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Counsel’s Corner: The Battle Over GSE Profits is Raging

Counsel's Corner
Hamish Hume pic

Hamish Hume

Hamish Hume is a partner with Washington, D.C.-based firm Boies, Schiller & Flexner. He is an experienced trial and appellate litigator who has argued, tried, and won important cases in courts throughout the country.  He has substantial expertise in constitutional law and tax law, but has also successfully litigated cases in a broad array of other areas, including antitrust, bankruptcy, the Administrative Procedure Act, foreign sovereign immunity, intellectual property, and general commercial disputes. 

Last week, Hume argued in the U.S. Court of Appeals for the District of Columbia Circuit on behalf of a class of preferred and common shareholders of both Fannie Mae and Freddie Mac in the ongoing legal battle challenging the August 2012 action by the U.S. Treasury and the Federal Housing Finance Agency (FHFA) to amend the terms of the bailout and sweep all GSE profits into Treasury, therefore completely nullifying the contractual dividend and liquidation rights of all private shareholders in Fannie Mae and Freddie Mac. This is Hume’s third major case involving the 2008 financial crisis—he previously played a critical role in the trial and appeal that secured a $13 billion victory for Barclays in connection with its September 2008 purchase of the Lehman Brothers business, and he also helped develop the legal theories in Starr International’s successful challenge to the U.S. Government’s takeover of AIG.

After the arguments last week, how do things look?

It's always difficult and hazardous to predict how a court, particularly a court of appeals, is going to act based on the questions they ask or don't ask during arguments. Sometimes it's a little clearer than other times. I thought this time, in general, it was a little hard to tell which way they are headed on the case—but what is possible to say is that the court of appeals is taking the case very seriously, which we are very grateful for. They gave us almost three hours of argument. That's very unusual in the court of appeals. They are obviously working very hard on the case. They recognize its importance. That alone is something we're very grateful for. We think that the more the court studies the case and looks at what really happened, looks at all the legal arguments, and looks at the decision below and at what we say about the decision below, the more likely it is that we're going to win. I take it as a very, very good sign for the class of plaintiffs I represent that the court is spending this much time on it. That is especially true because the defendants had no answer to the points I made about the merits of our breach of contract claims, and the flaws in the district court’s analysis of those claims.

Which shareholders do you represent?

I represent a class of shareholders. There are 10 different class representatives in our class in this case. They range from individuals who bought relatively small amounts to institutions that bought relatively modest amounts of either preferred or common stock. We represent the class of Fannie Mae preferred shareholders, Fannie Mae common shareholders, Freddie Mac preferred shareholders, and Freddie Mac common shareholders.

One thing I would note that came up at the end of the argument is we represent all of the shareholders, but some of them purchased stock in 2008 when Fannie and Freddie were issuing new shares of preferred stock to raise capital at a time when it was clear they were under significant pressure and some distress. Our shareholders relied on the terms of their contractual certificates, as did all investors, and what the government did in 2012 is a direct nullification of those contractual terms.

You have handled cases relating to the crisis before. How do you believe those experiences will help you in this case?

That's a good question. In some ways the cases are very different, but one or two things are similar. In both the Barclays case and in this case, the side of the case that I was working on was emphasizing the plain text and plain meaning of the contracts. In Barclays, we relied on the plain text of the contract and the other side tried to say, well, the contract wasn't fair—or the terms of the contract were not adequately disclosed to everyone or were not officially approved by the bankruptcy court. At a big picture level, that's what was being argued in that case. We ultimately showed that the court did approve it even though it knew there were some moving parts and uncertainty, and therefore the plain text of the contract had to be upheld.

The same is true in this case where the Defendants just want to overlook or ignore the plain meaning of the contracts governing the investments made by private shareholders into Fannie Mae and Freddie Mac, as well as the plain meaning of the original contract entered into by the Treasury when the enterprises went into conservatorship. No one questions that the government, the U.S. Treasury, is entitled to receive the first set of profits that come out of Fannie and Freddie, because it agreed to provide emergency funding in 2008. Also, no one disputes that the Treasury has made an enormous profit in accordance with that original contract and that it would continue to make a big profit in accordance with that original contract. What we're saying is the government can't change the deal four years later so that it takes everything and nullifies the rights of the private shareholders. So I think one area of overlap—and they are different cases, so I don't mean to suggest it's a perfect analogy—is that in both the Barclays/Lehman case and in this case, I am saying, you cannot retrade the deal after the fact. You have to stick with the deal you originally made and you don't get to nullify people's rights by retrading it later.

