Six former top executives of Fannie Mae and Freddie Mac were charged with securities fraud Friday morning in connection with mortgage backed securities issued by the firms.  The Securities and Exchange Commission filed separate suits against each of the government sponsored enterprises (GSEs) in the U.S. District Court for the Southern District of New York while at the same time revealing non-prosecution agreements with Fannie Mae and Freddie Mac in return for the cooperation of the GSEs in the upcoming litigation.

Named in the Fannie Mae suit were former Fannie Mae Chief Executive Officer Daniel H. Mudd, its former Chief Risk Officer Enrico Dallavecchia, and the former Executive Vice President of Fannie Mae's Single Family Mortgage business, Thomas A. Lund.  The three former Freddie Mac executives are Chairman of the Board and CEO Richard F. Syron, Executive Vice President and Chief Business Officer Patricia L. Cook, and former Executive Vice President for the Single Family Guarantee business Donald J. Bisenius.   The irony of the suits is that most if not all of the executives were hired by the companies to clean house following accounting scandals that cost their predecessors their jobs.

The lawsuits allege that the former executives caused their respective companies to materially misstate their holdings of risky loans, including subprime loans, in periodic and other filings with the SEC and in public statements, investor calls, and media interviews.  The Fannie Mae suit contains similar allegations about Alt-A mortgage loans.  The time period covered by the Fannie Mae suit is December 2006 to August 2008 and the Freddie Mac suit covers the period between March 2007 and August 2008. 

According to the complaint against Fannie Mae's executives, Fannie Mae reported its exposure to subprime loans in 2007 but described the loans as those "made to borrowers with weaker credit histories" and claimed that less than one-tenth of its loans met that description.  This, the suit alleges, was done with the "knowledge, support, and approval" of the three executives.  At the end of 2006 the company reported its exposure to subprime loans was 0.2 percent of its single family portfolio or approximately a $4.8 billion share.  Investors were not told, according to the SEC, that Fannie Mae did not include in this calculation loan products specifically targeted toward borrowers with weaker credit histories including more than $43 billion of Expanded Approval loans.

Similar claims were allegedly made by Fannie Mae officers about the company's exposure to Alt-A loans which was disclosed on March 31, 2007 as 11 percent of its portfolio.  In reality at that juncture the exposure was approximately 18 percent of all single family loan holdings. 

The suit against the former Freddie Mac executive alleges that they and the company used a narrow definition of subprime loans when they publicly proclaimed that the company had basically no subprime exposure when the single family part of the business was, at the end of 2006, actually exposed to $141 billion of loans which the company referred to internally as subprime or subprime-like which was 10 percent of the portfolio at that time.  This eventually grew to $244 billion or 14 percent of the portfolio. 

"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. All individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country's investors."

Under the Non-Prosecution Agreements entered into by Fannie Mae and Freddie Mac each company agreed to accept responsibility for its conduct and not dispute a Statement of Facts but did not have to admit or deny liability.  Each GSE also agreed to cooperate with SEC's investigation against the company's former executives. SEC said it entered into the Agreements in light of the companies' current status and considering that any damages the court levied against the companies would be paid by taxpayer funds.

The SEC is seeking financial penalties, disgorgement of ill-gotten gains with interest, permanent injunctive relief and officer and director bars against Mudd, Dallavecchia, Lund, Syron, Cook, and Bisenius.