Market Overview

SEC Smackdown! Agency Sues Former Fannie and Freddie Execs for Fraud


Finally, it looks like the SEC is going to attempt to act on behalf of investors who were lied to repeatedly in the run-up to the mortgage meltdown. In any event, they are at least attempting to give that impression. On Friday, the SEC announced civil actions against six former top executives at Fannie Mae and Freddie Mac - the GSE's that were forced into conservatorship due to massive losses on their loan portfolios in the wake of the crisis.

The agency accuses the executives of not adequately disclosing their firms' exposure to subprime mortgages. Complaints were filed against former Fannie Mae CEO Daniel H. Mudd, chief risk officer, Enrico Dallavecchia and executive vice-president Thomas Lund. In addition, Freddie Mac's former CEO Richard Syron, chief business officer Patricia Cook and executive vice-president Donald J. Bisenius were named in a separate complaint.

The case is one of the most significant enforcement actions brought by the government in the wake of the subprime mortgage collapse which triggered the most severe recession in the United States since the Great Depression. The lawsuit focuses on misrepresentations made at both companies regarding their exposure to risky mortgage debt.

For example, the lawsuit states that Fannie executives told investors in 2007 that it had around $4.8 billion worth of subprime holdings on its books. According to the SEC, the real number was $43 billion, accounting for 11% of its total holdings.

Similarly, in 2006, Freddie Mac said that it held between $2 and $6 billion of subprime paper. The SEC, however, argues that the holdings were closer to $141 billion, or 10% of Freddie's portfolio in 2006 and that the number was as high as $244 billion, or 14%, by 2008.

"Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was," said Robert Khuzami, director of the SEC's Enforcement Division. "These material misstatements occurred during a time of acute investor interest in financial institutions' exposure to subprime loans, and misled the market about the amount of risk on the company's books."

The lawsuits are seeking fines and disgorgement from the executives and also an order barring them from serving as officers or directors of other publicly traded companies. Former Fannie chief Mudd is the current CEO of Fortress Investment Group (NYSE: FIG), a publicly traded investment manager with around $44.6 billion in assets under management.


Traders who believe that the today's announcement could represent the culmination of the fallout of the mortgage crisis might want to consider the following trades:
  • Financial stocks such as Citigroup (NYSE: C) and Bank of America (NYSE: BAC) have been battered in the wake of the mortgage meltdown. If today's announcement is indeed a culmination of sorts, these stocks could be good investments.
  • If the mortgage market is getting set for a rebound, mortgage bond insurers such as Radian (NYSE: RDN) and MBIA (NYSE: MBI) should benefit.
Traders who believe that more charges and liabilities are likely to be faced by culpable parties in relation to the mortgage meltdown may consider alternative positions:
  • Shorting ratings agencies such as Moody's (NYSE: MCO).
  • Shorting the securities of Too Big To Fail banks with significant mortgage exposure such as Citigroup (NYSE: C), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC).
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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