Fannie Mae Escrow Grab Exposes Shareholders to 24% Loss in S

Discussion in 'Financial Cents' started by hacon1, Feb 13, 2008.

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    Fannie Mae Escrow Grab Exposes Shareholders to 24% Loss in Suit

    By Laurence Viele Davidson

    Feb. 13 (Bloomberg) -- Fannie Mae, the largest source of U.S. home-loan money, faces a proposed class-action lawsuit over as much as $7 billion it earned on property owners' escrow accounts starting in the 1970s.

    The company violated government policy and breached its duty to about 4,000 owners of government insured moderate- and low-income housing, lawyer Mark Lanier claims in federal court in Texarkana, Texas. Fannie Mae should return gains of $3 billion to $7 billion, said Lanier, 47, with the Houston-based Lanier Law Firm. The higher figure is $7.20 a share, 24 percent of the company's market value. Fannie Mae says it acted legally.

    U.S. District Judge David Folsom, 60, twice refused company requests to throw out the case. A plaintiffs' bid for class- action status has been pending since 2006, two years after three property owners sued, including Alfred Porkolab, now 93, who built a 36-unit complex in Lorain, Ohio, in 1969.

    ``It's a significant claim against Fannie Mae, which has already been in the spotlight with respect to its fiscal policies and ability to regulate its fiscal operations,'' said lawyer Francis Riley with the Philadelphia-based law firm Saul Ewing. Riley, a specialist in real estate law in the firm's Princeton, New Jersey, office, isn't involved in the case.

    Lanier won the biggest Vioxx jury award against Merck & Co. over the fatal heart attack of a man taking the recalled pain pill.

    Federal National Mortgage Association fell 45 percent in the past year. It reported a third-quarter net loss of $1.39 billion as a housing slump deepened and mortgage delinquencies increased. The company said a rise in foreclosures hurt fourth- quarter earnings. Fannie Mae faces a ``tough year'' in 2008, Chief Executive Officer Daniel Mudd said in a Jan. 29 interview.

    Owners' Claims

    The company yesterday rose 70 cents to $30.45 in New York Stock Exchange composite trading.

    Fannie Mae is accused of profiting by investing money from escrow accounts required by the U.S. Housing and Urban Development Department for repairing and improving the housing.

    ``We take the position that the conduct was, in fact, legal,'' Fannie Mae lawyer Brian Brooks said in a 2006 hearing. HUD knew Fannie Mae invested the funds from the escrow accounts, said Brooks, 38, head of the Washington office of Los Angeles- based O'Melveny & Myers law firm.

    William Ross, a HUD deputy undersecretary from 1966 to 1970, said in an affidavit in May 2006 that he believed HUD senior officials and Fannie Mae directors knew of the escrow investing.

    From 1969 to 1970, the years immediately after Fannie Mae was converted from an arm of government to a public company, Ross was its chairman and acting CEO. Fannie Mae spokesman Jon Searles declined to comment on the suit.

    Ex-HUD Top Lawyer

    A former HUD chief lawyer disputed Ross's version and backed the plaintiffs' claims.

    Ruth Prokop, HUD's general counsel from 1977 to 1979, said in a Feb. 4 interview she was ``shocked'' to learn Fannie Mae declared in court papers she knew the company was earning and keeping proceeds from escrow accounts.

    She gave plaintiffs' lawyers an affidavit in July 2006 saying she wasn't aware of the practice, she said. The funds are supposed to benefit only the housing projects, and owners were wrongly kept ignorant of the investments, she said.

    ``HUD rules aside, they were acting as a fiduciary and didn't have the authority to do what they did,'' Prokop said of Fannie Mae officials. Prokop, a 68-year-old retiree living in San Antonio, said she may testify at a trial.

    A HUD spokesman, Lemar Wooley, said rules since 1970 require that any interest on the accounts benefit the projects.

    Refusal to Dismiss

    The judge in Texas refused to dismiss the suit in 2005 after Fannie Mae argued it didn't have a fiduciary relationship with the mortgage-holders.

    ``An element of trust arguably exists between the parties because the plaintiffs trusted Fannie Mae to deposit their escrow payments into escrow accounts for their intended purpose and not use the payments for Fannie's own pecuniary gain,'' Folsom wrote in March 2005.

    Plaintiffs are asking to sue as a class, saying their claims are similar enough to be decided in one trial. Fannie Mae argues that because the case involves state laws, the owners are too diverse to sue as a group.

    ``The theory being put forth to the case has a lot of support to it,'' said Duke University law professor James Cox, a specialist in corporate governance. ``This has a lot of traction and a lot of support in the courts.''

    The company faces a separate shareholder lawsuit over a $6.3 billion earnings overstatement that led to a $400 million fine and the 2004 ouster of CEO Franklin Raines.

    In a November 2007 filing, Fannie Mae listed the case among pending lawsuits against it. Since a loss in any of them ``was not both probable and estimable,'' the company didn't record a reserve for them, it said.

    The case is Medlock Southwest Management v. Federal National Mortgage Association, 04cv129, U.S. District Court, Eastern District of Texas (Texarkana).

    To contact the reporter on this story: Laurence Viele Davidson in Atlanta at .
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