Q1. What is the purpose of this article?
A1. I will summarize recent developments on the "secrecy" front, including Professor Prakash's paper and Judge Sweeney's release of documents to other courts. I have previously discussed the secrecy issue here, here, and here. Judge Sweeney at the federal Court of Claims has overseen the "discovery" process in recent years, including the sharing of certain documents with other courts, which has led to some documents being released to the public. The continued release of documents may be shifting the ground - improving the likelihood that Judge Lamberth's decision may eventually be overturned.
Recent releases of documents have shed some light on what the U.S. Treasury and the Federal Housing Finance Agency (FHFA) knew and when they knew it, e.g., in the days before August 17, 2012, it appears that they knew or could have known that the GSEs were likely to be entering the "golden years of GSE earnings."
Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are together known as the government sponsored enterprises, or GSEs. The ongoing litigation has to do with the Senior Preferred Stock Purchase Agreements (SPSPAs), which are formal agreements between the U.S. Treasury and the two GSEs; as conservator, the FHFA is supposed to act on the GSEs' behalf. The 3rd Amendment to the SPSPAs was announced by Treasury and FHFA on August 17, 2012. It even seems possible that Treasury expedited the 3rd Amendment process because it had begun to realize the "window" for instituting the net worth sweep would soon disappear.
A favorable decision in the appeal is possible, which could provide noteworthy upside for GSE common and preferred investors, as discussed here and here. It continues to be true that investors in GSE common and preferred stocks need to do thorough due diligence with respect to the GSEs' investment prospects.
Q2. Do you have any comments on S. B. Prakash's article, "The Government's Seizure of Private Property Behind a Veil of Secrecy?"
A2. Yes, I do. S. B. Prakash's recent paper (May 16, 2016) on the government's hiding behind a veil of secrecy is instructive, but focuses almost entirely on the Court of Claims. Professor Saikrishna Bangalore Prakash's article is here, and an earlier article is here. Audio of a recent Investors Unite conference call with Prakash is here.
Prakash points out:
Private parties, in this case shareholders of Fannie and Freddie, have billions of dollars at stake, while the public has inestimable interests in open government, the rule of law, and accountability. Given the circumstances, the court reviewing the claim of executive privilege should rebuff the executive's attempt to cast a shroud of secrecy over its expropriation.
I would highlight the following points from Professor Prakash's paper:
- "Given FHFA's status as an independent agency, its role as a conservator, and Treasury's limited statutory authority, FHFA and Treasury were supposed to maintain an arm's-length relationship, not a cozy one where Treasury could dictate terms to FHFA."
- For the pre-decisional privilege to apply, "only materials generated before a government decision that relate to internal deliberations are protected. This requirement makes sense in light of the desire to foster free debate and discussion prior to a final decision."
- "Plaintiffs need discovery as a means of proving their claims. In this case, the plaintiffs sought to establish that Fannie and Freddie were financially sound at the time of the inauguration of the Net Worth Sweep and that plaintiffs therefore had 'a reasonable investment-backed expectation' of return."
- In asking for a protective order, the "government argued that making such documents publicly available would (A) destabilize financial and housing markets and the general economy and (B) impede the passage of new congressional legislation regarding Fannie and Freddie. In 2014, Judge Margaret Sweeney, of the U.S. Court of Claims, imposed a protective order."
- "The courts make this [privilege] determination on a case-by-case basis, balancing the need for the information against the harm to the government's internal deliberative processes. Among other things, the courts must consider relevance of the evidence, the availability of other substitute evidence, the seriousness of the litigation, whether the government is a litigant, and possible effects on future government employees."
In a previous Seeking Alpha article, which is available here, I speculated that it could be argued that "Treasury is effectively the co-regulator of the GSEs" because "the SPSPAs are an agreement between the Treasury and the FHFA." As I will discuss in some detail below, some evidence has recently been released that begins to fill in the dots.
