Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 1 of 20 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA

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1 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 1 of 20 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM, 277 East Town Street Columbus, Ohio and STATE TEACHERS RETIREMENT SYSTEM OF OHIO, 275 East Broad Street Columbus, Ohio Civil Action No. Plaintiffs, v. FEDERAL HOUSING FINANCE AGENCY, 1700 G Street, N.W., Washington, D.C and EDWARD DEMARCO, in His Official Capacity as Acting Director of the Federal Housing Finance Agency, 1700 G Street, N.W., Washington, D.C Defendants. COMPLAINT Plaintiffs Ohio Public Employees Retirement System and State Teachers Retirement System of Ohio bring this Complaint against Defendants Federal Housing Finance Agency and its Acting Director, Edward DeMarco, in his official capacity. Upon knowledge as to their own acts, and upon information and belief as to all other matters, Plaintiffs allege as follows:

2 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 2 of 20 PRELIMINARY STATEMENT 1. The Federal National Mortgage Association popularly known as Fannie Mae is a government-sponsored enterprise that buys and guarantees residential mortgage loans and mortgage-related securities. From at least 2001 through 2004, Fannie Mae misled its investors and the public by issuing materially false and misleading financial reports and other statements that artificially inflated the price of Fannie Mae securities, costing investors billions of dollars in losses when the truth about Fannie Mae s fraud emerged. Plaintiffs in this action are defrauded pension-fund investors who are the court-appointed lead plaintiffs in a federal securities fraud class action against Fannie Mae and three of its former officers, currently pending in this Court before the Honorable Judge Richard Leon. 2. On June 14, 2011, Fannie Mae s conservator, defendant Federal Housing Finance Agency ( FHFA ), promulgated a rule designed to single out securities fraud victims and restrict their ability to recover their losses from Fannie Mae, regardless of the merits of their claims. That rule subordinates the claims of securities fraud victims to the lowest priority on par with mere equity interests while Fannie Mae is in receivership. 12 C.F.R (a). It also prohibits the payment of securities fraud claims even claims reduced to judgment and courtapproved settlements while Fannie Mae is in conservatorship, absent the FHFA s consent. Id (a),.13(a). 3. The FHFA s rule must be set aside in its entirety because the agency s Acting Director lacked authority to promulgate it under the Appointments Clause, U.S. Const. art. II, 2. The challenged provisions are also contrary to the governing statute and longstanding Supreme Court precedent, both of which require securities fraud victims to be treated on par with other creditors in receivership. The provisions also violate the Takings Clause and the Due Process Clause. 2

3 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 3 of Accordingly, through this action under the Administrative Procedure Act and the U.S. Constitution, Plaintiffs seek a declaratory judgment that (1) the FHFA s rule is unlawful in its entirety under the Appointments Clause; (2) the rule s provision subordinating securities fraud claims in receivership is unlawful; and (3) the rule s provisions prohibiting payment of securities fraud claims in conservatorship are unlawful. Plaintiffs also seek an injunction prohibiting enforcement of the rule. PARTIES 5. Plaintiff Ohio Public Employees Retirement System is a public pension fund based in Columbus, Ohio. It provides retirement, disability, and survivor benefit programs for thousands of public employees throughout the State. Serving nearly 954,000 members, and with assets of more than $75 billion as of December 31, 2010, it is the largest state pension fund in Ohio and the twelfth largest public retirement system in the United States. 6. Plaintiff State Teachers Retirement System of Ohio is also a public pension fund based in Columbus, Ohio. It serves nearly 470,000 active, inactive, and retired public educators in Ohio, with investment assets of $58.8 billion as of June 30, Defendant Federal Housing Finance Agency ( FHFA ) was established as an independent agency of the United States government by the Housing and Economic Recovery Act of 2008, Pub. L. No , 122 Stat The FHFA currently acts as conservator of Fannie Mae. It maintains its headquarters at 1700 G Street, N.W., Washington, D.C. 8. Defendant Edward DeMarco is currently Acting Director of the FHFA. President Obama designated Mr. DeMarco Acting Director on August 25, 2009, effective September 1, 2009, without Senate confirmation. Mr. DeMarco has now served in that acting capacity for over 23 months, spanning three sessions of Congress. 3

