February 17 2014
Did the Fannie and Freddie Bailout Involve Securities Fraud?
Jillian Kay Melchior
The U.S. Treasury decided that private shareholders in Fannie Mae and Freddie Mac would receive no future profits from the firms — but it neglected to mention that crucial fact to investors.
Though the policy dates back to at least 2010, news of this restriction has just now been released, as the New York Times reports:
This month, an internal United States Treasury memo that outlined this restriction came up at a forum in Washington.
The memo was addressed to Timothy F. Geithner, then the Treasury secretary, from Jeffrey A. Goldstein, then the under secretary for domestic finance. In discussing Fannie and Freddie, the beleaguered government-sponsored enterprises rescued by taxpayers in September 2008, the memo referred to “the administration’s commitment to ensure existing common equity holders will not have access to any positive earnings from the G.S.E.’s in the future.”
The memo, which was produced in a lawsuit filed by Fannie and Freddie shareholders, was dated Dec. 20, 2010. Securities laws require material information — that is, information that might affect an investor’s view of a company — to be disclosed.
That the government would deny a company’s shareholders all its profits certainly seems material, but the existence of this policy cannot be found in the financial filings of Fannie Mae. Neither have the Treasury’s discussions about the future of the two finance giants mentioned the administration’s commitment to shut common stockholders out of future earnings.
Freddie Mac’s filings do refer, albeit incompletely, to the administration’s stance, noting that the Treasury “has indicated that it remains committed to protecting taxpayers and ensuring that our future positive earnings are returned to taxpayers as compensation for their investment.” Note that this reference does not say all earnings.
It would have been one thing if the Treasury had barred shareholders from profits until taxpayers were repaid for the Fannie and Freddie bailouts, but an undisclosed and permanent ban on profits is extreme, especially for those who bought in when times were hard. It’s not quite nationalization, as Fannie and Freddie are both government-sponsored enterprises, but Treasury’s actions could be reasonably interpreted as a kind of seizure of private assets. After all, who would invest in a stock knowing that any of the firm’s earnings would basically be confiscated?
Leading securities lawyer James R. Cummins tells National Review Online: “This was a material bit of non-disclosed information that the shareholders of Fannie Mae would have wanted to know, and anyone thinking about buying the stock even at its depressed level would have wanted to know this because the economic effect is that no matter how hard Fannie Mae management works, and no matter how much it grows the business, the shareholders are never going to get anything. It’s so contrary to the U.S. model of rewarding basic capital that it’s clearly something that everyone would have wanted to know about.”
Though Cummins said he couldn’t yet call Treasury’s behavior outright securities fraud, he anticipates that investors will sue over the omission.
“It would be like an appropriation of by the Soviet Union of private industry,” Cummins says, adding that “it happens all over the world, but it’s not supposed to happen here in the U.S.”
— Jillian Kay Melchior writes for National Review as a Thomas L. Rhodes Fellow for the Franklin Center. She is also a senior fellow for the Independent Women’s Forum.