huvelle, who reviewed a proposed $75 million settlement with Citigroup, said during a 2010 hearing in Washington. “These things don’t happen without individuals.”
Mudd is the most prominent of six former executives of Fannie Mae and its smaller cousin, Freddie Mac, who are accused in the SEC’s Dec. 16 lawsuit of defrauding investors about their subprime portfolios before souring mortgages sent the companies to the verge of bankruptcy and led to their federal takeover. Shareholders were wiped out and, so far, U.S. taxpayers have spent about $190 billion keeping the companies afloat.
“Fannie Mae and Freddie Mac (FMCC) 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.”
Still, the lawsuit, which also names Freddie Mac chief executive Richard F. Syron, highlights how hard it’s been for the SEC to find direct evidence that top corporate executives ordered or were complicit in deception.
‘Battle of Experts’
The SEC’s court filings suggest the outcome will hinge on the technicalities of the language in the companies’ public disclosures. Veterans of some similar cases say that while Mudd’s management at Fannie Mae is open to criticism, regulators may face a challenge convincing a jury that the financial statements were misleading because there’s no universal agreement on the definition of subprime loans.
“It’s going to be a battle of the experts,” said Charles M. Carberry, a partner at the law firm of Jones, Day in New York, who isn’t representing any of the parties. Of the SEC, he said, “You wonder what their ultimate theory is.”
The SEC didn’t respond to requests for comment.
Mudd said his reputation and future is 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 said.
Mudd arrived at Fannie Mae as chief operating officer in 2000 after a career at GE Capital, where he had been president of the company’s Asia-Pacific operations in the late 1990s.
The son of television 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 have sent their children. Mudd 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, 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 originators and packaging them into securities on which they guarantee the interest rate. They also bought some mortgages to hold on their books.
Fannie Mae’s troubles began before Mudd became Raines’ chief operating officer. 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, who was ousted and forced by Fannie Mae’s overseer to pay back $25 million of the $90 million he had earned as CEO since 1998. The SEC didn’t file claims against any individual, nor did the Justice Department file criminal charges.
Fannie Mae’s board installed Mudd as chief executive in Raines’ place in 2005. Colleagues nicknamed him “Harry Houdini,” according to one former staff member, since he got promoted rather than sanctioned.
Outsiders also were surprised.
“Mudd should never have been permitted to be Raines’ successor,” William K. Black, a professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “Mudd was part of the Raines regime. It was just an unconscionable mistake.”
Mudd said in the interview that 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,” he said.
From 2006 to 2008, the time at issue in the lawsuit, Mudd earned almost $24 million in taxable compensation, according to the SEC.
Footsteps of Democrats
Mudd, a Republican, represented a political shift from his predecessors. Raines was a Democrat who worked in the administrations of presidents Bill Clinton and Jimmy Carter. He left Fannie Mae with a $19 million severance package and a $1 million annual pension. Raines’ predecessor, Jim Johnson, an adviser to Democrat Walter Mondale’s 1984 presidential campaign who earned a total of $100 million at Fannie Mae, receives an annual pension of $900,000.
While at Fannie Mae, Mudd donated to members of both parties, federal election records show. He also gave $5,000 to the Susan B. Anthony List, a political action committee that funds anti-abortion candidates and where his wife, Maura, is a board member. Maura Mudd donated $5,000 in 2010 to a PAC run by Representative Michele Bachmann of Minnesota, who made a bid for the 2012 Republican presidential nomination.
At Fannie Mae, Mudd also tried to mend fences with lawmakers who had been at odds with Raines. He apologized to Congress for the company’s accounting scandal.
Fannie Mae had begun purchasing riskier mortgages under Raines in the 1990s, as Congress required the government-sponsored companies to help lower-income families buy homes. That expanded under Mudd.
Defining the Terms
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. The agency alleges that Mudd and his co-defendants failed to disclose the full amount of such mortgages held or guaranteed by Fannie Mae. Mudd and his co-defendants say there was no universal definition. Instead, Mudd said in his motion to dismiss the lawsuit, 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.
In its court filings, the SEC said Mudd signed disclosures saying the company had about $8 billion in subprime loans and $300 billion in Alt-A reduced-documentation loans. In reality, the SEC said, the company’s subprime holdings exceeded $100 billion and its Alt-A holdings exceeded $600 billion.
In April 2007, Mudd said in testimony before lawmakers that the firm’s exposure to subprime loans “remains minimal, less than 2.5 percent of our book.” Fannie Mae’s book of business for single-family mortgages was $2.65 trillion in 2007.
The SEC’s suit alleges that Mudd didn’t disclose the full scope of its Alt-A loans, counting only mortgages in which the borrowers requested reduced documentation, not those loans issued when lenders themselves decided to skip the paperwork. Mudd also improperly excluded about $43 billion in loans in the company’s “Expanded Approval” program, which went to borrowers with weaker credit history, the SEC claims.
Some of Mudd’s critics see merit in his argument about Fannie Mae’s filings. “The SEC has this really difficult complaint about disclosures of the numbers,” Black said.
The SEC may cite other evidence to support its theory, including an e-mail that was uncovered and publicized by the Financial Crisis Inquiry Commission in 2010. In the message, which was sent two months after Mudd’s testimony before Congress in 2007, Fannie Mae Chief Risk Officer Enrico Dallavecchia warned Mudd that the company wasn’t adequately managing risk.