Last week, there were some documents unsealed related to Fairholme's lawsuit against the government over the GSE profit sweep (Net Worth Sweep). Those documents seem to suggest that certain government officials knew that Fannie Mae and Freddie Mac were on the verge of making big profits in 2012. Do you think that will have any bearing on how courts handle litigation relating to the Net Worth Sweep?

I think it was helpful to us. I think the more that is unsealed, the better for our side, and I think those specific documents show that Fannie and Freddie and the government and Treasury all knew that they were likely going to become more profitable and that the Net Worth Sweep was going to be very good for Treasury and very bad for private shareholders.

It turned out that Fannie and Freddie were even more profitable than expected in August 2012, but they knew they were going to be profitable, and they knew they were not in a "death spiral." That's what those documents proved, and they are very helpful to us and we're very grateful for the ability to present them to the court and to the public.

So you used those documents in your arguments last week?

Yes, absolutely. Particularly in my rebuttal, because initially one of the judges seemed a little dismissive of the documents and said, well, the deposition just shows that one person, the CFO of Fannie, thought that they were about to make an extra $50 billion in profits. I said first of all, that's a big deal—she's an important person and she thought that. Second of all, it wasn't the only thing. There were other documents showing projections of profits from Fannie and Freddie for many years and showing that they were on schedule to repay more in dividends than the government had contributed and invested. The government knew it was going to be making money based on Fannie and Freddie profits; it just decided it wanted to make even more money. So it retraded the deal so that it would take everything instead of its original 10 percent dividend plus 80 percent of the common. Don't forget, the government would have gotten, first and foremost, a 10 percent dividend on the total amount of its investment. Then, if it wanted more, if there were more profits, which it knew there would be, it had the ability to acquire 80 percent of the common stock for a very small amount, like $10,000 or $15,000, and then it would get the common stock dividends as well. What that means is, if the government wanted to receive dividends under the original deal of more than the 10 percent, it had to exercise the warrants for the common and before a common stock dividend could be paid, there had to be a dividend on the junior preferred shareholders, the private preferred shareholders, because they had priority over the common. That was recognized in all the contracts—and when the dividend was paid on the 80 percent of the common, the 20 percent of the common held by private shareholders would get a prorata dividend. That was the original deal. What we're saying is the government isn't allowed to change that original deal so that it takes 100 percent of all dividends equal to the entire net worth of the companies no matter what—which is what the Net Worth Sweep does.

Since the Net Worth Sweep was put into place, Fannie and Freddie have paid approximately $130 billion to the U.S. Treasury over and above what would have been paid under the original deal—i.e., through the payment of the 10 percent senior preferred stock dividend. So it paid the 10 percent senior preferred stock dividend and then paid an additional $130 billion in the three years since the Net Worth Sweep. Had they complied with the terms of the original deal with Treasury, and had they wanted more than their 10 percent dividend, then the only way for any of that $130 billion to have been paid out to the government was by the government exercising its right to acquire 80 percent of the common. Basically, for $10,000 or $15,000, the government could have bought 80 percent of the common—which was then worth at least $100 billion, because the $130 billion, you first have to pay a preferred dividend to the junior preferred shareholders, which would have been somewhere between $7 and $8 billion, or at the most, $9 billion. The remaining $122 billion would have been split 80 percent/20 percent between the government and common shareholders who are the private common shareholders. The government still would have gotten roughly $100 billion out of the $130 billion, but they wanted everything, so they put in effect the Net Worth Sweep. That's what we're complaining about, in a nutshell.

What is the next step in this case?

This is one of two cases. There is this case and then there is the Court of Federal Claims case. There are three next steps: One, the Court of Appeals has asked for a supplemental brief this Friday addressing a specific statute. So the parties are all going to submit that—very short, just 10 pages each. Then we are waiting for the Court of Appeals to make a decision in that case. In the Court of Federal Claims, we are finishing up some jurisdictional discovery, and then we have one issue for the court to decide and then we are going to amend our complaints and proceed to pursue our takings claim and possibly other related claims in the Court of Federal Claims.

About Author: Brian Honea

Brian Honea
Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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