The total bill is actually even higher – and the worst part is that, by law, taxpayers shouldn’t have to pay it at all.
Taxpayers have footed the bill for $194.4 million on legal fees to defend former executives like Franklin Raines and the companies themselves over accounting frauds that boosted bonuses and predated the government takeover of the companies, as well as for their role in the housing collapse. And that’s money spent only since the government seized them in 2008.
The new figures come from the office of Rep. Randy Neugebauer (R-Tex.), whose House oversight subcommittee oversees Fannie and Freddie. The figures are based on confidential government documents FOX Business has reviewed.
Rep. Neugebauer now has a bill cosponsored by Reps. Spencer Bachus (R-Ala.), Scott Garrett (R-NJ) and three other Congressmen that will attempt to minimize the impact on taxpayers, his office says.
Fannie and Freddie have also spent another $272 million for general legal costs since their government takeover, for things like bringing actions against banks to take back bad mortgage bonds the two had bought, Rep. Neugebauer’s office says.
Veering Towards Half a Billion Dollars
That brings the total Fannie and Freddie have spent on legal costs to $466.4 million since the government took them over through July 2011, “a number that is now rising well above a half a billion dollars, because we are still awaiting a document dump for a year's worth of data,” says a Congressional official close to the matter.
The controversy raises anew the question whether the government should have restructured them instead by placing the two into receivership, since a bankruptcy trustee would have been legally free to nix these legal fees.
And under the 2008 federal law letting the government seize Fannie and Freddie, the former executives would be prohibited from suing the companies’ bankruptcy estate—they’d have to get in line with other unsecured creditors, and possibly end up with nothing.
“Seems a Little Fishy”
Moreover, Fannie signed agreements with its former executives in 2004 stipulating it would refund their legal fees—well after the companies’ government regulator had launched an investigation into its accounting fraud engineered by these officials. ''It seems a little fishy that we had to renew the contracts in 2004,'' Mr. Neugebauer has said.
Taxpayers are paying a virtually open-ended legal bill for an army of lawyers and expert witnesses to defend former Fannie and Freddie executives and their increased compensation, which they got through orchestrating accounting frauds that helped destroy their companies and drove the two into the arms of the U.S. government in September 2008.
Fannie and Freddie execs routinely donated to Congressional campaigns. Countrywide Financial was one of Fannie’s biggest clients, providing about 28% of all the mortgages Fannie guaranteed. Fannie in 1999 backed Countrywide's "Fast and Easy" program to give buyers loans without proof of their income or assets.
Because of their unlimited pipeline into the U.S. Treasury, taxpayer costs for Fannie and Freddie continue to mount, with Fannie yesterday asking another $4.57 billion, bringing their total taxpayer cost to nearly $190 billion.
The FHFA, the regulator for both, is charged with “minimizing taxpayer losses” at the two. Today, Fannie and Freddie guarantee an estimated three out of every four new mortgages.
“A Feeding Frenzy”
And because of that unlimited Treasury pipeline, the government has created a perverse incentive for outside lawyers for Fannie and Freddie to delay and not settle, and to run up colossal legal bills footed by U.S. taxpayers, says Rep. Neugebauer, with no end in sight.
“This is a feeding frenzy,” Ohio’s attorney general has testified--his state’s public pension system is suing Fannie Mae.
It’s the equivalent of betting against the house, having the house fall down not on you, but on taxpayers--and letting your lawyers charge taxpayers legal fees into infinity to defend you for the collapse you created.
The inspector general for the Federal Housing Finance Agency (FHFA) has reported that Fannie and Freddie spent $110 million to defend former executives since 2004.
That includes $37 million shelled out since the government took them over in September 2008—and all of that money was spent on just the three former Fannie execs, an official with the FHFA’s inspector general’s office confirms to FOX Business.
The actual $194.4 million number breaks down to an estimated $159.7 million for Fannie and its execs since September 2008, and an estimated $34.7 million for Freddie and its execs for that time (factor in the $73 million paid for just the executives legal fees since 2004, and the total number rises to $267.4 million).
Fannie did not return calls for comment. Freddie Mac spokesman Michael Cosgrove emailed FOX Business to say such payments are “in accordance with Virginia law and our bylaws and indemnification agreements.”