4 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 4 of 20 JURISDICTION AND VENUE 9. This Court has jurisdiction over this action pursuant to 28 U.S.C because it arises under the Constitution and laws of the United States. 10. This Court has personal jurisdiction over Defendants because they are domiciled in this district and/or engaged in the acts at issue in this district. 11. Venue is proper in this district pursuant to 28 U.S.C. 1391(e) because this is a civil action against an agency of the United States and a purported officer of that agency acting in his official capacity, and a substantial part of the events or omissions giving rise to the claim occurred in this district. THE FRAUD AT FANNIE MAE AND THE RESULTING LAWSUIT 12. Plaintiffs in this case are Ohio state pension funds that invested in Fannie Mae s common stock. They have been appointed lead plaintiffs in a securities fraud class action currently pending in this Court, captioned In re Fannie Mae Securities Litigation, Consol. Civ. No. 1:04- cv (D.D.C.) (the Securities Class Action ). In that case, originally filed in September 2004, the court certified a class consisting of certain Fannie Mae investors from April 2001 through December The class includes public and private pension funds representing more than 30 million pensioners and other individual investors. 13. In the Securities Class Action, Plaintiffs allege that Fannie Mae and three of its former senior officers violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The details of Fannie Mae s fraud are set out in the operative complaint in that case and are merely summarized here. 14. Fannie Mae is a publicly traded, government-sponsored enterprise chartered by Congress. Its mission is to provide liquidity, stability, and affordability to the U.S. housing and mortgage 4

5 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 5 of 20 markets. It buys and guarantees residential mortgage loans and mortgage-related securities, which it finances by issuing mortgage-related securities, debt, and equity. For many years, Fannie Mae s common stock traded on the New York Stock Exchange under the ticker symbol FNM. 15. Like other publicly traded companies, Fannie Mae routinely issues financial reports and other statements concerning its performance to the investing public. As with most other publicly traded companies, a substantial part of the compensation of Fannie Mae s senior officers was tied directly to the company s stock price. 16. For several years until late 2004, Fannie Mae, through its senior officers, issued materially false and misleading financial reports and other statements that artificially inflated its stock price. Those false statements misled investors into believing, among other things, that Fannie Mae (1) had accounting policies and practices and financial statements that conformed to generally accepted accounting principles ( GAAP ); (2) was a conservative, stable investment with little or no earnings volatility; (3) had a capital structure adequate to meet regulatory requirements and business needs; (4) had steady quarter-over-quarter earnings growth through the use of properly reported financial transactions, even in times of market and interest rate volatility; and (5) had effective internal controls and transparent disclosure policies and procedures. 17. Those statements were false. Unbeknownst to investors, Fannie Mae materially misstated its reported earnings during the class period in order to increase its senior officers compensation. Over thirty of Fannie Mae s accounting policies and practices nearly every major accounting standard applicable to its mortgage-financing business violated GAAP. 5

