Daniel Schmerin: The remaining Fannie Mae (FNMA, Financial) and Freddie Mac (FMCC, Financial) questions pertain to the ongoing litigation so I’d like us to turn to David Thompson from Cooper & Kirk, whose team has been representing the Fairholme Fund (Trades, Portfolio) on behalf of all our shareholders. David, I get to speak to you every day but our shareholders do not, so given the large number of questions that we’ve received on this topic I wonder if you could begin by providing some historical context.
How do these cases compare to Glendale Savings or the Winstar litigations? And have you ever seen such blatant overreach by the administrative state before?
David Thompson: Dan, I think there are a lot of parallels to the Winstar situation. Back in the late 1980s, the government upended settled expectations of investors in financial institutions and specifically the S&L industry. And we brought suit challenging that governmental action. Very few people thought we would succeed and indeed, when we went to the Court of Appeals for the first time, we lost two to one, just as we have in the Perry Capital case.
We ultimately prevailed seven to two before the Supreme Court in that case, and I think the lesson we learned is that the path to victory isn’t without some bumps along the road. I think this path to victory will be more expeditious because the issues are not as factually complicated and we’re proceeding in multiple forums, but I do think that’s a powerful historical analogy.
Daniel Schmerin: Can you discuss the current state of play in the Court of Federal Claims? Where do we stand on discovery? How do you feel about the results to date, and what are the anticipated next steps?
David Thompson: Just to refresh recollections, when we had our last call together, at that point we had been very upset that the government had given us a privilege log with over 12,000 items. It was really the mother of all privilege logs. So we selected 56 documents for the court to look at to see if the government had been turning square corners.
The court agreed with us that the government had improperly withheld all 56 of those documents. The government appealed since our last call to the Federal Circuit and prevailed on four presidential privilege documents, but on 48 of the 52 deliberative process documents, the government lost. So it was remanded back and we went to the court and said, Your Honor, if they’re wrong on 48 of the 52 documents that we’ve randomly selected, they should have to go back and reassess all the others.
And they were ordered to do so through the full privilege log and we’ve now received over 3,500 additional documents. We’re continuing to skirmish a little bit in the weeks ahead, but discovery should end shortly. We’re very gratified that we have insisted on our rights and on receiving documents that should not be improperly withheld, and we’ll be amending our complaint in the coming months, and then our case will move forward to adjudication on the merits.
Daniel Schmerin: The cases brought around the country under the Administrative Procedure Act have had only limited success to date. Can you discuss the D.C. Circuit’s recent opinion in our case and next steps for us and other similarly situated plaintiffs?
David Thompson: Sure. So the D.C. Circuit ruled at the end of February of this year and we were gratified that Judge Janice Rogers Brown saw the case exactly the way we see the case. I’d like to just read to you a few of the quotes from her excellent dissent. Thanks to our Court of Claims discovery, she said that “information recently obtained in this litigation creates, to put it mildly, a dispute of fact regarding the motivations behind FHFA and Treasury’s decision to execute the Third Amendment.”
She continued, FHFA “pole vaulted over” the boundaries of its statutory authority when it agreed to the Net Worth Sweep, “disregarding the plain text of its authorizing statute and engaging in ultra vires conduct.”
She added, “Having been appointed as conservator for the companies, FHFA was obligated to behave in a manner consistent with the conservator role as it is defined in HERA or risk intervention by courts.”
She went on to say that by imposing the Net Worth Sweep, Treasury received a contractual right from FHFA “to loot the companies to the guaranteed exclusion of all other investors,” and “FHFA’s decision to strip these cash reserves from Fannie Mae and Freddie Mac, consistently divesting the companies of their near entire net worth, is plainly antithetical to a conservator’s charge to ‘preserve and conserve’ the companies’ assets.
She added, “The capital depletion accomplished in the Third Amendment, regardless of motive, is patently incompatible with any definition of the conservator role … rendering Fannie Mae and Freddie Mac mere pass-through entities for huge amounts of money destined for Treasury does exactly that which FHFA has deemed impermissible.”
She went on to say, “The practical effect of the Court’s ruling is pernicious. By holding, contrary to the Act’s text, FHFA need not declare itself as either a conservator or receiver and then act in a manner consistent with the well-defined powers associated with its chosen role, the Court has disrupted settled expectations about financial markets in a manner likely to negatively affect the nation’s overall financial health.”
She concluded, “What might serve in a banana republic will not do in a constitutional one.”
It is a powerful opinion, yet unfortunately, it was a dissent. There were two judges on the panel who disagreed. Now, one might say how could you look at the Net Worth Sweep and conclude that it is consistent with the statute’s language that FHFA is supposed to preserve and conserve assets and operate institutions in a sound and solvent manner?
I would submit that it is impossible to square that language with the Net Worth Sweep. And the majority essentially conceded as much, because the maneuver the majority employed was to say that those are mere suggestions, that they’re not binding on the FHFA, and so FHFA wasn’t required to operate the companies in a sound and solvent manner. And the problem with that argument and holding is that for years in official filings and sworn written statements, the FHFA has consistently acknowledged that those are statutory mandates.
