For Fannie And Freddie Shareholders, It's "How Now, SCOTUS?"

Summary

• Given Treasury Secretary Mnuchin's sad and lamentable capitulation, the fate for GSE shareholders rests principally on how SCOTUS will rule on the Collins APA and constitutional structure claims.
• I provide herein my best assessment as to how I expect SCOTUS to rule. Spoiler alert: the APA claim is relatively straightforward; the constitutional claim is relatively complicated.
• What began as a litigation-driven special situation has now returned as a litigation-driven special situation.
• While we know we can't trust "City Hall" (Treasury and FHFA),we will find out if we can trust SCOTUS. My bet is that we can (sort of).
• A SCOTUS ruling on Collins, expected around April FoolsDay, will provide Fannie and Freddie shareholders substantial price appreciation if it is favorable to the Plaintiffs.

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THE SET UP

So, it turns out that Treasury Secretary Mnuchin was all hat and no cattle. Shame on us for believing that he would do what he said he would do. I suppose when you are born with a nepotistic Goldman Sachs spoon in your mouth, doing what you say you will do is for the little people.

To quote George Steinbrenner, Mnuchin "spit the bit".

Of course, a Fannie and Freddie investment was always fundamentally a litigation-driven special situation. The fortuity of the Trump election, coupled with the appointment as Treasury Secretary of a mortgage finance banker who (should have) appreciated the importance of the role played by the GSEs, seemed to be a karmic dice roll that came up all 7s for GSE shareholders back in 2016. But the bureaucratic solution for the GSEs proved to be simple but, for some reason, not easy for the Trump administration.

My purpose now is not to examine the putrid entrails of a futile Trump administration process, but return to our point of departure, and assess the litigation merits that reemerge front and center with respect to the GSE investment analysis. I will focus on the Collins statutory ("APA") and constitutional claims argued before SCOTUS December 2020. SCOTUS should render its decision on or about this April Fools Day. The Fairholme Court of Federal Claims case and the Fairholme breach of implied fair dealing contract case in D.C. Federal District Court can serve as negotiating chips for GSE plaintiff (“P”) shareholders down the road, but what will initiate that negotiation will be the Collins SCOTUS decision.

Suggested background reading includes the Collins 5th Circuit en banc decision, the government's cert. petition regarding the APA claim, P's cert petition regarding the constitutional claim, the government's brief regarding the APA claim, P's brief regarding the constitutional claim and reply brief regarding the APA claim, the amicus curiae's brief regarding the constitutional claim, the government's reply brief regarding both claims and the transcript of the SCOTUS oral argument.Also especially pertinent are the amici briefs filed by Thomas Vartanian and J. Timothy Howard. Full marks, indeed extra credit, for doing this reading.

I will try to distill these analytical references into something that is useful below. Remember, I am giving you my analysis, not my assurances. Caveat emptor.

Collins Ps make two claims: the APA claim and the constitutional structure claim. The APA claim alleges that the Net Worth Sweep ("NWS") violated the mandate of FHFA as conservator to take such actions as may be necessary to rehabilitate the GSEs. This entails an affirmative duty to preserve and conserve GSE assets, and do such things as may return them to a safe and sound condition. Rebuilding capital is the sine qua non of returning the GSEs to a safe and sound condition.

The constitutional structure claim alleges that FHFA is unconstitutionally structured with a single director removable by POTUS only for cause. Building upon theSeila Lawcase decided last year, this claim argues that SCOTUS should provide Plaintiffs ("Ps") "backward relief" by voiding the NWS as an action consummated by an unconstitutionally structured administrative agency. If SCOTUS grants such relief (by overturning that portion of the 5th Circuit en banc holding that called for only prospective relief), this would result in well over $100 billion as a remedy for Ps, which could be effectuated, in the most part, by an elimination of Treasury's senior preferred stock.