6 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 6 of 20 Fannie Mae tolerated weak or non-existent internal controls in order to overstate its reported earnings, while creating the illusion that its earnings were less volatile than they actually were. 18. Fannie Mae s misconduct was investigated by the Department of Justice and Fannie Mae s two government regulators the Securities and Exchange Commission ( SEC ) and the Office of Federal Housing Enterprise Oversight ( OFHEO ). 19. In September 2004, OFHEO released a report citing concerns regarding the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision, and the overall safety and soundness of Fannie Mae. In December 2004, the SEC s Office of the Chief Accountant determined that Fannie Mae had violated accounting standards that Fannie Mae had designated as critical or significant to its business. Shortly thereafter, Fannie Mae s CEO and CFO both left the company. 20. In May 2006, OFHEO produced a final, lengthy report finding that Fannie Mae had deliberately and intentionally manipulat[ed] accounting to hit earnings targets. 21. In December 2006, Fannie Mae restated its financial results, revising its accounting under virtually every key accounting policy affecting its business. The company admitted that its misapplications of GAAP resulted in material modifications to [its] financial statements. The restatement resulted in a reduction in retained earnings of $6.3 billion through June 30, 2004, and has been described as the largest financial restatement in U.S. corporate history. 22. Following its investigation, the SEC filed a securities fraud lawsuit against Fannie Mae, alleging that the company had violated Section 10(b) of the Securities Exchange Act based on the same misconduct Plaintiffs alleged in the Securities Class Action. In May 2006, Fannie Mae paid the SEC a civil money penalty of $350 million to settle those claims. OFHEO also obtained a $50 million settlement from Fannie Mae as well as settlements valued at over $30 million from 6

7 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 7 of 20 three of Fannie Mae s senior officers. To preserve the deterrent effect of the civil money penalty paid to the SEC, the SEC consent order expressly prohibits Fannie Mae from using any part of the penalty as a setoff in any civil lawsuits. 23. Fannie Mae s Board of Directors commissioned and paid former Senator Warren B. Rudman to head an independent investigation of OFHEO s findings. Senator Rudman s 616- page report, publicly released in February 2006 and immediately adopted by Fannie Mae, found that management s accounting practices in virtually all of the areas that we reviewed were not consistent with GAAP, and, in many instances, management was aware of the departures from GAAP. 24. When the fraud was revealed and Fannie Mae s true financial condition exposed to the public, the company s stock price dropped sharply. The class members in the Securities Class Action suffered billions of dollars in losses as a result of Fannie Mae s fraud. Plaintiffs in this case in particular two Ohio state pension funds lost millions of dollars as a result of Fannie Mae s fraud. 25. On November 19, 2004, Plaintiffs filed suit against Fannie Mae and its senior officers in the U.S. District Court for the Southern District of Ohio. Ohio Pub. Employees Ret. Sys., et al. v. Fannie Mae, et al., No. 2:04-cv (S.D. Ohio). Claims arising out of Fannie Mae s fraud were subsequently consolidated in this Court as In re Fannie Mae Securities Litigation, Consol. Civ. No. 1:04-cv (D.D.C.). Plaintiffs filed a complaint in that consolidated case on March 4, 2005, an amended complaint on April 17, 2006, and a second amended consolidated class action complaint on August 14, That action remains pending. Over 67 million pages of documents have been produced; 123 fact depositions and 35 expert depositions have been taken; and summary judgment motions have been filed and are currently being briefed. 7

8 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 8 of 20 THE HOUSING AND ECONOMIC RECOVERY ACT 26. The financial weaknesses concealed by Fannie Mae s fraud convinced Congress of the need to reform oversight of the company. To that end, as part of the Housing and Economic Recovery Act of 2008 (the Act ), Pub. L. No , 122 Stat. 2654, Congress established the Federal Housing Finance Agency ( FHFA ) to supervise Fannie Mae, its companion enterprise the Federal Home Loan Mortgage Corporation ( Freddie Mac ), and the Federal Home Loan Banks. Congress directed the FHFA to promote the safety and soundness of the institutions, support housing finance and affordable housing, and support a stable and liquid mortgage market. 27. Congress structured the FHFA as an independent agency. It provided that the agency would be headed by a Director appointed by the President, by and with the advice and consent of the Senate. 12 U.S.C. 4512(b)(1). The Director serves for a five-year term, subject only to forcause removal by the President. Where there is a vacancy in the office, the statute authorizes the President to designate an Acting Director. Id. 4512(f). 28. James Lockhart was the first official to run the FHFA. He obtained that position pursuant to 12 U.S.C. 4512(b)(5), a transitional provision that designated OFHEO s Director as the first FHFA Director. Mr. Lockhart was never confirmed for that position by the Senate. 29. After Mr. Lockhart resigned, on August 25, 2009, President Obama designated Defendant Edward DeMarco, former Deputy Director and Chief Operating Officer of OFHEO, as Acting Director of the FHFA, effective September 1, Mr. DeMarco has never been confirmed by the Senate either. 30. The Act authorizes the FHFA to place Fannie Mae and Freddie Mac in conservatorship or receivership, and to act as conservator or receiver for the enterprises. 12 U.S.C. 4617(a)(1). As conservator, the agency is supposed to take steps to put the regulated entity in a sound and 8