In sworn testimony to Congress just last month, Mel Watt said, “FHFA’s statutory mandate obligates it to conserve and preserve the assets of the enterprises while they are in conservatorship.” So we feel very confident that the line of analysis adopted by the Perry Capital majority – and that was really the linchpin of the decision – is not going to withstand judicial scrutiny.
It’s likely that you’ll see a cert petition filed in the coming months in Perry Capital and if the Supreme Court takes that case, we’ll get a decision about a year from now.
In addition, Cooper & Kirk has now been retained in four cases that we had been closely following but we are now counsel of record for those cases in the Fifth, Sixth, Seventh, and Eighth Circuits. The Sixth Circuit oral argument will be on July 27, and I think it is reasonable to expect that we might well get a decision by the end of the year out of the Sixth Circuit. There is a lot going on around the country.
Daniel Schmerin: Good. Are there any other legal avenues that plaintiffs are exploring?
David Thompson: Yes, there are. Just in the last couple of weeks, there are two very interesting new suits that have been launched in Michigan and Minnesota, and we’re following them closely because they are premised on the idea that even if the government is absolutely right about the factual background of the Net Worth Sweep and the reasons why they did it – and discovery has shown they’re not – but even if they were right, these suits say the Net Worth Sweep must be invalidated on the basis of three separate theories.
The first is the separation of powers theory. Namely, that the FHFA is unconstitutionally structured. It is an agency that we are told is immune from judicial oversight. It is immune from congressional oversight because it doesn’t rely on Congress for appropriations. It’s immune from presidential oversight because the president can only remove the director for cause. And it has a single director, not a multimember panel which is more frequent among independent agencies.
To my knowledge, there is only one other prominent agency that is so constituted and it’s the CFPB. And both are obviously of recent vintage, and the CFPB was recently ruled unconstitutional on exactly this theory by a majority of the D.C. Circuit.
The second theory is the Appointments Clause, which requires principal officers to be nominated by the president and confirmed by the Senate. In this instance, Ed DeMarco, when he was the acting director of FHFA and signed the Net Worth Sweep, had been acting for three years and these lawsuits maintain that it’s inconsistent with the Appointments Clause to put someone in as a principal officer in an acting capacity for three years. That would just be way too easy an end run around the Appointments Clause.
The final theory is nondelegation, which is a constitutional doctrine that says that agencies need to have an intelligible principle that binds their conduct. Well, of course, the Perry Capital majority said that the intelligible principle of preserving and conserving assets and operating the institutions in a sound and solvent manner was not binding at all. And so these new lawsuits are saying that if that’s correct, then we have a nondelegation problem because there is no intelligible principle binding the FHFA because it can do whatever it wants. So those are two suits to be watching. The first theory is present in the Fifth Circuit appeal that we’ll be handling in a case called Collins, but all very important litigation that is proceeding.
Daniel Schmerin: Another shareholder focused on the violations by big banks of federal securities laws and common law in the sale of residential private-label mortgage-backed securities to Fannie Mae and Freddie Mac, and he asked why plaintiffs have not brought direct or derivative suits against those big banks for the harm they caused to the GSEs?
David Thompson: The short answer is that the companies themselves have brought that litigation and have garnered settlements well in excess of $20 billion. So it wouldn’t make sense to try to bring a derivative case when the companies have already directly vindicated their rights. That is pretty much water under the bridge at this point.
Daniel Schmerin: What is your assessment of the timeline for this multifaceted legal fight, and what events should we mark down on our calendars as we look ahead to the remainder of 2017?
David Thompson: As I noted, on July 27 the Sixth Circuit will be having oral arguments in a case that is very similar to Perry Capital and we expect that an opinion may be rendered before the end of the year. So that’ll be a very important moment. Certainly if the cert petition for Perry Capital is filed as we expect later this year, it will be important to see whether the Supreme Court grants cert and that should probably happen toward the end of the calendar year.
We’ll be amending our complaint in the Court of Federal Claims and bringing together the fruits of all of the documents that we found that are helpful, including from those 3,500 additional documents that we recently received. I think six to 12 months from now, we’re going to know a lot more than we do right now. So there are number of important events over the next year.
Daniel Schmerin: If you have to summarize the most important points for someone who is new to the situation, what would you say to them?
David Thompson: I would say we are in multiple forums and there are multiple theories that are moving forward. If a plaintiff wins in just one of these places, the Net Worth Sweep will be enjoined on a nationwide basis. As in Winstar, the path to victory may not be without setbacks along the way, but we remain very confident that the federal judiciary will not uphold the Net Worth Sweep.
Daniel Schmerin: Thank you, David.
David Thompson: My pleasure.
Bruce Berkowitz (Trades, Portfolio): David, on behalf of all our shareholders, thanks to you and all of your team members for their hard work. We are looking forward to a positive outcome in one of the venues.
From Bruce Berkowitz (Trades, Portfolio)'s June 29, 2017, public conference call transcript.
