Trolling for Windfalls

On September 30, 2014, the federal District Court for the District of Columbia let the first shoe drop in the controversial takings litigation based on the federal government’s bailout of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). In Perry Capital, LLC v. Lee, the District Court (Judge Royce Lamberth) rejected stockholder claims that the decision by the Federal Housing Finance Agency (“FHFA”) to virtually wipe out the stockholders’ equity in these companies resulted in a compensable taking.  An appeal will surely follow.

In 2008, during the so-called Great Recession, after Fannie Mae and Freddie Mac had suffered serious financial losses as a result of widespread mortgage defaults, the FHFA placed the companies into a conservatorship.  The terms of the conservatorship evolved over time. In 2012, the companies and the FHFA entered into an agreement that required the companies, in consideration for the infusion of taxpayer dollars, to pay a quarterly dividend to the Treasury Department equal to the entire worth of the companies, minus only a small reserve that shrinks to zero over time.  Various shareholders, including some hedge funds that purchased shares in the companies at a deep discount, brought suit seeking just compensation for the taking of their stakes in the companies.  (The lawsuit might have proceeded in the District Court, rather than the U.S. Court of Federal Claims, because the plaintiffs framed their case as a class action suit under the Little Tucker Act.)

Judge Lamberth rejected the takings claim on the ground that the plaintiffs lacked a protected property based on their stock in the companies given that the shareholders were at all times exposed to the risk, based on pre-existing federal regulations, that they might lose their investments if and when the companies were placed in a conservatorship.  Relying on several Federal Circuit precedents involving similar cases, the District Court ruled that the “shareholders necessarily lack the right to exclude the government from their investment when FHFA places the [companies] under governmental control—e.g., into conservatorship.”  In addition, and in the alternative, the Court ruled, emphasizing the plaintiffs’ lack of reasonable investment-backed expectations, that the plaintiffs’ takings claims failed under the Penn Central analysis.

For a withering critique of this litigation – and the similar AIG lawsuit – see Stephen Ratner’s column in the NY Times.