An Army of Lawyers and Experts
Tens of millions of dollars in taxpayer money has been flying out the door for an army of outside lawyers, consultants and troves of expert witness to defend the former executives, and their increased compensation, as well as for things like computer data services.
Fannie and Freddie are also reimbursing lawyers for their copying costs, long distance phone calls, and travel expenses, government documents show.
Based on info from the FHFA, and according to analysis by Rep. Neugebauer’s office, an army of lawyers has racked up an astonishing 159,000 billable hours for just the three former Fannie executives since the government took them over.
There are only 8,760 hours in a year.
That means these lawyers somehow packed in 18 years worth of round the clock work, wall to wall, 24/7 legal work in just four years’ time.
Also, the government lets the former executives’ lawyers bill for charges at every one tenth of an hour (six minutes), says the new report from the inspector general for the FHFA.
A Fannie case “ongoing since 2004 has included over 120 fact depositions, various expert depositions and millions of discovery documents. Unfortunately, no end is in sight,” Rep. Neugebauer says.
Ohio attorney general Michael Dewine notes that, even just for short routine conferences, “where nothing substantive is discussed,” Fannie Mae typically brings a crowd of 35 to 40 attorneys and paralegals, “costing taxpayers over $600 per hour for some of these lawyers.”
For example, Raines’ deposition held in April 2010 “lasted 12 hours, covering two days,” Dewine says, adding that “the Fannie Mae defendants brought 13 lawyers,” including five for Raines, two each for the former CFO and controller, and one for Daniel Mudd, a former Fannie Mae official, “who isn’t even a defendant in the case.”
What did taxpayers get for these 13 lawyers?
“None of these 13 lawyers asked a single question at this particular deposition,” Dewine testified.
Just as bad are the taxpayer-paid for “expert” witnesses hired to defend the former executives against their accounting fraud — and to defend their compensation rigged higher by the frauds.
At one point in the Ohio suit, defendant KPMG had five experts. But the Fannie Mae defendants had “25 experts, costing taxpayers an astounding $600 to $1500 an hour,” Dewine testified.
Moreover, Raines had “nine experts just for himself, including four to say essentially that he fulfilled his job as CEO by properly relying on others,” and “two to say that his $91 million in compensation over five years was justified,” the Ohio attorney general says.
Dewine noted that at a later hearing, the judge on the case said there is absolutely no way that so many experts would actually testify at trial, “admonishing Fannie Mae defendants: ‘so you don’t need to have five experts say the same damn thing...the costs are just staggering.’”
The problem is, the Ohio case has been going on now for over seven years. There are other lawsuits as well, involving even more lawyers.
Dewine has warned: “It’s really easy to hold up the resolution of a lawsuit, when you’ve got a seemingly bottomless coffer of U.S. taxpayer dollars from which to pay your legion of lawyers to engage in wasteful delay tactics.”
Ignoring Efforts to Settle
Dewine noted that, although his office is trying to settle its class action suit, their “efforts, at every turn, have been ignored, with no meaningful conclusion in sight.”
Dewine also has testified that Fannie Mae “is doing everything in its power to delay and stall, all while racking up astronomical legal costs and sticking America’s taxpayers with the bill,” because they continue to use “U.S. taxpayer dollars to pay their highly compensated cadre of lawyers to over-lawyer their indefensible actions.”
The judge on the Ohio class action suit has also commented in court that “I am not so sure the taxpayers are doing pretty well, but the lawyers are doing pretty well in this deal.”
Shangri-La for Lawyers
And the Ohio attorney general has noted: “If, what Supreme Court Justice David Brewer once said is true -- that ‘America is the paradise of lawyers’ -- then counsel for Fannie Mae, Raines, Howard, and Spencer have found Shangri-La!”
Dewine notes that in his experience, “98% of all securities cases reach a conclusion in far less time -- and with far less cost,” adding that even a similar June 2003 securities fraud class action case against Freddie Mac “was resolved in a little under three years.”
The bottom line, as Judge Leon put it, is this: “The more this litigation is protracted and prolonged, the greater the risk that..pensioners and the shareholders will not have as much or will have markedly less and the taxpayers will be out millions and millions and tens and tens of millions of dollars for legal fees that can’t be recouped."
Taxpayers Still Kept in the Dark
And after all these payments are shelled out by taxpayers, Fannie and Freddie still must abide by the executives “attorney client privileges.”
