Posted on Thursday, February 17, 2011
WASHINGTON — When the government took over Fannie Mae, it could have voided the contracts that have since left taxpayers liable for more than $100 million in legal bills defending the mortgage company and its former executives, according to statements at a Congressional hearing on Tuesday.
The legal opinion, cited by Randy Neugebauer, Republican of Texas, runs counter to the assertions by officials of the Federal Housing Finance Agency, created to oversee Fannie. Overturning the contracts, the agency’s officials said, would have been inappropriate and possibly unconstitutional.
Edward J. DeMarco, acting director of the federal housing agency, and Alfred M. Pollard, its general counsel, reiterated that view before the oversight and investigations subcommittee of the House Financial Services Committee. Mr. DeMarco added that canceling the executives’ employment contracts would make it difficult to attract skilled professionals to work at the company.
The amount advanced by the government to pay legal bills for Fannie Mae and its former executives accused of accounting improprieties was a well-kept secret for more than two years. But the bills add up quickly. In the main lawsuit, 35 to 40 lawyers representing Fannie defendants attend monthly conferences by the judge.
Mr. Neugebauer, chairman of the oversight subcommittee, ferreted out the total expense after requesting an accounting from the federal housing agency, charged with conserving Fannie Mae’s assets on behalf of taxpayers.
The contracts for Fannie Mae and its former executives are typical of those across corporate America. Under these deals, executives are indemnified against having to pay “reasonable” legal bills arising from lawsuits associated with their work for the company. If the executives are found liable for wrongdoing, however, they are required to return the amounts advanced for their defense.
But in sometimes heated testimony at Tuesday’s hearing, lawmakers questioned whether the legal fees charged to taxpayers by Fannie and its former executives were reasonable.
“For me, $160 million of legal fees certainly sounds unreasonable,” said Michael E. Capuano, Democrat of Massachusetts and the ranking member of the subcommittee. “Let’s be serious; we’re never going to get this money back, and that’s the problem.”
Most of the fees are from a shareholder lawsuit brought against Fannie and three of its former officers by shareholders who lost money when the company’s accounting scandal erupted in 2004, well before the government takeover in September 2008. After six years of fact-finding and the production of millions of documents, a trial is at least two years away.
Mike DeWine, attorney general of Ohio, is overseeing this litigation on behalf of two state pension funds that owned Fannie shares. Testifying before the subcommittee, he characterized the legal defense of the company and its executives as “a feeding frenzy.” At depositions in the case, he said, Fannie officials have brought 13 lawyers, many of whom said nothing during the interviews.
Franklin D. Raines, who was Fannie Mae’s chief executive when the accounting irregularities took place, brought five lawyers to the depositions he has attended, Mr. DeWine said. Timothy Howard, Fannie’s former chief financial officer, and Leanne Spencer, its former controller, each had two lawyers representing them at depositions.
Mr. DeWine described the monthly conferences convened by the judge as drawing 35 to 40 lawyers representing the Fannie defendants. “It is time for someone to stand up and just say stop,” he said.
According to Mr. Neugebauer, the Housing and Economic Recovery Act of 2008, which created the new federal overseer of Fannie and Freddie Mac, allowed for the indemnification contracts to be voided. But by keeping the arrangements intact, the regulator has created a perverse incentive for Fannie Mae’s former executives and their lawyers to run up enormous legal bills, Mr. Neugebauer said.
“The history of Fannie Mae, under the management of Franklin Raines, Timothy Howard and Leanne Spencer, is a story of abusing their positions to use the assets of the enterprise to further their own interest and careers,” Mr. Neugebauer said. “Years after they were forced out of the company for their misdeeds, Franklin Raines and his management team have continued their abuse. This time however, it is against the U.S. taxpayers.”
Mr. DeMarco and Mr. Pollard replied that refusing to honor the indemnification contracts would have resulted in additional legal bills because the executives would have sued. But the costs for such a suit would be nominal, legal experts said, because the regulator would be represented by its own counsel, not legions of high-cost lawyers.
Given the size of the advances over the years, it is unclear whether the money might be recovered. Since he left the company in 2004, Mr. Raines has received advances of $38 million. Mr. Howard has received $18 million, while Ms. Spencer has had $31 million covered since she left the company in early 2005.
Before the company collapsed and taxpayers took over, Fannie Mae had been covering the costs.
The agreements struck between Fannie Mae and its former executives state that indemnification will be canceled when an employee breaches the duty of loyalty to the corporation or engages in intentional misconduct.
In 2006, the Office of Federal Housing Enterprise Oversight, then the company’s regulator, published an in-depth report on the company’s accounting practices, accusing Mr. Raines, Mr. Howard and Ms. Spencer of taking actions to manipulate profits and generate $115 million in improper bonuses. The regulator settled with the three former executives, who neither admitted nor denied the allegations. Together, they returned around $31 million to the government.
According to a timeline provided by the subcommittee, new indemnification agreements were struck for the top Fannie executives in May 2004, well after the company’s regulator had begun an extensive investigation into the company’s accounting practices. Timothy J. Mayopolous, general counsel for Fannie Mae, testified that the board had undertaken a review of the indemnification policies at that time.
“It seems a little fishy that we had to renew the contracts in 2004,” Mr. Neugebauer said.
Since Fannie Mae and Freddie Mac were taken over by the government, their losses stemming from bad loans have mounted, totaling about $150 billion in a recent reckoning. Last week the Treasury issued a report recommending that Fannie and its fellow mortgage company Freddie Mac be wound down.
By GRETCHEN MORGENSON, THE NEW YORK TIMES