Banking and Finance Law Daily Federal government brief argues that Net Worth Sweep is valid exercise of power
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Wednesday, August 19, 2020

Federal government brief argues that Net Worth Sweep is valid exercise of power

By J. Preston Carter, J.D., LL.M.

According to the government’s Supreme Court brief, the Housing and Economic Recovery Act’s succession clause and anti-injunction clause foreclose shareholders’ challenge to the legality of giving Fannie Mae’s and Freddie Mac’s net worth to Treasury on a periodic basis as compensation for capital infusions.

In a merit brief to the U.S. Supreme Court, the federal government contends that an agreement between the Federal Housing Finance Agency and the Treasury Department that has been diverting the Government Sponsored Enterprises’ (GSEs) net worth to the Treasury (New Worth Sweep) does not violate the Housing and Economic Recovery Act (Mnuchin v. Collins, Docket No. 19-563). The government argues that two separate provisions of the Recovery Act—the succession clause and the anti-injunction clause—foreclose that challenge.

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 Fannie Mae and Freddie Mac (the GSEs). 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.

The Supreme Court accepted the government’s petition to review the Fifth Circuit’s decision that the Recovery Act allows Fannie Mae and Freddie Mac shareholders to sue over the validity of the Net Worth Sweep (see Banking and Finance Law Daily, July 10, 2020.).

Succession clause argument. The government argues that the Recovery Act’s succession clause—which vests in FHFA, as conservator, the shareholders’ "rights * * * with respect to the [enterprises] and the[ir] assets," including the right to bring derivative suits on behalf of the enterprises (12 U.S.C. 4617(b)(2)(A)(i))—precludes shareholders from challenging FHFA’s adoption of the Third Amendment. The government acknowledges that one of the traditional rights of a corporate shareholder is the right, in certain circumstances, to bring a derivative suit, that is, a suit on behalf of and for the benefit of the corporation. However, the brief contends, "it is clear and undisputed that the succession clause generally eliminates the shareholders’ right to bring derivative suits during a conservatorship."

According to the government, the suit is derivative. The shareholders’ complaint alleges that the Third Amendment harms the GSEs by requiring them to turn over their net worth. The relief sought "might put more money in the enterprises’ coffers but would not directly add any money to the shareholders’ personal bank accounts," according to the government. Therefore, the brief states, the challenge is derivative, and the succession clause bars it.

The brief also argues that the court of appeals erred in holding that the succession clause does not bar the shareholders’ claim simply because the shareholders have invoked the Administrative Procedures Act cause of action. The APA’s right of review, the government contends, neither displaces separate limitations on review nor transforms the claim from derivative to direct. The shareholders also may not invoke a "conflict of interest" exception to the succession clause. The text contains no such exception, and the context refutes it, the government argues.

Anti-injunction clause argument. 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)), precludes judicial invalidation of the Third Amendment. The brief states that FHFA exercises "broad powers and functions as conservator." The Recovery Act empowers the conservator to take actions that "may be" "necessary" to put the enterprises "in a sound and solvent condition" and "appropriate" to "preserve and conserve the[ir] assets and property." The brief contends that the Third Amendment "falls well within those statutory powers."

The government noted that, at the time of the Third Amendment, the enterprises collectively owed an annual dividend to Treasury of roughly $19 billion. If the conservator were to continue its practice of paying the dividend by drawing on Treasury’s commitment of capital to the GSE, the brief reasoned, Treasury’s capital commitment would soon have become capped, creating a possibility that the ever-increasing dividend would have consumed the remainder of the commitment backstopping the GSEs’ vital operations. According to the government, the Net Worth Sweep eliminated any need for the GSEs to draw on Treasury’s commitment in order to pay their dividends, and "it was permissible for the conservator to conclude that the Amendment may have been appropriate to preserve and conserve the commitment and necessary to put the enterprises in a sound and solvent condition."

Therefore, the brief concluded, the Third Amendment falls within FHFA’s broad powers as conservator, the anti-injunction clause bars the shareholders’ challenge to it. Moreover, the brief stated, in reaching the contrary conclusion, the Fifth Circuit broke from the five other courts of appeals that have considered the question."

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

MainStory: TopStory GovernmentSponsoredEnterprises SupremeCtNews

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