In SEC v. Mudd, No. 11 Civ. 9202 (PAC), 2016 BL 58699 (S.D.N.Y. Feb. 29, 2016), the United States District Court for the Southern District of New York denied a motion for summary judgment by Daniel Mudd (”Defendant”), former CEO of Federal National Mortgage Association (“FNMA”), for claims brought by the Securities and Exchange Commission (“SEC”) alleging false and misleading statements made in public SEC filings and the media.
FNMA offered mortgage and loan services, including subprime mortgages made to “borrowers with weaker credit profiles.” FNMA offered such loans through tow programs; the Expanded Approval (“EA”) mortgages to “borrowers with blemished credit,” and MyCommunityMortgage (“MCM”) mortgages to “low- and moderate-income home buyers.” From December 2006 to September 2008, FNMA used a variety of definitions in its SEC public filings and media to classify subprime mortgages including, among others, “a mortgage loan underwritten using lower credit standards than those used in the prime lending market,” “loans offered to borrowers with damages credit,” and loans that originated from specialized lenders “using processes unique to subprime loans,” or “original or resecuritized . . . securities that we hold in our portfolio, if the securities were labeled as subprime when sold.” FNMA also offered Alt-A loans, mortgages that did not require full financial disclosure.
According to the SEC, FNMA over time changed its definitions of subprime, but failed to quantify billions of dollars of loan exposure subprime mortgages. Additionally, the SEC foundFNMA did not quantify lender-selected loans in its Alt-A exposure, thereby omitting $300 billion from its disclosures. This led the SEC to believe FNMA made material misstatements about its subprime and Alt-A exposure, resulting in extensive financial losses. In December, 2001, the SEC brought suit alleging specifically that Defendant (1) knowingly or recklessly made material statements regarding FNMA’s exposure to subprime and Alt-A loans in violation of Section 10(b) of the Exchange Act and Rule 10b-5; (2) violated Section 17(a)(2) of the Exchange Act by knowingly, recklessly, or negligently obtained money by means of material misstatements; (3) aided and abetted a primary securities violation against Section 10(b) and Rule 10b-5; (4) signed false certifications to the SEC in violation of Rule 13(A)-14(A) of the exchange act; and (5) aided and abetted violations of Section 13(A) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13.
The court found a jury could infer Defendant made false or misleading statements to obtain money, acted with scienter, aided and abetted SEC violations, and received money or property from material misrepresentations. The court determined a reasonable investor could expect EA and MCM to be included with subprime mortgages under FNMA’s definition, and could expect the definition of Alt-A to include investor-selected low-documentation loans. The court held misrepresentations could be material as the disclosures did not contemplate information relevant to subprime mortgages, nor do they preclude liability from fraudulent activity.
Additionally, court determined Defendant could have acted with scienter by making public statements and signing SEC disclosures while knowing FNMA’s disclosures and classifications could mislead buyers and that a jury could infer Defendant aided and abetted a securities fraud when he provided substantial assistance in making material misrepresentations. Further, the court noted that any finding Defendant recklessly also shows he acted negligently. Finally, the court stated Defendant’s financial losses suffered in conjunction with FNMA’s decline did not preclude a jury from deciding whether he received “money or property” by means of material misrepresentations.
The court found material issues of fact in each claim and accordingly denied Defendant’s motion for summary judgment.
The primary materials for this case may be found on the DU Corporate Governance website.