In the same article, I also pointed out that the SPSPAs are "odd" administrative documents, i.e. the SPSPAs aren't statutes; they aren't formal rules; they aren't regulatory decisions by the FHFA that were decided after notice, comment, and hearing. Note that the FHFA has conceded that it didn't collect an administrative record while it was "deliberating" the SPSPAs, so it would seem to be particularly difficult to determine whether any specific documents - amongst the 12,000 or so that are under dispute - were actually "pre-decisional."
Note also that, per professor Prakash, the agency head (Acting Director DeMarco was the agency head in 2012) may only invoke the privilege as to documents that he has personally reviewed. Prakash explains that "only the agency head may invoke the privilege and only as to documents he or she personally reviews." Given that an administrative record was not collected by FHFA prior to the 3rd Amendment to the SPSPAs, it would seem all but impossible for Director Watt, former Acting Director DeMarco, Judge Sweeney, or anyone else to reliably determine that any particular document had actually been personally reviewed by Dr. DeMarco.
One way of interpreting Judge Sweeney's oversight and decision making in the discovery process is that she is empirically testing, bit by bit, the proposition that the release of documents would destabilize financial and housing markets and the general economy. Some documents were released to the Circuit Court on April 13, 2016 with no evident destabilization of the American economy, then other documents were released to a U.S. District Court in Kentucky on May 11, 2016, again with no apparent destabilization. One may speculate that Judge Sweeney may decide to continue to test this proposition empirically, gradually releasing more and more documents.
Q3. Has information been released that supports the thesis that Treasury is a co-regulator of the GSEs?
A3. Yes. Some evidence is emerging that Treasury led the decision making related to the 3rd Amendment to the SPSPAs. However, perhaps 12,000 documents remain unavailable to the public, and therefore uncertainty remains.
This is the case despite the fact that the Housing and Economic Recovery Act of 2008 (HERA) specifically states that FHFA is not to be directed or supervised by Treasury:
(7) AGENCY NOT SUBJECT TO ANY OTHER FEDERAL AGENCY.-When acting as conservator or receiver, the Agency shall not be subject to the direction or supervision of any other agency of the United States or any State in the exercise of the rights, powers, and privileges of the Agency.
Some evidence has begun to emerge supporting the proposition that FHFA has effectively agreed to make the Treasury the co-regulator of the GSEs via the SPSPAs. This was accomplished while Edward DeMarco was the Acting Director of the FHFA. It continues to be the case that the FHFA Director Watt will defer to Treasury with respect to the SPSPAs and will defer to Congress with respect to overhauling the housing finance system. I discuss this here.
At best, the term "independent agency" is ambiguous. In public utility regulation, "independence" usually means that the regulator is appointed for a defined term by the state governor and approved by the state senate. The state regulatory agency is typically funded from payments by the regulated firm's customers (e.g., a small cents per kWh charge that is born by electric utility customers) rather than receiving ordinary tax/budget treatment. Federal agencies such as the Federal Energy Regulatory Commission and the Federal Communications Commission are funded similarly.
Nevertheless, an "independent agency" can be influenced by the executive branch. For a typical federal agency, Professor Morrison explains that:
The basic question to be asked is, how independent are independent agencies? The answer, it seems to me, is 'not very.' The key person at the independent agencies is the chairman who can be redesignated on an annual basis by the President. In addition, the agency's budget must go through the Office of Management and Budget (OMB), and, with only a minor wrinkle or two, … the fact remains that independent agencies are still heavily affected by the White House, especially on important issues, and especially for those members who are interested in being reappointed. Thus, while the independents are more independent than the executive agencies, the difference in my view is not substantial.
Given the specific statutory language in HERA of 2008, it seems clear to me that Congress intended FHFA to be more independent than the "typical" regulatory agency, as discussed by Professor Morrison. [Note, however, that I am not an expert on the legislative history of HERA.]
New evidence has come to light with respect to the question of whether Treasury led the way toward agreeing to the 3rd Amendment. A useful summary is available here.
