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Indemnification Rights for Fannie and Freddie Leads to Ironic Defense from SEC Charges

Robert M. Siegel

On December 16, 2011, the SEC filed two separate suits charging securities fraud by three former top executives from Fannie Mae and Freddie Mac, respectively. Both suits were filed in the U.S. District Court for the Southern District of New York, and allege that the executives knew and approved of 1) making misleading statements that the companies’ subprime exposure was substantially smaller than it really was, and 2) understating the level of risk. The SEC is seeking financial penalties, disgorgement of gains with interest, permanent injunctive relief, and officer and director bars against the individual executives.

The SEC leveled charges at a predictable target, following widespread criticism for not penalizing top executives for reckless actions that triggered the 2008 market crisis. A real question remains, however, as to whether any other culpable individuals from the too-big-to-fail banks will be held accountable.

In addition, a recent report issued by the Inspector General of the Federal Housing Finance Agency says that both Fannie Mae and Freddie Mac have paid more than $109 million in legal expenses for former executives since 2004. The report recommends that standard legal billing practices should be developed for Fannie Mae and Freddie Mac, in addition to expanding oversight of such expenses in order to control costs. Ultimately, because of the broad indemnification rights given to the executives of Fannie and Freddie, the companies are covering the legal costs of each executive. Ironically, the government on the one hand is prosecuting these individuals while on the other hand, it is paying for their defense.

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