A
federal judge ruled that an SEC action alleging securities fraud against the
former CEO of Fannie Mae for misleading investors about the GSE’s level of
exposure to risky subprime loans could proceed. The court, using the recent
Second Circuit test for substantial assistance announced in SEC v. Apuzzo, held
that aiding abetting fraud charges against the CEO and two other former Fannie
Mae senior officers, the chief risk officer and an executive vice president,
could also proceed. As a threshold matter, the court said that the Federal
National Mortgage Association is not an exempt independent establishment of the
United States
under Section 3(c) of the Exchange Act. (SEC v. Mudd, et al., 11 Civ. 09202,
Aug. 10, 2012)
Rather,
Fannie Mae is a private corporation whose stock is listed on the exchange and
is publicly traded. FNMA is managed and
controlled by a board of directors, noted the court, who are elected by the
shareholders. FNMA pays its own way; it raises its operational expenses by
generating revenue and does not receive federal appropriations. Of course, conceded the court, FNMA furthers
an important federal mission and is subject to regulation by HUD, but these
facts are not dispositive when weighed against the other factors. Additional
external indicia supported the court’s conclusion: the defendants in this action are not
represented by the federal government; money judgments against FNMA are not
paid from the US Treasury; and FNMA is not exempt from federal taxes.
Moreover,
the court noted that Congress had two opportunities to designate FNMA an
independent establishment within the meaning of Section 3(c), in 1938, when
FNMA was created, and in 1968, when FNMA was reorganized into a government sponsored
private corporation, but Congress never designated FNMA as an independent establishment.
FNMA is
a shareholder-owned private corporation that voluntarily registered under the
Exchange Act in 2003, and has since then been required to file periodic and
current reports with the SEC. In registering under the Exchange Act, FNMA
explicitly acknowledged that voluntary Exchange Act registration would also
subject Fannie Mae to the provisions of the Exchange Act, and to the SEC’s
enforcement jurisdiction thereunder.
The
court also reasoned that, as a matter of policy, exempting FNMA’s employees
from liability for their false and misleading public statements would
contravene the Exchange Act’s purpose of protecting the investing public from
false public filings. Accordingly, the
Exchange Act’s purpose suggests that Section 3(c) does not apply to FNMA or the
defendants. The court concluded that
FNMA is not an independent establishment under Section 3(c), and that the defendants
are not exempt from liability.
The
court also ruled that the SEC adequately alleged that FNMA’s quantitative
subprime and reduced documentation loans were false because they failed to
include all loans that fell within FNMA’s subprime and reduced documentation description.
Thus, the SEC has adequately alleged that FNMA’s quantitative subprime
disclosures were misleading.
The SEC
adequately alleged that FNMA and the CEO committed a primary securities law
violation by materially misstating FNMA’s subprime and reduced documentation
loan exposure, and that the defendants had actual knowledge of this violation.
To state an aiding and abetting claim under Section 20(e) of the Exchange Act,
the SEC must also adequately allege substantial assistance by the aider and
abettor in the primary securities fraud.
Employing
a standard very recently announced by the Second Circuit Court of Appeals in
SEC v. Apuzzo, the district court said that in order to satisfy the substantial
assistance component of aiding and abetting the SEC must show that defendants
in some sort associated themselves with the venture, that they participated in
it as in something that they wished to bring about, and that they sought by
their actions to make it succeed. The SEC has done so here, said the court.
The SEC
plausibly alleged that the CEO, the chief risk officer and the executive vice
president consciously assisted the venture to misstate FNMA’s subprime and
reduced loan documentation exposure in
an active way. The SEC said that they received and reviewed FNMA’s periodic
filings and that the chief risk officer drafted FNMA’s first definition of
subprime, contained in its Form12b-25. The CEO commented on multiple drafts of
each periodic filing and met with the other two senior officers individually to
discuss the SEC filings. The CEO signed,
and the other two defendants sub-certified, all of FNMA’s 10-Ks and 10-Qs
during the relevant period, and approved the Form 12b-25.
Further,
the SEC alleged that the CEO and the chief risk officer spoke to investors on
conference calls and repeated FNMA’s misleading disclosures while emphasizing
that FNMA’s subprime exposure was “immaterial,” and constituted approximately
“zero percent” of FNMA’s book of business. In the court’s view, these
allegations were sufficient at this juncture to show that the senior officers
associated themselves with the venture, participated in it as in something that
they wished to bring about, and sought by their actions to make it succeed. The
court denied the defendant’s motion to dismiss the SEC’s complaint.