9 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 9 of 20 solvent condition so it can carry on its business, and to preserve and conserve its assets and property. As receiver, the agency places the regulated entity in liquidation and proceeds to realize and distribute its assets among those with claims against the entity. 31. The Act specifies the priority of claims in receivership. Specifically, it states: Unsecured claims against a regulated entity, or the receiver therefor,... shall have priority in the following order: (A) Administrative expenses of the receiver. (B) Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D)). (C) Any obligation subordinated to general creditors (which is not an obligation described under subparagraph (D)). (D) Any obligation to shareholders or members arising as a result of their status as shareholder or members. 12 U.S.C. 4617(c)(1) (emphasis added). 32. The Act s priority scheme thus clearly distinguishes between creditor claims (subsection (B)) and mere equity interests (subsection (D)). Nowhere does the Act provide that defrauded investors with valid securities fraud claims against the enterprise are to be treated as mere equity interests rather than general creditors. 33. Nor does the Act give the FHFA authority to single out securities fraud claims for nonpayment while Fannie Mae is in conservatorship. While the Act specifies a priority scheme for claims in receivership, it contains no comparable priority scheme or other provision authorizing selective non-payment of debts in conservatorship. To the contrary, the Act contemplates that an entity in conservatorship will continue to carry on its business as a going concern and pay its bills as they become due. 9

10 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 10 of Pursuant to its authority under the Act, the FHFA placed Fannie Mae and Freddie Mac in conservatorship on September 6, Both entities remain in conservatorship to this date. THE FHFA S SUBORDINATION AND NON-PAYMENT RULE 35. The Housing and Economic Recovery Act authorizes the FHFA to prescribe such regulations as the Agency determines to be appropriate regarding the conduct of conservatorships and receiverships. 12 U.S.C. 4617(b)(1). 36. Even though the FHFA s predecessor agency had obtained multimillion-dollar settlements from Fannie Mae and its senior officers as a result of Fannie Mae s fraud, the FHFA decided to use its rulemaking authority to attempt to restrict the ability of securities fraud victims to recover from the company. 37. Accordingly, on July 9, 2010, almost two years after placing Fannie Mae and Freddie Mac in conservatorship, the FHFA proposed a rule that would sharply limit the ability of defrauded stock purchasers to recover from the entities. See Conservatorship and Receivership, 75 Fed. Reg. 39,462 (July 9, 2010). The proposed rule provided that, rather than being treated on par with other creditor and tort claims, securities fraud claims would be subordinated to the lowest level of priority in receivership, on par with ordinary equity interests. To ensure the effectiveness of that priority scheme, the proposed rule also prohibited the regulated entities from paying securities fraud claims while in conservatorship, absent the FHFA s consent. 38. Because the proposed rule unreasonably and unlawfully singled out securities fraud victims in a thinly veiled attempt to thwart Plaintiffs claims, Plaintiffs and their representatives submitted written comments opposing the proposed rule on substantially the grounds set forth in this Complaint (attached as Exhibits A through C). Many Members of Congress including those involved in the passage of the Housing and Economic Recovery Act also submitted 10