APA CLAIM

As to the APA claim, the government (as opposed to briefing and argument in NWS court challenges previously, Treasury and FHFA did not appear separately, but were both represented by the Department of Justice) argued that i) the "succession clause" of HERAprevents Ps from asserting the APA claim, since the government alleges this claim is derivative in nature and FHFA as conservator succeeded to, and has the sole right, to bring derivative claims and exercise all of the shareholders powers and rights "withrespect to the assets of the GSEs"; and ii) the "anti-injunction clause" of HERA protects the NWS from Ps attack because the NWS was an exercise of the conservator's powers under HERA, and the anti-injunction clause prevents Ps from restraining or invalidating any valid exercise of conservator power.

It is important to note at the outset that the government's argument before SCOTUS regarding the HERA anti-injunction clause was diluted by a significant retreat from its argument before all appellate courts. Previously, the government asserted that one of the conservator'sincidentalpowers was to manage the GSEs' businesses, and since it is clear that the NWS was an act performed by FHFA as conservator in connection with managing the GSEs' businesses, so the NWS must be valid. Furthermore, the government argued previously HERA did not impose a "duty" or "mandate" on the conservator to do such things as would make the GSEs "safe and sound" (meaning having more capital), but merely stated that the conservator "may" seek to make the GSEs safe and sound. The government had alleged that, may, means it is at the conservator's option.

While this minimalist view of the conservator's duties won the day before several appellate courts in other circuits, it was rejected by the 5th Circuit en banc in Collins. The 5th Circuit era banc majority made it clear that as an "enumerated" power of the conservator to do such things as may restore the safety and soundness of the GSEs, FHFA had a mandate as opposed to an option to rehabilitate as conservator (this mandate description was consistently stated by FHFA prior to the commencement of litigation), and that the incidental powers of the conservator to manage the GSEs' businesses did not supersede, but rather must be understood in the context of, the conservator's mandate to seek safety and soundness.

So as to the merits of whether FHFA properly exercised its powers as conservator, it is important to understand that the government had now chosen to argue before SCOTUS that the NWS complies with the conservator's mandate to seek safety and soundness...it just didn't do a very good job at that, with the benefit of hindsight. Of course, this is a much weaker argument than the one that previously won the day in all appellate courts other than the 5th Circuit. So on the merits, the government has a much harder time to convince SCOTUS that the NWS is protected by the anti-injunction clause.

In other words, you would be wrong to count up the circuit court wins and losses, under the lesser standard that the NWS need simply be shown to be part of the conservator's management of the GSEs' businesses, and use that scorecard to gauge a SCOTUS outcome on the APA claim merits.

The second point to understand about the merits of the APA claim is that the claim comes to SCOTUS on a grant of a motion to dismiss at the federal district court, which was vacated by the 5th Circuit en banc. All Ps have to show is that based upon the evidence presented in their complaint (which includes evidence highly adverse to the government (such as public statements by Treasury that the purpose of the NWS was to prevent the GSEs from rebuilding capital) that was obtained during discovery in the Fairholme takings case), Ps have made a "plausible" argument that the NWS did not comply with the conservator's duty to take such actions as may make the GSEs safe and sound...indeed, that the NWS was antithetical to making the GSEs safe and sound.

So because the government decided not to argue before SCOTUS that the conservatorhad no rehabilitation duty (probably because what passes the "red face test" before a circuit judge won't necessarily pass muster before SCOTUS), SCOTUS has a much easier task to affirm the 5th Circuit en banc's holding that Ps can go to trial, or file a motion for summary judgment at the federal district court without trial, to prove that the NWS did not, indeed could not, comply with the conservator's rehabilitation mandate.

At oral argument, SCOTUS spent little time probing government counsel with respect to the APA merits, other than a few references to Ps claim that the NWS was a "nationalization" of the GSEs, which of course is inconsistent with the conservator's rehabilitation mandate. This proved a rather uncomfortable line of questioning for thegovernment counsel to parry. So if SCOTUS proceeds to address the merits of the APA claim, I feel quite confident that SCOTUS will affirm the favorable 5th Circuit en banc holding.

