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Report: Fannie, Freddie regulator must keep close eye on mounting legal costs
The housing regulator overseeing Fannie Mae and Freddie Mac might have had little choice to pay out nearly $100 million in legal fees to former embattled executives, but should still be on the hunt for a way to control legal costs in the future, according to a new report.
The Inspector General for the Federal Housing Finance Agency (FHFA) said in a report released Wednesday that the FHFA is in a tough spot. On the one hand, contracts for the former executives contain indemnity clauses that ensure Fannie and Freddie will cover legal fees tied to their work at the housing giants. Furthermore, it might be in Fannie’s and Freddie’s best interests to defend their former leaders in court, as any tough rulings could come back to bite the struggling entities themselves — even as Fannie has shelled out $99.4 million to defend just three former top executives, who face accusations of accounting chicanery while running the housing giant.
But at the same time, the FHFA has an obligation to ensure the millions heading out to court are being spent properly and efficiently, the IG said.
“FHFA and Fannie Mae believe that their options are limited in paying current legal fees for former officers and directors, which now amount to almost $100 million,” said FHFA Inspector General Steve Linick. “OIG nonetheless believes that FHFA must continue its efforts to both control and scrutinize these legal expenses now and in the future.”
At the center of the dispute are three former heads of Fannie — Franklin Raines, Timothy Howard and Leanne Spencer — who face legal challenges that they used accounting tricks to inflate Fannie’s stock price and maximize their bonuses. The executives have agreed to pay $31 million to settle a government investigation into the matter, but a class-action lawsuit is still pending before a District of Columbia court. Several other class-action suits are pending elsewhere across the country.
Further complicating the legal morass is the fact that the Securities and Exchange Commission filed its own suit in December against six other former top executives and Fannie and Freddie, arguing that they misled investors about the amount of risky mortgages in their portfolios. Fannie and Freddie so far have also paid the legal expenses for those executives.
Beyond a contractual obligation, the FHFA defended the practice to the IG, arguing that by defending the executives, it also is defending Fannie and Freddie. The FHFA’s stated mission is to conserve the assets of the housing giants, so by successfully defending former bosses in court, it is ensuring Fannie and Freddie do not face a hefty court claim.
The IG noted in its report that the FHFA does have the right to reject existing contracts under law, but doing so to void indemnification agreements could open it up to a legal challenge from the former executives themselves. The FHFA has opted not to reject any of those contracts.
The report also noted that, for all practical purposes, it appears FHFA regulations could prevent Fannie and Freddie from ever paying out litigation claims. That’s because under existing rules, the federal government is first in line when it comes to repayments, ahead of anyone filing litigation claims against the housing giants. And with the government already $183 billion in the hole on Fannie and Freddie, and the general expectation that they will never fully repay that commitment, it does not appear likely that any other claimants will see a dollar. The report did note, however, that this FHFA regulation is currently facing a legal challenge, after the regulator unsuccessfully used it in an argument in a pending court case.
The IG also pressed the regulator to ensure that billing guidelines for law firms retained by the entities are proper, and to maintain proper oversight of the legal work contracted by Fannie and Freddie.
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