11 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 11 of 20 comments opposing the proposed rule (attached as Exhibits D through F), as did a number of labor organizations with pension funds (see, for example, Exhibit G). 39. Despite that opposition, on June 14, 2011, almost a year after the FHFA proposed its rule, the agency adopted the rule without any material modification to the provisions at issue. That final rule was then published in the Federal Register on June 20, 2011, and took effect on July 20, See Conservatorship and Receivership, 76 Fed. Reg. 35,724 (June 20, 2011). 40. At the time Mr. DeMarco authorized and signed that rule on behalf of the FHFA, he had been serving for almost 22 months after the President installed him as the FHFA s Acting Director without Senate confirmation. 41. Contrary to the statutory priority scheme, the FHFA s rule subordinates securities fraud claims to the lowest level of priority in receivership, on par with ordinary equity interests. 42. Specifically, the rule provides that the receiver will grant priority to unsecured claims against a regulated entity in the following order: (1) Administrative expenses of the receiver (or an immediately preceding conservator). (2) Any other general or senior liability of the regulated entity (that is not a liability described under paragraph (a)(3) or (a)(4) of this section). (3) Any obligation subordinated to general creditors (that is not an obligation described under paragraph (a)(4) of this section). (4) Any claim by current or former shareholders or members arising as a result of their current or former status as shareholders or members, including, without limitation, any securities litigation claim. Within this priority level, the receiver shall recognize the priorities of shareholder claims inter se, such as that preferred shareholder claims are prior to common shareholder claims C.F.R (a) (emphasis added). 43. Similarly, even though the statutory priority scheme applies only in receivership and the Act contains no provision authorizing selective non-payment of debts in conservatorship, the 11

12 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 12 of 20 FHFA s rule purports to prohibit payment of securities fraud claims during conservatorship absent the FHFA s consent even claims reduced to judgment and court-approved settlements. 44. Specifically, the rule provides that [t]he Agency, as conservator, will not pay a Securities Litigation Claim against a regulated entity, except to the extent the Director determines is in the interest of the conservatorship. 12 C.F.R (a). It further provides that a regulated entity shall make no capital distribution while in conservatorship unless authorized by the FHFA s Director, 12 C.F.R (a), and defines capital distribution to include payments on securities litigation claims, id (3). 45. Thus, under the FHFA s rule, Plaintiffs claims against Fannie Mae are placed in a special category and subordinated to every other type of debt. For example, if Fannie Mae s officers the very individuals responsible for the fraud sued the company to recover their attorney s fees, their claims would receive priority over Plaintiffs valid securities fraud claims. THE INVALIDITY OF THE FHFA S RULE 46. The FHFA s rule is invalid in its entirety because Mr. DeMarco lacked authority to promulgate it under the Appointments Clause, U.S. Const. art. II, 2, and the Housing and Economic Recovery Act. Moreover, the rule s provisions subordinating securities litigation claims to the lowest priority in receivership (the subordination provision ) and prohibiting payment of such claims in conservatorship (the non-payment provisions ) are invalid because they are arbitrary and capricious, an abuse of discretion, not in accordance with law, contrary to constitutional right, and in excess of the agency s statutory authority. Appointments Clause Violation 47. The Appointments Clause requires principal officers of the United States to be appointed by the President with the advice and consent of the Senate. U.S. Const. art. II, 2. 12

