Two former CEOs at mortgage giants Fannie Mae and Freddie Mac yesterday became the highest-profile individuals to be charged in connection with the 2008 financial crisis.
In a lawsuit filed in New York, the Securities and Exchange Commission brought civil fraud charges against six former executives at the two firms, including former Fannie CEO Daniel Mudd and former Freddie CEO Richard Syron.
The executives were accused of understating the level of high-risk subprime mortgages that Fannie and Freddie held just before the housing bubble burst.
"Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was," said Robert Khuzami, SEC's enforcement director.
Khuzami noted that huge losses on their subprime loans eventually pushed the two companies to the brink of failure and forced the government to take them over.
The charges brought follow widespread criticism of federal authorities for not holding top executives accountable for the recklessness that triggered the 2008 crisis.
Before the SEC announced the charges, it reached an agreement not to charge Fannie and Freddie. The companies, which the government took over in 2008, also agreed to cooperate with the SEC in the cases against the former executives.
The Justice Department began investigating the two firms three years ago. In August, Freddie said Justice informed the company that its probe had ended.
Many legal experts say they don't expect the six executives to face criminal charges.
"If the US attorney's office was going to be bringing charges, they would have brought it simultaneously with the civil case," said Christopher Morvillo, a former federal prosecutor now in private practice in Manhattan.
Robert Mintz, a white-collar defence lawyer, says he doubts any top Wall Street executives will face criminal charges for actions that hastened the financial crisis, given how much time has passed.
Mudd, 53, and Syron, 68, led the mortgage giants in 2007, when home prices began to collapse. The four other top executives also worked for the companies during that time.
In a statement from his attorney, Mudd said the government reviewed and approved all the company's financial disclosures.
"Every piece of material data about loans held by Fannie Mae was known to the United States government and to the investing public," Mudd said. "The SEC is wrong, and I look forward to a court where fairness and reason — not politics — is the standard for justice."
Syron's lawyers said the term "subprime had no uniform definition in the market" at that time.
"There was no shortage of meaningful disclosures, all of which permitted the reader to assess the degree of risk in Freddie Mac's" portfolio, the lawyers said in a statement. "The SEC's theory and approach are fatally flawed."
According to the lawsuit, Fannie and Freddie misrepresented their exposure to subprime loans in reports, speeches and congressional testimony.
Fannie told investors in 2007 that it had roughly $4.8 billion (£3bn) worth of subprime loans on its books, or just 0.2 percent of its portfolio. That same year, Mudd told two congressional panels that Fannie's subprime loans represented didn't exceed 2.5 percent of its business.
The SEC says Fannie actually had about $43 billion (£28bn) worth of products targeted to borrowers with weak credit, or 11 percent of its holdings.
Freddie told investors in late 2006 that it held between $2 billion and $6 billion of subprime mortgages on its books. And Syron, in a 2007 speech, said Freddie had "basically no subprime exposure," according to the suit.
The SEC says its holdings were actually closer to $141 billion (£90bn), or 10 percent of its portfolio in 2006, and $244 billion (£157bn), or 14 percent, by 2008.
Syron also authorized especially risky mortgages for borrowers without proof of income or assets as early as 2004, the suit alleges, "despite contrary advice" from Freddie's credit-risk experts. He rejected their advice, "in part due to his desire to improve Freddie Mac's market share."
Fannie and Freddie buy home loans from banks and other lenders, package them into bonds with a guarantee against default and then sell them to investors around the world. The two own or guarantee about half of US mortgages, or nearly 31 million loans.
During the financial crisis, the two firms verged on collapse. The Bush administration seized control of them in September 2008.
So far, the companies have cost taxpayers more than $150 billion (£97bn) — the largest bailout of the financial crisis. They could cost up to $259 billion (£167bn), according to their government regulator, the Federal Housing Finance Administration.
Mudd was paid more than $10 million (£6.5m) in salary and bonuses in 2007, according to company statements. He was fired from Fannie after the government took over. He's now the chief executive of the New York hedge fund Fortress Investment Group.
Syron made more than $18 million (£11.6m) in 2007, according to company statements. His compensation increased $4 million from 2006 because of bonuses he received — part of them for encouraging risky subprime lending, according to company filings. It's not clear what portion of the bonuses was for his efforts to promote subprime lending.
Syron resigned from Freddie in 2008. He's now an adjunct professor and trustee at Boston College.
The other executives charged were Fannie's Enrico Dallavecchia, 50, a former chief risk officer, and Thomas Lund, 53, a former executive vice president; and Freddie's Patricia Cook, 58, a former executive vice president and chief business officer, and Donald Bisenius, 53, a former senior vice president.
Lund's lawyer, Michael Levy, said in a statement that Lund "did not mislead anyone." Lawyers for the other defendants declined to comment yesterday.
Based on the outcomes of similar cases, the lawsuit might not yield much in penalties against the former executives.
In July, Citigroup paid just $75 million (£48m) to settle similar civil charges with the SEC. Its chief financial officer and head of investor relations were accused of failing to disclose more than $50 billion worth of potential losses from subprime mortgages. The two executives charged paid $100,000 (£65,000) and $80,000 (£50,000) in civil penalties.
Fines against executives charged in SEC civil cases can reach up to $150,000 per violation. SEC Chairman Mary Schapiro has asked Congress to raise the limit to $1 million.
The SEC has brought other cases related to the financial crisis since it began a broad investigation into the actions of Wall Street banks and other financial firms about three years ago.
Goldman Sachs & Co., for example, agreed last year to pay $550 million to settle charges of misleading buyers of a complex mortgage investment. JPMorgan Chase & Co. resolved similar charges in June and paid $153.6 million (£100m).
Citigroup Inc. agreed to pay $285 million (£183m) to settle similar charges, though that settlement was recently struck down by a federal judge in New York City.
Most cases, however, didn't involve charges against prominent top executives.
An exception was Angelo Mozilo, the co-founder and CEO of failed mortgage lender Countrywide Financial Corp. He agreed to a $67.5 million (£43m) settlement with the SEC in October 2010 to avoid trial on civil fraud and insider trading charges that he profited from doling out risky mortgages while misleading investors about the risks.
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