‘Not Even Close’
“We are not even close to having proper control processes for credit, market, and operational risk,” wrote Dallavecchia, now one of Mudd’s co-defendants in the SEC suit.
Through his attorney, Kelly Kramer, Dallavecchia declined to comment.
Dallavecchia’s e-mail proved prophetic. In the year that followed, losses on risky loans pushed Fannie Mae and Freddie Mac toward insolvency.
On the afternoon of Sept. 5, 2008, Mudd was summoned to a meeting at the Federal Housing Finance Agency, the agency that now oversaw Fannie Mae. He found Treasury Secretary Hank Paulson, Federal Reserve Board Chairman Ben S. Bernanke and FHFA director James Lockhart in the room. Fannie Mae was being taken over by the government, he was told. He was out of a job.
While the FHFA blocked his $8 million severance, he took with him pension and 401(k) benefits totaling $5.6 million. For now, most of Mudd’s legal fees are being covered by Fannie Mae’s insurance company, which has paid out nearly $100 million to defend Raines and other former executives in other cases.
In 2009, Mudd took over at Fortress, a publicly traded hedge fund and private-equity firm that manages about $43.7 billion, including two independently run companies that specialize in real estate. Mudd had gotten to know Fortress’s co-chairman, Peter Briger Jr., while the two worked in finance in Asia during the 1990s, and Mudd had served on the company’s board during his time at Fannie Mae.
In the fall of that year, Mudd, his wife and four children moved into a 15,000-square-foot home in Greenwich, Connecticut, that they bought for $6.5 million.
During Mudd’s tenure, a Fortress unit benefited from doing business with Fannie Mae, though Mudd said in an interview that he had nothing to do with the transaction.
The hedge fund had purchased the subprime mortgage arm of homebuilder Centex in 2006, renamed it Nationstar, and transformed it into a servicer of troubled loans. Its annual revenues more than quintupled from 2009 to 2011, from $62 million to $334 million, largely due to its contracts with Fannie Mae and to a lesser degree Freddie Mac, according to disclosures filed with the SEC.
About half of the more than $100 billion in loans that Nationstar now services are either Fannie Mae loans on which the company has purchased the servicing rights, or loans that Nationstar services under contract to Fannie Mae.
Nationstar went public March 7, rising to $14.14 yesterday after pricing 16.7 million shares at $14 in the initial public offering. Fortress retains a 77 percent stake.
“During his time as CEO of Fortress, Dan Mudd had absolutely no involvement in investment decisions, client relationships or negotiations for our servicing businesses, including Nationstar,” Fortress spokesman Gordon Runté said.
A month after Mudd resigned from Fortress, Nationstar hired two of his former Fannie Mae lieutenants -- Harold Lewis as president and COO and David Hisey as chief financial officer.
Fannie Mae intruded on Mudd’s time at Fortress in another way. In 2010, Representative Darryl Issa, a California Republican who is chairman of the House Oversight and Government Reform Committee, announced that Mudd was one of dozens of Fannie Mae executives who between 1996 and 2008 received so-called “VIP loans” from Countrywide Financial, the troubled subprime lender later purchased by Bank of America Corp.
Mudd had refinanced his Washington home with Countrywide for $3 million in 2001. Countrywide executives said in e-mails that the firm was “taking a loss,” on Mudd’s loan, according to documents released by Issa.
In response to Issa’s allegation, Mudd said that he hadn’t received a special rate.
Part of the SEC’s legal theory against Mudd and the other executives already failed once before U.S. District Judge Paul A. Crotty, who will be hearing the matter in New York.
Last year 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. The judge found that Fannie Mae’s public filings explicitly warned investors about the risks of investing in subprime and Alt-A loans.
Crotty did allow 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.
Besides Mudd, Syron and Dallavecchia, the SEC’s December lawsuit names former Freddie Mac Executive Vice President Patricia Cook; Donald Bisenius, ex-senior vice president at Freddie Mac; and Thomas Lund, Fannie Mae’s former executive vice president.
The regulator is seeking financial penalties and an order barring the six from serving as officers or directors of other public companies. The SEC signed non-prosecution agreements with the companies themselves.
“This will be a very complicated and long case,” Carberry said. “It seems the theory has been discredited.”
Some longtime critics of Fannie Mae’s management say they see Mudd as the person left holding the bag, rather than the architect of practices that drove the company to ruin.
‘Guy at the Helm’
“He happened to be the guy at the helm when the ship sank,” said Bert Ely, a bank consultant based in Alexandria, Virginia. “I don’t feel he can be uniquely blamed for what happened.”
Mark Calabria, director of regulation studies at the Washington-based Cato Institute, which favors free markets, said Mudd inherited a lot of Fannie Mae’s problems.
“He clearly didn’t save the company,” Calabria said. “Whether he simply continued them on the path they were on is another question.”
Ironically, Mudd’s efforts to improve Fannie Mae’s SEC filings may have given regulators a better paper trail to use in building a case against him than they had for his predecessors, Calabria said.
“I suspect part of the reason he has gotten far more attention is that the SEC has more tools against him,” Calabria said.
Now that he has his legal team set up, Mudd said he’s begun to think about his next steps. He said he would be up for the challenge of managing or restructuring a private company.
“At some level,” Mudd said, “I’m not really afraid of messy situations.”
To contact the editor responsible for this story: Maura Reynolds at email@example.com