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Waite, Schneider, Bayless &
Chesley Co., L.P.A.
Jeffrey A. Lamken
Stanley M. Chesley
Waite, Schneider Bayless & Molo Lamken LLP
Chesley Co., L.P.A. 600 New Hampshire Avenue, N.W.
One West Fourth Street
Washington, D.C. 20037
Cincinnati, Ohio 45202
MORTON ROSENBERG, LITIGATION CONSULTANT33 Eton Overlook Rockville, MD 20850 T: 240-344-2373 August 25, 2010 Mr. Alfred M. Pollard General Counsel Attention: Comments/RIN 2590-AA23 Federal Housing Finance Agency Fourth Floor 1700 G Street, N.W.
Washington, D.C. 20552 Re: Proposed Rule Regarding Conservatorship and Receivership 75 Fed. Reg. 39,462 (July 9, 2010); RIN 2590-AA23
Dear Mr. Pollard:
We submit the following comments and objections to RIN 2590-AA23 (the “Proposed Rule”) on behalf of Lead Plaintiffs Ohio Public Employees Retirement System and State Teachers Retirement System of Ohio and the Class in the currently pending federal securities fraud class action against Fannie Mae, Franklin Raines, Timothy Howard, and Leanne Spencer (In Re Fannie Mae Securities Litigation, Consolidated Case No. 04-cv-1639 (D.D.C.)). The pending litigation is based on the 2001-2005 fraud at Fannie Mae that was discovered and detailed in two comprehensive public reports by the Office of Federal Housing Enterprise Oversight, the predecessor to the Federal Housing Finance Agency (“FHFA” or the “Agency”). FHFA, through its predecessor, has already obtained a $50 million FHFA August 25, 2010 settlement from Fannie Mae and settlements valued at over $30 million from Raines, Howard, and Spencer based upon that same fraud. Now that FHFA (which was not damaged by the fraud) has obtained those settlements, it has proposed a new rule to prevent the more than 30 million pensioners throughout the 50 States who were damaged by the fraud, as well as other members of the class, from obtaining their just compensation.
That effort violates the express provisions of the Housing and Economic Recovery Act of 2008 (“HERA” or the “Act”), Pub. L. No. 110-289, 122 Stat.
2654, which requires FHFA to accord tort victims priority equivalent to that of other unsecured creditors. The Agency’s Proposed Rule improperly subverts that express statutory priority scheme. Because the Proposed Rule conflicts with the statute, exceeds FHFA’s authority, and is otherwise arbitrary, illegal, and unconstitutional, we respectfully request that the Agency reject the Proposed Rule or eliminate the improper provisions discussed below.
HERA authorizes FHFA to act as conservator or receiver for regulated entities including Fannie Mae and Freddie Mac. 12 U.S.C. § 4617(a)(1). The Act sets forth specific powers the Agency may exercise as conservator or receiver, including power to “prescribe such regulations as the Agency determines to be appropriate regarding the conduct of conservatorships and receiverships.” Id.
§ 4617(b). But the Act also contains provisions that limit FHFA’s exercise of that authority. One such provision is the statutory priority scheme for receivership set forth in 12 U.S.C. § 4617(c)(1). Under that provision, “[u]nsecured claims against a regulated entity, or the receiver therefor,... shall have priority in the following
(A) Administrative expenses of the receiver.
(B) Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D)).
(C) Any obligation subordinated to general creditors (which is not an obligation described under subparagraph (D)).
(D) Any obligation to shareholders or members arising as a result of their status as shareholder or members.
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12 U.S.C. § 4617(c)(1) (emphasis added). Subject to limited exceptions not applicable here, “[a]ll creditors that are similarly situated under paragraph (1) shall be treated in a similar manner.” Id. § 4617(c)(2). The statutory priority scheme thus plainly distinguishes between general creditor claims (subsection (B)) and mere equity interests (subsection (D)).
On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac in conservatorship pursuant to HERA. On July 9, 2010, FHFA published the Proposed Rule at issue. See Conservatorship and Receivership, 75 Fed. Reg.
39,462 (proposed July 9, 2010). The Proposed Rule purports to implement HERA for conducting any conservatorship or receivership of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Id. at 39,462-72.