13 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 13 of Since his designation as Acting Director more than 23 months ago, Mr. DeMarco has exercised extraordinary authority subject to the supervision of no one other than the President. His duties, length of tenure, and independence from supervision render him a principal officer for purposes of the Appointments Clause. 49. Contrary to the Appointments Clause, however, Mr. DeMarco has never been confirmed by the Senate. 50. Although the Housing and Economic Recovery Act purports to authorize the President, acting alone, to designate an Acting Director when there is a vacancy in the office, the Appointments Clause permits such acting appointments (if at all) only for brief periods of time and only in emergency situations. Mr. DeMarco has now served as Acting Director for more than 23 months, far exceeding the constitutional limit on service as an acting officer. 51. Mr. DeMarco thus holds office in violation of the Appointments Clause, and lacked authority to promulgate the FHFA s rule. 52. Mr. DeMarco s appointment also violated the Housing and Economic Recovery Act. That Act authorizes the President to designate an Acting Director only after a validly appointed Director previously held office. But the FHFA head who preceded Mr. DeMarco was not confirmed for that position by the Senate either. Because Mr. DeMarco s predecessor was not validly appointed, the President lacked authority to designate Mr. DeMarco Acting Director. Invalidity of the Subordination Provision 53. Even apart from the FHFA s lack of authority to promulgate the rule, the provision subordinating securities fraud claims in receivership, 12 C.F.R (a), is invalid on a number of grounds. 13

14 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 14 of The subordination provision is contrary to the express terms of the statute, which requires securities fraud claims to be treated on par with other creditor claims, not subordinated to the lowest level with equity. 55. In Oppenheimer v. Harriman National Bank & Trust Co., 301 U.S. 206 (1937), the Supreme Court held that claims of securities fraud victims must be treated on par with other creditor claims in receivership, not as mere equity interests, absent statutory language to the contrary. Nothing in the Housing and Economic Recovery Act authorizes the FHFA to subordinate securities fraud victims below the priority of other general creditors and treat them as mere equity interests. The FHFA s subordination provision defies the Supreme Court s express holding in Oppenheimer. 56. The subordination provision also defies Congress s intent as reflected in the legislative history of the statute on which the Housing and Economic Recovery Act was modeled the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No , 103 Stat When Congress enacted that earlier statute, it specifically rejected a proposal to subordinate shareholders claims against directors and officers of failed financial institutions to the claims of the Federal Deposit Insurance Corporation, expressing concern that subordination would be unfair to investors and contrary to federal fraud enforcement policies. 57. By modeling the Housing and Economic Recovery Act on that earlier statute, Congress intended to continue that policy of refusing to subordinate securities fraud claims. The subordination provision of the FHFA s rule defies that plain congressional intent. 58. Finally, the subordination provision is unconstitutional. It violates the Takings Clause and Due Process Clause by expropriating property interests without just compensation and retroactively eliminating already accrued causes of action. 14

15 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 15 of 20 Invalidity of the Non-Payment Provisions 59. The provisions of the FHFA s rule prohibiting payment of securities fraud claims in conservatorship, 12 C.F.R (a),.13(a), are also unlawful. 60. The FHFA justified those non-payment provisions as necessary to ensure the effectiveness of the provision subordinating securities fraud claims in receivership. To the extent the subordination provision is invalid, the non-payment provisions are necessarily invalid as well. 61. The non-payment provisions are also independently invalid because they exceed the FHFA s statutory authority. The Act equips the agency with only certain enumerated powers as conservator, such as authority to operate the regulated entity with all the powers of the shareholders, the directors, and the officers of the regulated entity and to preserve and conserve the assets and property of the regulated entity. 12 U.S.C. 4617(b)(2)(B)(i), (D)(ii). No provision of the Act authorizes the agency to refuse to pay valid claims much less judgments and court-approved settlements during conservatorship. 62. Other provisions of the Act clearly reflect Congress s intent that a regulated entity will continue to pay its debts in conservatorship. For example, while the Act authorizes regulated entities to refuse to pay certain claims in receivership by establishing a priority scheme for distribution where claims exceed assets available, it contains no comparable priority scheme for conservatorship. Congress provided no such scheme because it contemplated that regulated entities would continue to pay their debts in conservatorship. 63. Similarly, while the Act bars creditors from avoiding the statutory priority scheme by attaching a regulated entity s assets in receivership, 12 U.S.C. 4617(b)(11)(C), it contains no 15

