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Fannie Mae/Freddie Mac Securities Tumble Following Dismissal of Investor Suits Alleging Government Sweep of Profits to be Illegal

Posted on Thursday, October 2nd, 2014 at 6:51 pm    

On Tuesday, September 30, 2014, after the markets closed, U.S. District Judge Royce Lamberth issued an order dismissing lawsuits filed by Fairholme Capital Management LLC, Perry Capital LLC, and other shareholders, which claimed that the government acted illegally in 2012 when it enacted legislation requiring Fannie Mae and Freddie Mac to pay nearly all of their massive profits to the U.S. Treasury in the form of dividends. When the US government rescued Fannie Mae and Freddie Mac in 2008 and injected taxpayer funds, it gained an almost 80% stake in the companies, according to Bloomberg. For the past two years, the value of Fannie Mae and Freddie Mac securities had climbed based on speculation that shareholder rights to the earnings could be restored. During this time, financial advisors may improperly have recommended an investment in Fannie Mae and Freddie Mac as safe or conservative, or recommended this high risk, speculative investment to investors who had no interest in high risk, speculative investments.

Judge Lamberth’s dismissal of the lawsuits dashed those hopes. Fannie Mae’s common stock declined 37% to $1.70 the day after the ruling, while shares of Freddie Mac were down 38% to $1.65. Fannie Mae’s common stock started the year at $3.00, and opened at $2.83 on September 30. Freddie Mac common stock started the year at $2.90, and opened at $2.79 on September 30. In addition, some classes of the companies’ preferred shares fell by more than 50% after the ruling, according to the Wall Street Journal.

The legal actions dismissed by Judge Lamberth were a key part of a strategy by hedge fund investors to turn a huge profit on the securities of Fannie Mae and Freddie Mac. Hedge fund investors purchased Fannie Mae and Freddie Mac securities at a substantial discount after the government’s 2008 conservatorship, and intended to tap into the profits being paid to the Treasury Department. In particular, the investors sued for breach of contract over allegedly promised dividends and liquidation preferences, and what they called an illegal “taking” under the U.S. Constitution related to the enactment of the so-called sweep amendment in August 2012. The sweep amendment provided that all profits of the GSEs would go the Treasury’s senior preferred stock.

Judge Lamberth disagreed with the investors, and held that investors could not avoid the Housing and Economic Recovery Act signed into law by President George W. Bush, which created the Federal Housing Finance Agency and gave it the authority to place Fannie Mae and Freddie Mac into conservatorship and regulate the GSEs.

“It strikes this court as odd that a statute like HERA, through which Congress grants immense discretionary power to the conservator, and prohibits courts from interfering with the exercise of such power, would still house an implicit end-run around FHFA’s conservatorship authority by means of the shareholder derivative suits that the statute explicitly bars,” Judge Lamberth wrote. “The plaintiff’s grievance is really with Congress itself.”

In August, Pershing Square Capital Management LP filed separate lawsuits in the U.S. Court of Federal Claims in Washington, D.C. and U.S. District Court in Washington, D.C. against the government on behalf of common shareholders. Those cases are ongoing.

If your financial advisor recommended that you invest in Fannie Mae or Freddie Mac common stock or preferred shares and you suffered losses in 2014, please contact Erez Law to explore your options. If your financial advisor failed to disclose the risks of investing in Fannie Mae or Freddie Mac common stock or preferred shares, then you may have a claim for misrepresentation. If you were seeking safe investments and your financial advisor recommended Fannie Mae or Freddie Mac common stock or preferred shares, then you may have a claim for unsuitability. Erez Law is a nationally recognized law firm representing individuals, trusts, corporations and institutions in claims against brokerage firms, banks and insurance companies. To learn more, please call us at 888-840-1571 or complete our “contact form.”