In fact, however, the Proposed Rule significantly departs from HERA’s statutory framework. Section 1237.9(a) of the Proposed Rule sets forth a revised priority scheme, in which claims in receivership are satisfied in the following
(1) Administrative expenses of the receiver (or an immediately preceding conservator).
(2) Any other general or senior liability of the regulated entity (that is not a liability described under paragraph (a)(3) or (a)(4) of this section).
(3) Any obligation subordinated to general creditors (that is not an obligation described under paragraph (a)(4) of this section).
(4) Any obligation to current or former shareholders or members arising as a result of their current or former status as shareholders or members, including, without limitation, any Securities Litigation Claim.
Proposed 12 C.F.R. § 1237.9(a) (emphasis added). The term “Securities Litigation Claim” is defined very broadly to include “any claim, whether or not reduced to judgment, liquidated or unliquidated, fixed, contingent, matured or unmatured, disputed or undisputed, legal, equitable, secured or unsecured, arising from rescission of a purchase or sale of an equity security of a regulated entity or for damages arising from the purchase, sale, or retention of such a security.” Proposed 12 C.F.R. § 1237.2. The Proposed Rule thus classifies securities fraud claims — even those reduced to final judgment in federal court — as the lowest priority, on par with equity.
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The Agency attempts to justify reclassifying securities fraud claims as equity claims on the ground that doing so is “fair and appropriate.” 75 Fed. Reg. at 39,466. The Agency notes that Section 510(b) of the 1978 Bankruptcy Code expressly subordinates securities litigation claims to the lowest level of priority with shareholder claims in bankruptcy. Id. (citing 11 U.S.C. § 510(b)). Although HERA contains no analogous language, the Agency attempts to explain away that omission: HERA “does not contain all of the details governing insolvent entities that the Bankruptcy Code does,” the Agency asserts, “because Congress expected FHFA to fill in the gaps.” Id. The Agency contends that its choice is permissible because Congress enacted HERA “against the backdrop of... statutory and common law... treating Securities Litigation Claims derived from equity ownership as subordinated to or having the same priority as the underlying equity.” Id. at 39,466-67. The Agency also claims support from certain appeals court cases, such as Gaff v. FDIC, 919 F.2d 384 (6th Cir. 1990), that have “looked to the Bankruptcy Code for guidance on relative priorities of shareholder claims as well as other issues arising in receiverships of financial institutions.” 75 Fed. Reg. at 39,467.
Having proposed to subordinate the claims of securities fraud victims in receivership, the Agency also proposes corresponding changes to the provisions governing conservatorship. In particular, Section 1237.13(a), entitled “Payment of Securities Litigation Claims while in conservatorship,” would provide that “[t]he Agency, as conservator, will not pay a Securities Litigation Claim against a regulated entity, except to the extent the Director determines is in the interest of the conservatorship.” And Section 1237.12(a) would provide that, subject to limited exceptions, “a regulated entity shall make no capital distribution while in conservatorship,” which is also defined to include payments on securities litigation claims. See Proposed 12 C.F.R. § 1777.3(3). The Agency explains its nonpayment policy as a corollary of its revised priority scheme: “If the Conservator were to authorize payment of Securities Litigation Claims despite the statutory receivership priority system ranking such claims below all other claims, the purpose of the receivership priority system could be thwarted.” 75 Fed. Reg. at 39,468.
For the reasons explained below, neither the Agency’s proposed surgery on the statutory receivership priority scheme, nor its proposal to rely on that revised scheme to refuse to pay even valid judgments in conservatorship, is consistent with
the statute. Neither proposal can be reconciled with general legal principles or basic notions of fairness. And neither will withstand constitutional scrutiny. In short, both are arbitrary, capricious, and unlawful.