Which leaves us to consider whether the government will be successful in convincing SCOTUS that Ps don't have standing to assert the APA claim in the first place, given the succession clause.

As to the government's second APA argument, that Ps do not have standing under the succession clause to argue the merits of the APA claim, this whole inquiry turns on whether P's APA claim is direct (Ps have suffered a direct injury arising from the NWS, since the NWS transfers all future equity value from common and junior preferred shareholders to Treasury as senior preferred shareholder) or only derivative (Ps have been indirectly injured since NWS dissipated GSEs' assets, so the GSEs are the sole entities that have been directly injured).

While Ps argue (convincingly) that their claim is direct under normal principles of Delaware corporate law, Ps even better argument is that Section 702 of the Administrative Procedure Act provide Ps a right to judicial review of FHFA's agency action in adopting the NWS ("A person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute [HERA], is entitled to judicial review thereof.") SCOTUS precedent holds that a party who is within the "zone of interests" of the relevant statute (here, HERA) has standing under Section 702.

The zone of interests test is not a stringent standard and is easily satisfied in my view by GSE shareholders with respect to the NWS. HERA is a comprehensive statute setting forth the conservatorship and receivership terms relating to the GSEs. It is manifestly clear that these HERA provisions relate to respective rights of parties within the GSEs' capital structures. Any GSE shareholder is within the zone of interests of HERA.I believe that Ps will win on the APA claim, meaning that there will be aSCOTUS order affirming the 5th Circuit en banc APA decision and remanding the case back to the federal district court in Houston, Texas for further proceedings (trial or motion for summary judgment).

CONSTITUTIONAL STRUCTURE CLAIM

To begin to analyze P's constitutional structure claim, you have to begin with the Seila Law case decided by SCOTUS last year...and it is a very good place for Ps to start from. SCOTUS found the CFPB, structured very similarly to the FHFA with a single agency director not subjectto at will removal by POTUS, to be unconstitutionally structured, and granted backward relief to the Seila P to invalidate the civil investigative demand ordered against Seila (subject to the lower court not finding that agency action had been validly ratified during the pendency of the case).

There are differences between Collins and the FHFA on the one hand, and Seilaand the CFPB on the other hand, and it was government counsel's and amicus counsel's job to exploit those differences in order to distinguish Collins and the FHFA from Seila Law and the CFPB.

The most prominent difference is that the relief sought by the Ps in Collins amounts to well over $100 billion, whereas relief granted in Seila was a do-over of an agency request for documents. This gives rise to the belief, espoused by many in the commentariat, that SCOTUS will find a way to distinguish Collins from Seila since the Collins remedy is such a "tough swallow" (quoting Justice Gorsuch in the Collins oral argument).Let's go over the differences that the government counsel and amicus raised in their briefing and oral argument to assess whether SCOTUS will be nudged to distinguish Seila and deny the Collins Ps a remedy, or a portion of the remedy, it might otherwise order in Collins, if SCOTUS were simply to apply Seila to Collins.

The first distinction from Seila is that the Acting Director of the FHFA signed the NWS, and the government counsel and amicus argued that the Acting Director was removable at will by POTUS. SCOTUS spent a fair amount of time at oral argument seeing where this argument led, assuming that the claim that the Acting Director was subject to POTUS unfettered control was correct.

In my view, this is a weak argument. At the beginning of the HERA statute, there is a statutory provision which states that FHFA is anindependentagency. This is a term of art and it means that the Director of an independent agency is not under the direction of POTUS...the agency is not a part of the Executive Branch, like a cabinet office, and POTUS cannot remove the Director simply because POTUS disagrees with an independent agency policies (like POTUS could remove a cabinet officer). HERA goes on to state that the FHFA Director has a term of five years and is removable by POTUS only for cause.