Meaning, the lawyers don’t have to disclose any further evidence they uncover that the executives knowingly and willingly broke the law--and thus broke the companies’ indemnification standards.
Here’s What Happened
In 2006, the federal government found that Fannie’s former head, Raines, and two other executives put their own personal interests ahead of Fannie’s when they engineered a $10.6 billion accounting fraud to manipulate earnings, and their bonuses, higher over a six-year period, from 1998 to 2006. The moves smoothed Fannie’s earnings so as to hit Wall Street earnings targets.
Freddie, too, was found to have manipulated its profit figures from 2000 to 2002; the company later revised its results by $5 billion.
Raines and the executives could not be reached for comment.
That fraud resulted in Fannie Mae overstating reported income and capital by an estimated $10.6 billion, said the Office of Federal Housing Enterprise and Oversight, Fannie and Freddie’s federal overseer at the time, in a May 2006 report. The fraud triggered a restatement and losses.
Fannie Mae admitted its wrongdoing in May 2006, when it paid a record $400 million total to the SEC and OFHEO for violating more than two dozen generally accepted accounting principles and a variety of OFHEO rules, among other things.
Former OFHEO head James Lockhart described Fannie as having an “arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings” which in turn “maximized the bonuses” for Raines, which totaled over $90 million from 1998 through 2003. Of Raines’ total, “over $52 million was directly tied to achieving earnings per share targets,” OFHEO said.
Neither Admit Nor Deny = Refunded Legal Fees
However, the trio neither admitted nor denied the charges—which means taxpayers have to keep on paying. “They did not admit to offenses that would have cost them their indemnification,” Edward J. DeMarco, Acting Director Federal Housing Finance Agency, testified last year.
It is standard practice for executives to settle cases neither admitting nor denying culpability, although the SEC is now trying to curtail this practice.
In addition, the executives got their total settlement fines of $31 million covered by Fannie's insurance policies, and paid via forfeiture of stock options, pension and bonuses, among other things.
Taxpayers Foot Fannie’s Legal Bills for Housing Collapse
And taxpayers are now footing the legal bills for class action and other law suits, legal fights between Fannie and its auditor KPMG, as well as government investigations that are nearly a decade old, including probes by the Securities and Exchange Commission, the FBI, and other Congressional probes.
Taxpayers are also footing legal bills to defend the Fannie and Freddie for their outsized role in the housing crisis—where they took on an estimated $1.7 trillion in high risk mortgages.
The two are now stuck with trillions of dollars in mortgages and securities, including fraudulent liar loans and fraudulent subprime liar’s loans, which they took on so as “to increase profits and regain market share,” guaranteeing even fatter bonuses and more fatal losses, noted Armando Falcon, Lockhart’s successor at OFHEO.
Both of their balance sheets combined now total $5.4 trillion—equal to the gross domestic product of Germany and the United Kingdom--combined.
Paying Cash Advances, Too
Moreover, both Fannie and Freddie are paying cash advances to former executives to cover their legal fees ahead of time with little oversight—which means they face “no expense in just running up the tab for the U.S. taxpayers,” says Rep. Neugebauer.
Moreover, Fannie’s board sped up the time of that payment, a deadline of just 20 days for executives like Raines to get their taxpayer funded cash advances. Freddie, too, pays after 45 days time.
This practice, too, is causing taxpayer costs to soar.
Moreover, the FHFA has not independently certified whether the internal systems that Fannie and Freddie use to pay these cash advances for legal bills protect taxpayers, government documents show.
On Feb. 29, 2008, Fannie Mae’s board adopted a policy allowing for the advancement of cash to current and former board directors and executives for these costs.
The board suddenly decided that, if an executive was in compliance with its indemnification standards, “Fannie Mae will pay to directors and officers expenses incurred in advance of the final disposition of a proceeding,” an internal company document says.
Fannie didn’t return calls asking how the board determined Raines and the execs were “in compliance” with these standards.
Also, all Raines and the executives have to do is send a letter of request to Fannie’s general counsel, which is then supposedly put to a vote by the board.
And in a confidential, internal document, Freddie’s bylaws prohibit payment of legal fees if an employee “knowingly engaged in certain conduct and knowingly or recklessly caused a substantial loss to Freddie Mac or a substantial pecuniary gain or other benefit.”
