Banking and Finance Law Daily Fannie, Freddie shareholders barred from contesting Net Worth Sweep, government brief argues
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Monday, October 26, 2020

Fannie, Freddie shareholders barred from contesting Net Worth Sweep, government brief argues

By Charles A. Menke, J.D.

According to the federal government’s Supreme Court brief, the Housing and Economic Recovery Act’s succession clause and anti-injunction clause bar the shareholders’ statutory challenge, and any constitutional defect in the FHFA’s structure has no prejudicial effect.

In a reply and response brief to the U.S. Supreme Court, the federal government contends that shareholders of Fannie Mae and Freddie Mac (the Enterprises) have failed to justify invalidating an agreement between the Federal Housing Finance Agency and the Treasury Department that has been diverting the Enterprises’ net worth to the Treasury (New Worth Sweep) and that does not violate the Housing and Economic Recovery Act (Collins v. Mnuchin, Docket No. 19-422 and Mnuchin v. Collins, Docket No. 19-563). The government argues that the shareholders have failed to have overcome the Recovery Act’s sweeping grant of power to the Federal Housing Finance Agency as conservator of the Enterprises or the strict limits on judicial interference with that power. In addition, while the shareholders also argue that the FHFA’s structure violates the separation of powers, that defect has no prejudicial effect on the agreement, according to the federal government.

Background. During the financial crisis in 2008, the Director of the FHFA exercised his authority under a federal statute to appoint the FHFA as conservator of the Enterprises. The FHFA, as conservator, negotiated agreements with Treasury under which Treasury committed to investing billions of dollars in the enterprises in return for compensation consisting, in part, of dividends tied to the amount invested. In 2012, after numerous quarters in which the enterprises’ dividend obligations exceeded their total earnings—causing the enterprises to draw additional capital from Treasury just to pay dividends to Treasury—FHFA and Treasury amended the purchase agreements a third time. The Third Amendment replaced the fixed dividends with variable quarterly dividends tied to the enterprises’ net worth—the Net Worth Sweep.

Supreme Court review. The Supreme Court accepted the government’s petition to review the Fifth Circuit’s decision that the Recovery Act allows the Enterprises’ shareholders to sue over the validity of the Net Worth Sweep (see Banking and Finance Law Daily, July 10, 2020). The High Court is scheduled to hear oral arguments on Dec. 9, 2020 (see Banking and Finance Law Daily, Sept. 17, 2020).

Succession clause. The Recovery Act’s succession clause bars the shareholders’ statutory challenge because the clause bars derivative suits during a conservatorship, the government brief argues. While the shareholders contend that their suit is direct, "corporation law treats a suit as derivative where, as here, it alleges diversion of corporate assets." In addition, the Administrative Procedure Act does not displace the Recovery Act’s limits on review and does not otherwise transform a derivative action into a direct action. Lastly, in response the shareholders’ claim that the FHFA has a conflict of interest in deciding whether the enterprises may sue, the government contends the succession clause does not contain any conflict of interest exception.

Anti-injunction clause. The government also argues that the Recovery Act’s anti-injunction clause, which prohibits courts from taking any action that would "restrain or affect the exercise of powers or functions of the Agency as a conservator" (12 U.S.C. §4617(f)), bars the shareholders’ suit. According to the brief, the Third Amendment falls within the FHFA’s broad powers as conservator and the shareholders’ allegations "confirm that the Third Amendment performs a classic conservatorship task: renegotiating financial obligations in light of their past and potential future effects on the corporate wards." Moreover, while the shareholders question the conservator’s motives and dispute the necessity and wisdom of the Third Amendment, as well as proposing alternative measures, Congress entrusted those judgments to the FHFA alone.

Constitutional defect. The government acknowledges that in light of the Court’s decision last term in Seila Law LLC v. CFPB, 140 S. Ct. 2183 (2020), the Recovery Act’s removal clause, which makes the FHFA Director removable only for cause, violates the separation of powers. The brief argues, however, that the removal clause is severable from the rest of the statute. Furthermore, the constitutional defect in the FHFA’s structure does not support invalidating the Third Amendment because, while the removal clause violates the Constitution, the Third Amendment does not since it was approved by an Acting Director of FHFA whom the President could displace at will, not by a Director removable only for cause. In addition, "the [Third] Amendment was the business action of a conservator standing in the shoes of private corporations, not an exercise of the executive power" the brief states. The government additionally argues that the shareholders’ constitutional claims are subject to remedial limitations that bar the invalidation of the Third Amendment, including the harmless-error rule and laches.

Attorneys: Attorneys: Jeffrey B. Wall, U.S. Department of Justice, for Steven T. Mnuchin. Charles Justin Cooper (Cooper & Kirk, PLLC) for Patrick J. Collins.

Companies: Fannie Mae; Freddie Mac

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