II. FHFA’S PROPOSED PRIORITY SCHEME CONFLICTS WITH THE
PRIORITIES CONGRESS EXPRESSLY SET FORTH IN HERAThe Proposed Rule should be rejected because subordination of securities fraud claims is directly contrary to the priority scheme Congress enacted. Contrary to the Agency’s claim, there is no “backdrop of... statutory and common law” that allows an agency to treat securities fraud claims — even those reduced to judgment — as mere equity interests. Rather, under Supreme Court precedent that the Agency does not even deign to cite (let alone attempt to distinguish), securities fraud claims must be treated as creditor claims absent statutory language mandating different treatment. Nothing in HERA supports that different treatment here. To the contrary, the legislative history of the statute on which HERA was modeled shows that Congress specifically considered subordination but overwhelmingly decided against it on a bipartisan basis. Moreover, the sound policy reasons that led Congress to reject subordination of securities fraud claims there — that doing so “would undermine fraud enforcement” and be “unfair to private plaintiffs who were innocent victims of wrongdoing” — apply with compelling force here. As a matter of law and policy alike, the Proposed Rule cannot be adopted.
A. UNDER THE SUPREME COURT’S DECISION IN OPPENHEIMER, SECURITIES FRAUD CLAIMS MUST BE
TREATED AS CREDITOR CLAIMS ABSENT STATUTORY
LANGUAGE TO THE CONTRARYHERA’s statutory priority scheme expressly distinguishes between creditor claims (“Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D))”) and equity claims (“Any obligation to shareholders or members arising as a result of their status as shareholder or members”), reserving the lowest priority for the latter. 12 U.S.C.
§ 4617(c)(1)(B), (D). Thus, the dispositive question here is whether, under governing legal principles, a defrauded investor’s securities fraud claim is properly considered a creditor claim (like any other tort victim’s claim against the company) or rather a mere equity interest.
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1. Although FHFA does not even bother to cite the case, the Supreme Court directly answered that question over 70 years ago in Oppenheimer v.
Harriman National Bank & Trust Co., 301 U.S. 206 (1937). That case stands squarely for the proposition that securities fraud claims are creditor claims, not equity interests, in a receivership, unless Congress provides specific statutory language providing for contrary treatment.
Oppenheimer involved a fraud claim by the purchaser of stock in a bank that had become insolvent and entered receivership. 301 U.S. at 207-08. Much like the class members here, the plaintiff in Oppenheimer claimed he had been defrauded into purchasing stock by the bank officers’ misrepresentations, and sought rescission. Id. at 208. The court of appeals ordered judgment for the plaintiff, but subordinated his claim to other creditors’ claims. Id. The fraud victim sought review, and the Supreme Court unanimously reversed.
The Court described the issue before it as “whether plaintiff’s judgment is entitled to share equally in the receivership estate with other unsecured creditors’ claims.” Oppenheimer, 301 U.S. at 213. It answered that question in the affirmative. “The fraudulent sale was subject to rescission by the plaintiff,” the Court explained, and “[n]either lapse of time while plaintiff remained ignorant of the fraud nor insolvency of the bank detracted from its liability.” Id. at 214. The plaintiff “merely s[ought] to share in the estate as do other unsecured creditors.” Id. That, the Court held, he was entitled to do: Securities fraud claimants “stand on the same footing as other creditors.” Id. at 215. And “[d]iscrimination against their claims is not authorized by the statute.” Id. “It follows,” the Court concluded, “that plaintiff’s judgment is entitled to rank on a parity with other unsecured creditors’ claims.” Id.
Oppenheimer thus stands squarely for the proposition that, except where discrimination is expressly “authorized by the statute,” securities fraud claimants must be treated the same as any other creditor in receivership. 301 U.S. at 213-15.
That 70-year-old holding reflected what was then already well-established law.
See Richardson v. Olivier, 105 F. 277, 280 (5th Cir. 1900) (“There is no sound reason, we think, for refusing to give a shareholder the same remedies against the bank on account of its frauds that are given to other creditors.”); Clark v. BostonCont’l Nat’l Bank, 84 F.2d 605, 607 (1st Cir. 1936) (victim of securities fraud “participate[s] ratably with other creditors in the distribution of the bank’s assets”);
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Salter v. Williams, 244 F. 126, 130 (3d Cir. 1917) (defrauded investor “approaches the receiver like an ordinary creditor”); Williams v. Green, 23 F.2d 796, 797-98 (4th Cir. 1928); Fla. Land & Imp. Co. v. Merrill, 52 F. 77, 80-81 (5th Cir. 1892);