08/10/2012 02:58 pm ET Updated Oct 10, 2012

Judge In SEC Probe: Ex-Executives Knew Fannie Mae's Disclosures On Subprime Mortgages Were 'Misleading'

* Ex-CEO Mudd accused of misleading mortgage disclosures

* Judge says SEC plausibly alleged intent to mislead

* Lawyers for defendants not immediately available

By Jonathan Stempel

Aug 10 (Reuters) - Three former senior Fannie Mae executives lost their bid to dismiss a U.S. Securities and Exchange Commission civil fraud lawsuit accusing them of misleading investors about the company's exposure to risky mortgages.

The executives, including one-time Chief Executive Daniel Mudd, contended that Fannie Mae had explicitly and accurately disclosed its exposure to subprime and low-documentation "Alt-A" home loans before the government seized the mortgage-finance enterprise in September 2008.

But U.S. District Judge Paul Crotty in Manhattan said the SEC plausibly alleged that Mudd, former Chief Risk Officer Enrico Dallavecchia and former Executive Vice President Thomas Lund materially misled investors by not disclosing exposures to risky mortgages that totaled more than $440 billion.

"They must have known that Fannie Mae's disclosed subprime and Alt-A exposure calculations were materially misleading," Crotty wrote on Friday. "Defendants' conduct in making, or aiding others that made, these misstatements constitutes and extreme departure from the standard of ordinary care."

James Wareham, a lawyer for Mudd, said in an email: "The evidence establishing the adequacy of Fannie Mae's disclosures (and the efforts by the many employees involved in making these disclosures to get it right) is overwhelming. Indeed, the company used the identical disclosures just this week. Discovery will reveal just how shameful this case truly is."

Andrew Levander, a lawyer for Dallavecchia; and Michael Levy, a lawyer for Lund, did not immediately respond to requests for comment.

SEC spokesman Kevin Callahan said: "We are pleased that the judge rejected the defendants' arguments and we look forward to proving our claims in court."

U.S. regulators seized Fannie Mae and the smaller Freddie Mac on Sept. 7, 2008, just over a week before Lehman Brothers Holdings Inc went bankrupt, and put them into a conservatorship.

The mortgage finance companies are now overseen by the Federal Housing Finance Agency, and have since the seizures drawn down about $188 billion of taxpayer money, while repaying only about $46 billion.

Mudd had run Fannie Mae from 2005 until the seizure.


Like other regulators, the SEC has faced criticism for not cracking down harder on individuals accused of contributing to the 2008 financial crisis and five-year housing slump through poor underwriting and misleading marketing of mortgage debt.

Mudd, Dallavecchia and Lund were sued on Dec. 16, 2011, the same day the SEC filed a similar lawsuit against three former Freddie Mac executives, including onetime chief executive Richard Syron.

The Freddie Mac are trying to dismiss that case , and oral argument is scheduled for Aug. 20 before another Manhattan federal judge, Richard Sullivan.

Mudd and Syron are among the most senior individuals charged by federal or state investigators in any case related to the financial crisis.

Angelo Mozilo, who built Countrywide Financial Corp into one of the biggest subprime lenders, settled an SEC case for $67.5 million in 2010, though Bank of America Corp, which had bought Countrywide in 2008, indemnified him for $45 million.

The SEC did in 2010 win a $550 million settlement with Goldman Sachs Group Inc over that bank's packaging and sale of a collateralized debt obligation known as Abacus.

Goldman did not admit wrongdoing, and the SEC is still pursuing its lawsuit against the only individual charged in that case, Goldman vice president Fabrice Tourre.

On Thursday, Goldman said the SEC dropped a separate probe over its role in selling $1.3 billion of subprime mortgage debt.


In its Fannie Mae lawsuit, the SEC contended that the company concealed exposure to more than $100 billion of subprime loans and $341 billion of Alt-A loans.

It quoted Mudd as telling the public as recently as Aug. 20, 2008, during a radio interview less than three weeks before the seizure, that Fannie Mae had "about zero percent" subprime loan exposure. He defined such a loan as "a loan to a borrower that has had a credit problem in the past," court papers show.

In their defense, lawyers for Mudd said some of the suspect loans did not meet Fannie Mae's definition of subprime loans.

They also said that Fannie Mae, even after going under "full government control and new management," continued to report loan exposures "exactly as it did" previously.

The FHFA last year filed lawsuits against 17 banks over losses that Fannie Mae and Freddie Mac suffered on about $200 billion of mortgage debt.

FHFA spokeswoman Stefanie Johnson said with regard to Crotty's decision: "We are reviewing the case."

Mudd resigned in January as chief executive of Fortress Investment Group LLC, one of a few publicly-traded U.S. hedge fund and private equity fund managers, after having taken a leave of absence in the wake of the SEC charges.

The Fannie Mae case is SEC v. Mudd et al, U.S. District Court, Southern District of New York, No. 11-09202. The Freddie Mac case is SEC v. Syron et al in the same court, No. 11-09201.