It goes on to say that any employee “who has engaged in misconduct resulting in a loss to Freddie Mac or who has improperly received benefits as a result of such misconduct” may be subject to “legal action by Freddie Mac for restitution or reimbursement.”
Frannie and Its Regulator Say “We Have to Pay”
But instead of minimizing taxpayer losses--as the FHFA is charged with doing--by fighting to void these legal fees, Fannie and Freddie now argue, along with the FHFA, that their options are limited; that court cases enforcing payment for legal bills take precedent; that the executives could sue them and win; and that they need to keep paying these fees to keep existing employees on staff and attract skilled workers.
Cosgrove adds that “if FHFA or we were to cut off these payments, the officers could sue us to enforce their rights to such payments, which could subject us to additional costs.”
However, efforts to save taxpayers money are spotty. Fannie merely questions bills if more than one lawyer attends, says the FHFA IG, while Freddie does not.
Taxpayers Should Not Have to Pay
Trouble is, the 2008 federal law sanctioning their government takeover and even the companies’ own bylaws let the two repudiate these legal fees if their executives act against the companies’ best interests, engage in intentional misconduct or breach their duty of loyalty to their companies.
The inspector general for the FHFA also noted that the FHFA could have voided these legal fees under the 2008 law authorizing their government takeover.
An outside law firm has confirmed these findings, noting that the FHFA “has express statutory authority to repudiate or disaffirm” the refunding of these legal fees, which come as part of what are called standard, corporate indemnification agreements.
Nothing to Lose By Nixing These Fees
However, an outside law firm which has reviewed the contractual agreements says the government should take a shot at this and not pay, because if it lost, taxpayers would only have to pay their legal fees anyway if Raines and the other executives turn around and sue for breach of contract.
That’s because under a worst case scenario, in the 2008 law letting the government seize Fannie and Freddie, the law says the government would only have to pay the legal fees.
The 2008 law says the costs “should not exceed what the FHFA would have paid if it had continued to pay the former employees’ legal fees under the indemnification agreements.”
The 2008 law also says the damages would only equal “actual direct compensatory damages,” not punitive damages, damages for lost profits or pain and suffering.
Meaning, “the former executives’ incurred legal fees and expenses” the government would have paid in the first place if it didn’t try to void them, the legal analysis shows.
And taxpayer costs for a lawsuit nixing these legal fees would be low, since the FHFA could use its own legal staff, and not a phalanx of outside lawyers.
Fannie’s Legal Fees Contravene SEC Order
And Fannie’s payment of these legal fees for the 2004 accounting fraud contravenes a consent order it entered into with the SEC earlier last decade when it settled its accounting charges.
According to FOX Business’s review of its SEC consent order, Fannie Mae agreed to “not take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the [SEC’s] complaint or creating the impression the [SEC’s] complaint is without factual basis.”
However, by continuing to pay to defend these executives, Fannie Mae is doing just that, as its lawyers are “dragging out” litigation “billable hour by billable hour -- and bleeding Americans,” Ohio Attorney General Dewine has testified to Congress last year.
Why the Sudden Indemnification?
Executives can get indemnification “only if the officers and directors were acting within the scope of their authorities, the FHFA IG’s report says.
Is securities fraud and cooking the books “in the scope of their authorities?”
Plus Fannie mysteriously, and suddenly, offered its executives indemnification well after the government had started probing its accounting fraud.
Another internal Fannie Mae document that Raines signed on Nov. 12, 2004 entitled “undertaking to repay indemnification expenses” noted that he agreed to reimburse Fannie Mae “for all expenses paid” by Fannie for his defense in any civil or criminal action if it’s determined he is “not entitled” to be indemnified.
The indemnification sets for “rights” AND “obligations” of these executives in order to be “indemnified.”
The document notes they must act “in good faith and in a manner he or she reasonably believed to be in or not opposed to Fannie Mae’s best interests.”
Being involved in an accounting fraud is not acting in the best interests of any company.
Also, according to their bylaws, payment of legal bills must be “reasonable” expenses.
Are 40 lawyers and paralegals for one short courtroom conference, and a phalanx of experts defending fat cat pay rigged by accounting frauds “reasonable”?
Elizabeth MacDonald joined FOX Business Network (FBN) as stocks editor in September 2007.
Follow Elizabeth MacDonald on Twitter @LizMacDonaldFOX.