‘Watchdogs’ Let Freddie and Fanny Execs Slide

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Ironically, the charges were filed in the same federal court in Manhattan where federal judge Jed S. Rakoff rejected a $285 million settlement between the SEC and Citigroup. Rakoff was fed up with the SEC’s practice of allowing companies to settle cases without admitting any wrongdoing. Yet here we are all over again: six executives get sued while Fannie and Freddie are allowed to remain in the legal limbo, neither admitting nor denying liability.

Furthermore, even if the SEC’s prosecution is “successful,” as defined by their objectives to have each of these executives pay financial penalties, repay with interest any “ill-gotten gains,” and be banned from serving as an officer or director of any public company, only the last objective may actually be consequential. Unless the SEC can prove “willful misconduct or knowing violation of the criminal law,” director and officer insurance policies covering these executives will underwrite the monetary damages.

“A lot of these end up working into the D&O (directors and officers) insurance,” said Jacob Frenkel, former SEC enforcement attorney currently specializing in white-collar defense at Shulman Rogers in Potomac, Md. “The Commission is generally more interested in seeing the case resolved on its merits, not in allowing the source of settlement funds to drive the outcome.”

What merits? Freddie Mac CEO Richard Syron made $14.7 million in salary and bonus in 2006 and $18 million in 2007. By 2008 the company reported a $26 billion loss. Fannie Mae CEO Daniel Mudd made $10.7 million in bonuses in 2007, even as Fannie Mae was only months from insolvency. Freddie VP Patricia Cook pulled down $5 million in bonuses in 2006, a year before claiming Freddie Mac had “basically no exposure” to sub-prime mortgages. If executive insurance pays off all compensation clawed back by the SEC–including fines–a case “resolved” on such “merits” is laughable.

Yet such resolutions are hardly unique. Former Countrywide Financial Corp CEO Angelo Mozilo paid $67.5 million to settle an SEC lawsuit without admitting or denying guilt. Former Fannie CEO Franklin Raines paid $24.7 million also without admitting guilt for allegedly “manipulating earnings” from 1998-2004 that allowed him to make $91.1 million during the same period. And Fannie Mae itself settled a lawsuit in 2006, paying a $400 million fine–also “without admitting or denying the allegations.”

And despite judge Rakoff’s decision, essentially telling the SEC that such an odious status quo is no longer acceptable, here they go again. In fairness to the agency, they can only pursue civil litigation. Criminal litigation requires the Department of Justice (DOJ) to get involved.

Unfortunately, as has been reported here before, the DOJ isn’t interested in pursuing criminal charges, because proving “criminal intent,” highlighted by the acquittal of two Bear Stearns hedge fund managers in 2009, is too difficult. Hence the pursuit of civil litigation by the SEC.

As of now, one thing is certain: without being forced to admit guilt in civil settlements, along with knowing that criminal cases are all but certain not to be pursued, those involved in taking inordinate risk in pursuit of personal profit have virtually no incentive to be responsible.

It doesn’t take a business MBA to figure out a worst case scenario that includes no period of incarceration whatsoever, or even the admission of guilt, is a gilded invitation to roll the fiscal dice with impunity. Toss in the twin bonuses of insurance policies protecting ill-gotten gains–and taxpayer re-capitalization of bankrupt entities–and a highly disturbing question arises:

In the current environment, why aren’t more company officers taking even greater risks?

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  • JasonPappas

    This is just an SEC witch hunt. Obviously their business model failed. However, it was the government that pushed them to lower their standards to enable unqualified poor and minority home owners to get mortgages. Andrew Cuomo, as head of HUD, set quotas for the GSEs. These quotas were raised by the Bush administration. Fannie and Freddie were doing what they were told and then some.

    Subprime isn’t a precise category. Traditional standards require a 20% down payment, adequate income, etc. However, there is a continuum. Between prime and subprime there is alt-A. Where alt-A ends and subprime begins is a matter of opinion. Fannie and Freddie, like virtually everyone else, assumed that housing prices can never go down. It’s obvious to everyone now that they can.

    Fannie and Freddie wouldn’t exist and grow to such proportions if it were for the government and people like Barney Frank. Frank was the enabler.

    • aspacia

      This FF meltdown is probably the reason he is not running. He probably has a huge amount of money in a Swiss bank account.

      • JasonPappas

        Gretchen Morgenson, in her book "Reckless Endangerment," insinuates that Barney, like everyone else involved, was corrupted by money. I think it is much worse, Barney's a true believer. Sometimes it is both! In any case, he's gone. Let's make sure this story isn't lost because Andrew Cuomo has presidential ambitions.

  • joy52

    Cuomo's first wife was one of Robert Kennedy's kids. They divorced after he caught her in bed with somebody else. He's knee deep in Freddie and Fannie.