I will discuss two emails that have come to light via discovery. First, in an email dated January 4, 2012, Mary Miller at Treasury sent Acting Director DeMarco an agenda for discussion, noting that "FHFA and Treasury share common goals to promote a strong housing market recovery, reduce government involvement in the housing market over time and to provide the public and financial markets with a clear plan to wind down the GSEs." Mary Miller adds that one of the actions necessary to facilitate achieving the common goals include "ensure sufficient capital support for the GSEs during the transition period and thereafter." Note that nothing here is particularly surprising or objectionable.
Second, in an email dated August 9, 2012, FHFA staffer Mario Ugoletti sent "[a]s a heads up, there appears to be a renewed push to move forward on PSPA amendments. I have not seen the proposed documents yet, but my understanding is that largely the same as previous versions we had reviewed in terms of net income sweep, eliminating the commitment fee, faster portfolio wind down, and a deminimus safe harbor for ordinary course transactions." Here there is at least the appearance that the FHFA may be subject to the direction or supervision of Treasury, at least with respect to the 3rd Amendment to the SPSPAs.
At this time it is impossible to say unequivocally that Treasury is effectively a co-regulator of the GSEs via the SPSPAs. Some additional evidence has begun to emerge on this score, but uncertainty remains. Note that there is at least the appearance that Treasury and FHFA statements made on August 17, 2012 may have been untruthful. Their statements can be found here and here. Note also that, per professor Prakash, privilege should not be a vehicle for hiding the improprieties of government officials from public scrutiny.
Q4. What does Justice Breyer have to say about due process in informal adjudication?
A4. Justice Breyer, in his book Regulation and its Reform, discusses informal adjudication in the context of the Administrative Procedure Act of 1946 (APA). I quoted from Justice Breyer's book in a previous Seeking Alpha article. Here is an expanded quotation of Justice Breyer's discussion of informal adjudication and due process as follows:
Informal adjudication. Most other agency decision making, including the millions of decisions made by civil servants in their offices every day, can be classified as 'informal adjudication' and are subject to few procedural requirements. Most of them can be reviewed in court for reasonableness and for conformity with the statutes and Constitution. In some instances an agency may be put to some trouble to show that it acted reasonably in light of the statute's language, particularly, for example, if a statute requires environmental impact to be taken into account. Yet most informal adjudications are left unreviewed by the courts.
Occasionally, the Constitution itself may transform an informal adjudication into a more formal one, because the Constitution imposes 'due process' requirements when the government takes from a person his 'life, liberty, or property.' The process 'due' typically involves notice, opportunity to present arguments and evidence and to cross-examine witnesses, an impartial decision maker, and possibly legal counsel. When these requirements apply, however, is a matter of much legal dispute, revolving around whether the government is in fact taking something from someone. Is, for example, a welfare payment or an education something to which a person is entitled and which the government, therefore, cannot take away without due process? Or is it a privilege given to a person by the government, which the government can then take away with fewer procedural protections? [footnotes excluded]
Justice Breyer goes on to explain:
One might summarize these procedural rules as providing persons with certain minimal procedural expectations. When agencies make decisions of importance, they are likely to be subject to the following general procedural constraints:
1. they must give notice of what they intend to do well in advance of their doing it;
2. they must provide reasons for their action and publicly present evidence supporting it;
3.they must allow affected parties to present arguments and evidence;
4. they must overcome court review of showing through argument and evidence that their position is reasonable.
I conclude my summary of Judge Breyer's discussion of informal adjudication as follows:
Although these requirements are minimal and administrative law is generally flexible, these points should be kept in mind. First, the law generally imposes greater protections and procedural requirements when the government orders someone to do something or takes something from someone than when the government gives someone something, such as a grant or a benefit. Regulation involves the former, not the latter, activity.