16 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 16 of 20 comparable provisions restricting execution in conservatorship. That omission only makes sense if Congress contemplated that the entity would continue to pay its debts in conservatorship. 64. Finally, the non-payment provisions are also unconstitutional. They violate the Takings Clause and Due Process Clause by expropriating property interests without just compensation and retroactively eliminating already accrued causes of action. They also violate separation-ofpowers principles by purporting to vest an officer of the Executive Branch with discretion either to satisfy or to repudiate valid federal court judgments. PLAINTIFFS INJURY AND STANDING 65. The FHFA s final rule constitutes a final agency action reviewable in this Court under the Administrative Procedure Act, 5 U.S.C Plaintiffs are aggrieved by the FHFA s rule. Plaintiffs have asserted valid securities litigation claims against Fannie Mae. The rule s non-payment provisions inflict present injuryin-fact on Plaintiffs by prohibiting Fannie Mae from making any payment on those claims (whether in settlement or otherwise) while in conservatorship, absent the Director s consent, which has not been given. 67. The rule s subordination provision threatens imminent future harm to Plaintiffs by threatening to subordinate their valid securities litigation claims to the lowest level of priority in receivership. If Fannie Mae is placed in receivership, it is very likely that the entity s assets will not be sufficient to pay all claims. Subordination would thus dramatically affect Plaintiffs ability to recover any of their losses from Fannie Mae. 68. The subordination provision is also inflicting present injury-in-fact on Plaintiffs because the FHFA relied on the subordination provision as its justification for the non-payment provisions, which currently harm Plaintiffs. 16

17 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 17 of Plaintiffs are further aggrieved because the FHFA s rule was imposed by an officer who serves in violation of the Appointments Clause, and because the payment of their claims is determined by that officer. 70. The FHFA s final rule is fit for judicial review. Plaintiffs challenges to the rule concern whether the FHFA s head was serving in violation of the Appointments Clause and whether the challenged provisions of the rule are consistent with the statute, Supreme Court precedent, congressional intent, and the Constitution. Those legal issues would not benefit from further factual development. 71. Delaying judicial review will result in significant hardship for Plaintiffs. The FHFA s rule currently precludes Fannie Mae from paying Plaintiffs valid securities litigation claims, in settlement or otherwise. Further, delay could result in Fannie Mae being unable to satisfy any judgments or settlements if placed in receivership. CLAIMS FOR RELIEF COUNT I DECLARATORY AND INJUNCTIVE RELIEF VIOLATIONS OF APPOINTMENTS CLAUSE AND STATUTORY APPOINTMENT PROVISION 72. Plaintiffs reassert and incorporate herein by reference the allegations contained in paragraphs 1-71 above, as though fully set forth herein. 73. The FHFA s final rule is invalid in its entirety because it was promulgated by an agency whose head was not appointed in the manner required by the Appointments Clause, U.S. Const. art. II, 2, and the Housing and Economic Recovery Act. 74. The FHFA s rule has caused, and threatens to cause, injury for which Plaintiffs have no adequate remedy at law. 17

18 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 18 of Plaintiffs are entitled to a declaratory judgment that the FHFA s rule is invalid in its entirety because Mr. DeMarco is not validly serving in office, and an injunction against enforcement of the rule. COUNT II DECLARATORY AND INJUNCTIVE RELIEF INVALIDITY OF SUBORDINATION PROVISION 76. Plaintiffs reassert and incorporate herein by reference the allegations contained in paragraphs 1-75 above, as though fully set forth herein. 77. The provision of the FHFA s final rule that subordinates valid securities litigation claims to the lowest level of priority in receivership, 12 C.F.R (a), is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; contrary to constitutional right, power, privilege, or immunity; and in excess of statutory jurisdiction, authority, or limitations, in violation of 5 U.S.C The subordination provision has caused, and threatens to cause, injury for which Plaintiffs have no adequate remedy at law. 79. Plaintiffs are entitled to a declaratory judgment that the subordination provision is invalid and an injunction against enforcement of the provision. COUNT III DECLARATORY AND INJUNCTIVE RELIEF INVALIDITY OF NON-PAYMENT PROVISIONS 80. Plaintiffs reassert and incorporate herein by reference the allegations contained in paragraphs 1-79 above, as though fully set forth herein. 81. The provisions of the FHFA s final rule that prohibit Fannie Mae from paying any securities litigation claim while in conservatorship absent the FHFA s consent, 12 C.F.R. 18

