Banking and Finance Law Daily Shareholders argue for remedy in remand of GSE conservatorship litigation
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Tuesday, July 27, 2021

Shareholders argue for remedy in remand of GSE conservatorship litigation

By Nicole D. Prysby, J.D.

Fannie Mae and Freddie Mac shareholders argued that the Fifth Circuit should place them in the position they would have been in, were it not for the unconstitutional removal protection for the FHFA Director.

Plaintiffs who sued the Federal Housing Finance Agency (FHFA) and Treasury Department over the treatment of Fannie Mae’s and Freddie Mac’s conservatorships filed a supplemental brief in the federal Fifth Circuit Court of Appeals, arguing that the unconstitutional removal restriction on the FHFA Director caused compensable harm. The plaintiffs asked the Fifth Circuit to put them in the position they would be in but for the constitutional violation. Specifically, the plaintiffs argued that the court should remand the case to the district court with instructions to enter a permanent injunction requiring, at a minimum, that defendants amend the purchase agreements to either: (1) reduce the liquidation preference on Treasury’s senior preferred stock to zero and end further increases to the liquidation preference except as necessary to offset any further draws on Treasury’s funding commitment; or (2) convert Treasury’s senior preferred stock to common stock (Collins v. Yellen, 5th Cir., Case No. 17-20364).

Background. Fannie Mae and Freddie Mac shareholders sought damages due to a 2012 amendment to the agreements between the FHFA and the Treasury Department under which the Treasury Department provided Fannie Mae and Freddie Mac needed capital in exchange for preferred shares in the GSEs, liquidation preferences, dividends, and related rights. The agreements, which are part of Fannie Mae’s and Freddie Mac’s FHFA conservatorships, are commonly referred to as the Senior Preferred Stock Purchase Agreements, which are intended to ensure that Fannie Mae and Freddie Mac, respectively provide stability to the financial markets; prevent disruptions in the availability of mortgage finance; and protect the taxpayer. The 2012 amendment is known as the "third amendment."

The shareholders’ lawsuit claimed that the third amendment exceeded the FHFA’s statutory authority under the Housing and Economic Recovery Act of 2008 (Recovery Act) and constitutional grounds in that the FHFA’s structure violates the separation of powers because the FHFA is led by a single director, removable by the President only for cause. In June 2021, the U.S. Supreme Court handed the shareholders a partial victory (see Banking and Finance Law Daily, June 23, 2021). As to the constitutional claim, the Court held that the Recovery Act’s restriction on the President’s power to remove the FHFA Director was a violation of the U.S. Constitution’s separation-of-powers provision. The Court found that the shareholders no longer have a live claim for prospective relief, but retrospective relief was at least possible and should be resolved by the lower courts.

Plaintiffs’ proposed remedy. Plaintiffs filed a supplemental brief in the Fifth Circuit, arguing that the Fifth Circuit should remand the case to the district court to enter appropriate injunctive relief or, in the alternative, send the case back to the district court so that plaintiffs can take discovery into disputed factual issues that are relevant after the Supreme Court’s decision.

The brief argued that the unconstitutional removal restriction caused compensable harm because President Donald Trump undoubtedly would have removed and replaced Director Watt (appointed by President Barack Obama) immediately upon taking office but for the unconstitutional statutory removal restriction. As to an appropriate remedy, plaintiffs argued that they should be restored to the position they would be in but for the constitutional violation. The steps the Trump Administration took towards housing finance reform after Director Watt’s departure, plaintiffs asserted, provide insight into what additional actions the Administration would have taken. Shortly after Director Watt’s term ended, a presidential memorandum directed Treasury to consult with the FHFA and develop a plan for ending the conservatorships of Fannie and Freddie.

The Treasury Dept. responded to the presidential memorandum with a September 2019 plan for reforming the housing finance system, ending the conservatorships, and recapitalizing the government-sponsored enterprises. In the months that followed release of the Treasury’s plan, Director Calabria set about pursuing recapitalization of Fannie Mae and Freddie Mac through a new stock issuance. Had the Treasury and FHFA been able to begin pursuing these reforms immediately when Trump took office, it is highly likely that the purchase agreements would have been amended to either: (1) reduce the liquidation preference on Treasury’s senior preferred stock to zero and end further increases to the liquidation preference so long as the Enterprises did not make further draws on Treasury’s funding commitment; or (2) convert Treasury’s senior preferred stock to common stock. Either change would have directly benefitted plaintiffs by making it possible for them to receive dividends if the Enterprises continued their strong financial performance and liquidation payments if they failed. Rather than completing these steps, because of the unconstitutional restriction on presidential removal of Director Watt, the Administration ran out of time.

To remedy the constitutional violation, plaintiffs argued, the court should order the defendants to do what would have been done but for Director Watt’s unconstitutional removal protection. At a minimum, an appropriate injunction must require the defendants to either reduce the liquidation preference to zero or convert the Treasury’s senior preferred stock to common stock.

Finally, the plaintiffs argued that any uncertainty about what the Trump Administration would have done but for Direct Watt’s unconstitutional removal protection should be resolved in plaintiffs’ favor.

Companies: Fannie Mae, Freddie Mac

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