In the case of the absence of the Director, POTUS can designate one of three people, each of which are FHFA deputy directors that were initially appointed by the very now absent FHFA Director that POTUS could not remove at will, to act as the Acting Director for a term that shall last until there is a POTUS-nominated and Senate-confirmed new Director. HERA is silent regarding POTUS power to remove the FHFA Acting Director.

Now government counsel and amicus argue that this silence should be construed as meaning that POTUS does have removal at will power (following a canon of statutory construction that holds one should avoid a constitutional issue unless one is forced to confront it by statutory language).

But this construction would mean that FHFA is an independent agency when there is a Director, but not an independent agency when there is an Acting Director...is this a sensible statutory interpretation? And if this is to be the case, wouldn't there be clear statutory language set forth in the HERA that, notwithstanding that FHFA is an independent agency, it loses this status when run by an Acting Director? In other words, the canon of statutory construction, to avoid constitutional issues by interpreting the Acting Director to be removable by POTUS at will, itself presents its own nonsensical interpretative difficulty.

To my mind, the better form of statutory interpretation is to not read into the statute a significant exception to the general rule of agency independence unless there is clear language to that effect. Certainly, as Ps counsel stated in briefing and in oral argument, it was reported that the Obama administration did not believe POTUS had the power to remove the Acting Director, with whom it had several serious policy differences.

But even if one reads the Acting Director to be removable by POTUS at will, is it legally significant that the NWS was executed as a happenstance by an Acting Director, if the agency itself was structured under the statute to violate the separation of powers by having a single agency director removable only for cause? And, how does one analyze that while the NWS was adopted under the auspices of an Acting Director in 2012, it has been implemented since 2014 by a Director who clearly was removable only for cause.

The Acting Director argument is very convenient since it is a handy means to distinguish away Seila, but I don't see a sufficient textual hook in HERA that makes this an intellectually palatable or supportable course of action for SCOTUS...unless a majority of SCOTUS can be cobbled together during conference and opinion writing that simply concludes that this will have to do,in the absence of anything better, in order to reach a preferred result.

There was also amicus briefing that there is a meaningful distinction between FHFA's removal for cause standard and the CFBP's removal for malfeasance, neglect or maladministration standard. This argument went nowhere before SCOTUS.

Likewise, there is the argument that while CFPB regulates substantial economic conduct of individual consumers, FHFA regulates directly only two private corporations, such that the need for POTUS to control the FHFA Director is diminished. Justice Sotomayor floated this distinction as a trial balloon, and Justice Alito promptly shot it down, and the attempted distinction didn't, and in my view shouldn't, serve as a basis for SCOTUS not to follow its Seila ruling in deciding Collins. Regulating the GSEs implies that FHFA regulates fully one-half of all conforming house mortgages in the US...this is no less consequential than the CFPB's national influence.

Another government counsel and amicus argument distinguishing Seila from Collins, that I believe will go nowhere, is that the activity of FHFA as conservator was not "governmental" action, since a private party could serve as conservator too. If the FHFA is not acting in a governmental capacity as conservator, its actions in adopting the NWS were not subject to POTUS control in any event, and were not subject to the separation of powers. Of course, HERA specified that a governmental agency, FHFA, and not a private party, act as conservator. Perhaps this argument would have some validity if a private party had in fact been appointed conservator, but that was not this case.

Then there was the "harmless error" argument. Government counsel and amicus argued that even if FHFA is unconstitutionally structured, POTUS still had control over whether or not the NWS was entered into, insofar as POTUS had full control with removal at will power over the Treasury Secretary, such that if POTUS did not want the NWS entered into, he could order Treasury not to agree to it.So while it was constitutional error for the FHFA to be structured as it was, this error was "harmless" in this case, insofar as the NWS was a product of a two party process over which POTUS had control.

The problem with this argument is that SCOTUS has never made available the harmless error escape hatch in a case of a constitutional structural separation of powers such as Collins. SCOTUS has stated in prior precedents that Ps dont have to posit a counter-factual world where Ps have to prove whether the agency action at issue, here the NWS, would not have occurred had the agency not have been improperly structured.

