Just in Time, or Out of Time?

, The American Lawyer



The Federal Housing Finance Agency is trying to recovera staggering $190 billion from the banks that sold mortgage-backed securities to Fannie Mae and Freddie Mac, but it faces a serious obstacle. The FHFA — which was created by Congress to serve as conservator for Fannie and Freddie — first has to wait for the U.S. Court of Appeals for the Second Circuit to rule on whether it brought its suits too late. A circuit panel heard arguments on the timeliness issue last fall; at press time, it had yet to issue a ruling.

The litigation began in September 2011, when the FHFA unleashed a flurry of suits against banks that sold mortgage-backed securities to Fannie and Freddie. Bank of America Corporation, Credit Suisse­ Group AG, General Electric Company (which owns the financial services firm General Electric Capital Corporation), JPMorgan Chase & Co., The Royal Bank of Scotland Group plc (which owns part of ALM Media LLC), UBS AG, and a dozen more financial titans were the targets. Quinn Emanuel Urquhart & Sullivan filed 14 of the complaints, while Kasowitz Benson Friedman & Torres filed the rest.

The FHFA's claim against UBS has emerged as the early test case in the agency's campaign. Represented by Skadden, Arps, Slate, Meagher & Flom, UBS moved to dismiss its case on timeliness grounds in January 2012. U.S. District Judge Denise Cote in Manhattan chose UBS's motion to decide the issue for each of the 16 cases before her at the time.

The defendants have conceded that the hastily written law that created the FHFA — the Housing and Economic Recovery Act of 2008, or HERA — extended the statute of limitations for FHFA to bring federal securities law claims against financial institutions. But they assert that the claims are barred by a three-year statute of repose in section 13 of the Securities Act of 1933. (A statute of repose begins running at the time of the alleged wrongdoing — as opposed to the point in time when the wrongdoing is discovered — and can't be tolled.) Cote rejected UBS's arguments last May, ruling that even if Congress didn't explicitly extend the statute of repose, it clearly intended to give FHFA time to bring claims over the subprime meltdown. But she also granted UBS's motion for interlocutory appeal.

A Second Circuit panel consisting of Denny Chin, Raymond Lohier Jr., and Paul Gardephe (a U.S. district court judge sitting by designation) took up the timeliness issue at a packed November 26 hearing. Skadden's Jay Kasner, representing UBS, argued that HERA clearly didn't extend the relevant statute of repose, so there was no need to surmise congressional intent. But if the court decides to wade into what Congress intended, it should still rule in UBS's favor, he said. Freddie and Fannie had never brought securities fraud claims prior to HERA's enactment, so it's entirely possible that Congress intended to limit the FHFA to the various state laws claims, Kasner maintained.

Quinn Emanuel's Kathleen Sullivan argued on behalf of the FHFA that "the statute of repose would kill [the agency] out of the cradle" — a result that Congress couldn't have intended. Perhaps to cover her bases, Sullivan also made a textual argument. HERA states that its new deadlines apply to "any action" filed by the FHFA — an umbrella that, at least according to Sullivan, encompasses securities claims. Therefore, HERA unambiguously displaced section 13's statute of repose, she said.

The judges gave few clues on how they would rule. But their questions suggested that if they only look at the text of HERA, without delving into legislative intent, they would favor UBS's interpretation of the law. "I don't see the displacing language," Judge Lohier told Sullivan at one point.

Once the judges address legislative intent, however, the FHFA's prospects started to look better. At one point Lohier asked "why in the world" Congress would create the FHFA and then hamstring it by purposefully not extending the relevant statute of repose. By the tone of his question, it was hard not to think that he saw the sense in Cote's ruling.

The Second Circuit's decision may be the banks' last hope for making a quick exit from the FHFA litigation. In addition to arguing that most of the claims in the agency's cases are time-barred, they've also moved to dismiss on the grounds that the FHFA's allegations are deficient. For purposes of ruling on those motions, Cote has lumped the defendants into two categories: those that face common law fraud claims, and those that don't. The judge has denied motions to dismiss by all six defendants in the first category, including JPMorgan Chase, Deutsche Bank AG, and Merrill Lynch & Co. Inc. Cote also largely denied a motion to dismiss by Barclays PLC, one of the defendants not facing common law fraud claims.

One defendant has decided that it's better to settle than to wait for the Second Circuit to rule on the timeliness question. On January 22 the FHFA voluntarily dismissed its case against General Electric after the parties notified Cote that they'd reached a settlement. The deal put an end to the FHFA's claims that GE Capital duped Freddie into buying $550 million in mortgage-backed securities by misrepresenting the quality of the underlying loans. The FHFA didn't disclose the terms of the settlement, which also resolves the agency's claims over the same offerings against MBS underwriters Credit Suisse and Morgan Stanley. The amount at stake in the GE suit made it one of the smaller cases. By way of comparison, in the JPMorgan case the agency is seeking to recover $33 billion.


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