Professor Ronald J. Krotosznski, Jr. (University of Alabama) points out:
One of the most significant omissions in the Administrative Procedure Act is its failure to prescribe procedures for--or even to address directly--informal adjudications. To be sure, Citizens to Preserve Overton Park, Inc. v. Volpe interprets the APA to provide for ex post judicial review of informal agency adjudications. Accordingly, a person dissatisfied with an agency's behavior may seek review under the APA after the fact. …
[T]he general absence of any ex ante procedural requirements surely burdens the ability of would-be plaintiffs to mount challenges to irrational agency action. Moreover, average citizens may be unaware of the availability of judicial review, or be unable to take advantage of it because of a lack of access to legal representation.
It is more than a little ironic that the vast bulk of federal agency action flies under the radar screen of the APA--yet, this is true. As Professor Edward Rubin noted, 'the APA does not actually use the term informal adjudication at all, and barely acknowledges the concept.' He suggests that '[t]he drafters have so little to say about it because they did not conceptualize it as an identifiable category of government action. Nevertheless, over ninety percent of agency actions constitute "informal adjudications. [Footnotes excluded]
Professor Alan B. Morrison (George Washington University) has written on the procedural protections in the APA in the context of informal adjudications as follows:
[U]nlike formal proceedings or informal rulemakings, there are no specific procedural requirements in the APA that agencies must follow when engaging in informal adjudication. This leaves interested persons with only the procedural protections in the applicable substantive statute, plus any found in the agency's regulations. The danger from this kind of procedural void was brilliantly captured by Representative John Dingell, when he was chair of the House Energy and Commerce Committee: 'Most people think of the procedure as just being kind of amorphous, and you don't have to worry about it. The procedure is exquisitely important . . . . I'll let you write the substance of a statute, and you let me write the procedure, and I'll screw you every time.' As described below, the courts have not been willing to allow agencies full carte blanche, but neither have they imposed substantial procedural requirements. In so doing, the courts have attempted to tailor the procedures to the nature of the proceedings, resulting in an almost case-specific approach within the general category of informal adjudications. Because the 'law of informal adjudications' is not based on the text of the APA, but rather on case holdings, it is necessary to explore these cases in greater detail here than was done in the rest of the Article. [Footnotes excluded]
To the best of my knowledge, the limitations of "informal adjudication" and the constraints imposed on it have not been thoroughly scrutinized in any of the ongoing legal proceedings. Note that I'm not a lawyer, so I'm not really sure about this. Nevertheless, I'd encourage any members of the legal community that are reading this to investigate this issue further.
Q5. Do you have any comments on White House staffer Jim Parrott's "fellow traveler" comment to the American Enterprise Institute (AEI)?
A. Yes, I do.
In an email sent at 8:30 am on August 17, 2012, Jim Parrott made the comment "Feel like fellow travelers at this point so I owe it to you" to Alex J. Pollock, Edward Pinto, and Peter Wallison from AEI. All three have been long-term critics of the GSEs.
Separately, note that Alex J. Pollock made the following statement on November 21, 2008:
A second thing to be hoped for in these interventions is that the taxpayers, who are being made into involuntary investors in the equity of financial firms and in distressed debt, will be thought of and treated like investors to the greatest extent possible. I even have the notion that if the various bailout schemes, like the TARP, succeed in making a profit, which in my view they very well may, 100% of that profit should be returned to those citizens who actually do pay federal income taxes as a dividend.
[Audience applause]
Thus, it seems that the net worth sweep was talked about as early as Friday, November 21, 2008, before an audience at the 2008 National Lawyers Conference.
I find it even more remarkable that Judge Douglas Ginsburg was the moderator of the panel, which included Peter Wallison, Bert Ely, John Taylor, Todd Zywicki, and Andrew Redleaf.
I don't know how to evaluate the fact that Judge Ginsburg was the moderator at what arguably may have been the first time that a 100 percent "net worth sweep" was discussed in public. Note that as moderator he was likely more concerned with the speakers keeping their presentations short than with what they said.
Q6. Do you have additional comments at this time?
A6. No, I do not. In a future article, I will discuss discovery on whether Treasury/FHFA knew or could have known that the GSEs were soon to return profitability prior to August 17, 2012.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