Again, if SCOTUS wants to avoid confronting the question of awarding a remedy in the size presented by Collins, SCOTUS might invoke the harmless error rule for the first time in a separation of powers case. But again, I don't see the intellectual support for this course of action, given the presence of substantial SCOTUS precedent against it.

This conflict between what makes sense for SCOTUS to do,from an intellectual and precedential standpoint, and what SCOTUS may not wish to do, from a prudential remedy-granting standpoint, can be gleaned from Justice Gorsuch at oral argument. At one point, Justice Gorsuch (who likes to cut to the chase) asked the government counsel what his fallback argument was if SCOTUS doesn't agree with his Acting Director and harmless error arguments. At this point government counsel says, well then, we lose. Does this means Justice Gorsuch has rejected those arguments? It is never wise to put too much stock into Justices' questioning during oral argument, but I would venture to say that it means that Justice Gorsuch was not at that point inclined to buy these arguments, and was wondering if government counsel had anything better.

Yet at another point in the oral argument Justice Gorsuch points out that the remedy asked by Ps was a tough swallow. Perhaps there is wavering there, implicit searching for an intellectually defensible path away from granting the twelve figure dollar remedy requested by Ps.

But note the follow-on questioning by Justice Barrett at the end of the oral argument, when she asks Ps counsel whether Ps are asking Treasury to write a check, and Ps counsel replies that, no, a write down of the Treasury seniorpreferred stock would be in order. Is this Justice Barrett trying to point out that if the merits require a remedy voiding of the NWS, there was a palatable way to execute that remedy?

As I wrote in the bullet points at the header of this piece, the constitutional structure argument is complicated.

CONCLUSION

I believe Collins Ps will win the APA claim and should win the constitutional structure claim. As to the latter, there have been many past instances in which SCOTUS contorts the law to reach a desired result, and it is possible that SCOTUS will do so in the Collins case...but if it does so, it will pursue a line of argument that I do not believe is intellectually supportable. As a lawyer with an abiding interest and respect for constitutional law, I am inclined (biased) to believe SCOTUS will follow the intellectually supportable path.

If Ps win the APA claim, Ps will march smartly to federal district court with a SCOTUS mandate that the APA claim must be heard. Assuming SCOTUS simply affirms the 5th Circuit en banc opinion with respect to the APA claim (ie SCOTUS doesn't water down the 5th Circuit en banc standard that FHFA as conservator was under a rehabilitative mandate), Ps will have an extraordinarily strong case to present at trial based upon the Fairholme discovery evidence Ps have already obtained...so strong that Ps may seek summary judgment on the claim.

If Ps win the constitutional structure claim, Ps will march even more smartly to federal district court with a SCOTUS mandate to impose a remedy that would follow from its holding that the NWS is void, since it was adopted by an unconstitutionally structured FHFA.

If SCOTUS decides to "split the baby" on the constitutional claim, holding that the NWS was valid from 2012 until the commencement of 2014 during the tenure of the FHFA Acting Director, but not after 2014 when implemented by the FHFA Director, then because most of the alleged dividend overpayments effectuated by the NWS occurred before Director Watt's confirmation in December 2013 (my analysis indicates that in the case of Fannie, approximately $70 billion of the total $87 billion of overpayments arising from the NWS occurred before 2014), most of the economics desired by Ps resulting from a remedy for the constitutional claim will be lost...but this portion of forgone remedy could be recouped pursuant to the continued prosecution of the APA claim.

I will end on a purely speculative note. In my opinion, the replacement of Justice Ginsburg by Justice Barrett is helpful to Ps from a Justice-counting point of view. If you think that a majority (on either claim) could consist of Justices Thomas, Alito, Gorsuch, Kavanaugh and Barrett, then the somewhat unpredictable Chief Justice Roberts becomes a dispensable vote.

First Published at https://ruleoflawguy.substack.com/p/for-fannie-and-freddie-shareholders