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On Aug 14, Bill Ackman, founder and CEO of Pershing Square Capital Management LP, along with three other individual plaintiffs holding common shares in Fannie Mae (FNMA) and Freddie Mac (FMCC), sued the U.S. government and two other regulators – Department of Treasury and the Federal Housing Finance Agency (:FHFA). The lawsuit pertains to violation of common shareholders’ rights and properties in the two above-mentioned government sponsored enterprises (:GSEs).

The lawsuit, filed in the U.S. Court of Federal Claims in Washington, challenges the U.S. government’s right to confiscate all profits from Fannie and Freddie. Through a 2012 amendment – the Net Worth Sweep Agreement – the FHFA (conservator of Fannie and Freddie) and the Treasury had agreed to change the terms of their preferred stake in these two GSEs.

Consequently, instead of paying 10% annual dividend, the full profit (except $3 billion capital cushion for each) of Fannie and Freddie was perpetually scheduled for the Treasury. This deprived other common shareholders of their rightful economic value from their holdings.

Further, the lawsuit alleges that the FHFA, as conservator, should have preserved the assets and properties of Fannie and Freddie. However, armed by the above-mentioned amendment, the government extracted all the profit without paying any compensation to the common shareholders, thereby violating the Constitution’s Fifth Amendment. Also, the lawsuit accuses the government of violating federal statutes and its fiduciary duties toward the shareholders of Fannie and Freddie.

Through this case, Pershing Square seeks damages, disgorgement and restitution of unlawfully attained profits from Fannie and Freddie.

Currently, the Treasury holds $189.4 billion worth of senior preferred stakes in Fannie and Freddie. Along with this, it also holds warrants to the ownership of 79.9% of these two GSEs common shares, though these warrants have not yet been exercised.

Other than Pershing Square (holding nearly 10% interest in Fannie and Freddie common stock), other three individual plaintiffs are Louise Rafter – a retired nurse with 36,000 shares of Fannie – and a husband-wife duo Josephine and Stephen Rattien, holding 1,000 shares of Fannie.

The present lawsuit has been assigned to Judge Margaret Sweeney, who is also supervising nine other lawsuits filed over Fannie and Freddie regarding the illegal assumption of profits by depriving preferred shareholders. Further, there are roughly 10 more cases that challenge the bailout of these two GSEs.

Separately, on Aug 15, Pershing Square filed another lawsuit against the U.S. government. The case filed in U.S. District Court in Washington accuses the defendants of violating the corporate law. This lawsuit seeks nullification of the Net Worth Sweep Agreement, through a declaration that this agreement is illegal, and consequently claims redemption of the unlawfully usurped profits.

We believe that the main purpose behind these lawsuits is to bring forth the plight of common shareholders of Fannie and Freddie. Further, Ackman, through his 111-page presentation in May 2014, had depicted the strong potential of these two GSEs to add value to the shareholders’ investments. (Read More: Ackman's Optimism on Fannie, Freddie).

Currently, both Fannie and Freddie carry a Zacks Rank #3 (Hold). Some better-ranked finance stocks include Home Loan Servicing Solutions, Ltd. (HLSS - Snapshot Report) and PennyMac Financial Services, Inc. (PFSI - Snapshot Report), each with a Zacks Rank #2 (Buy).

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