19 Case 1:11-cv RJL Document 1 Filed 08/26/11 Page 19 of (a),.13(a), are arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; contrary to constitutional right, power, privilege, or immunity; and in excess of statutory jurisdiction, authority, or limitations, in violation of 5 U.S.C The non-payment provisions have caused, and threaten to cause, injury for which Plaintiffs have no adequate remedy at law. 83. Plaintiffs are entitled to a declaratory judgment that the non-payment provisions are invalid and an injunction against enforcement of the provisions. WHEREFORE, Plaintiffs request that this Court enter an order: (a) (b) (c) declaring unlawful, setting aside, and permanently enjoining enforcement of the FHFA s final rule published in the Federal Register on June 20, 2011, in its entirety, on the ground that Mr. DeMarco is not validly serving as Director of the FHFA; declaring unlawful, setting aside, and permanently enjoining enforcement of that portion of the FHFA s final rule published in the Federal Register on June 20, 2011, that purports to subordinate securities litigation claims to the lowest priority level in receivership (12 C.F.R (a)); declaring unlawful, setting aside, and permanently enjoining enforcement of those portions of the FHFA s final rule published in the Federal Register on June 20, 2011, that purport to prohibit Fannie Mae from paying securities litigation claims in conservatorship absent the FHFA s consent (12 C.F.R (a),.13(a)); (d) granting Plaintiffs their reasonable attorney s fees and costs under 28 U.S.C. 2412; and (e) granting Plaintiffs such other and further relief as this Court deems just and proper. 19

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21 Case 1:11-cv RJL Document 1-1 Filed 08/26/11 Page 1 of 3 EXHIBIT A

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24 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 1 of 29 EXHIBIT B

25 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 2 of 29 Waite, Schneider, Bayless & Chesley Co., L.P.A. Stanley M. Chesley Waite, Schneider Bayless & Chesley Co., L.P.A. One West Fourth Street Cincinnati, Ohio T: F: stanchesley@wsbclaw.com Jeffrey A. Lamken Molo Lamken LLP 600 New Hampshire Avenue, N.W. Washington, D.C T: F: jlamken@mololamken.com MORTON ROSENBERG, LITIGATION CONSULTANT 33 Eton Overlook Rockville, MD T: August 25, 2010 Mr. Alfred M. Pollard General Counsel Attention: Comments/RIN 2590-AA23 Federal Housing Finance Agency Fourth Floor 1700 G Street, N.W. Washington, D.C Re: Proposed Rule Regarding Conservatorship and Receivership 75 Fed. Reg. 39,462 (July 9, 2010); RIN 2590-AA23 Dear Mr. Pollard: We submit the following comments and objections to RIN 2590-AA23 (the Proposed Rule ) on behalf of Lead Plaintiffs Ohio Public Employees Retirement System and State Teachers Retirement System of Ohio and the Class in the currently pending federal securities fraud class action against Fannie Mae, Franklin Raines, Timothy Howard, and Leanne Spencer (In Re Fannie Mae Securities Litigation, Consolidated Case No. 04-cv-1639 (D.D.C.)). The pending litigation is based on the fraud at Fannie Mae that was discovered and detailed in two comprehensive public reports by the Office of Federal Housing Enterprise Oversight, the predecessor to the Federal Housing Finance Agency ( FHFA or the Agency ). FHFA, through its predecessor, has already obtained a $50 million

26 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 3 of 29 FHFA August 25, 2010 settlement from Fannie Mae and settlements valued at over $30 million from Raines, Howard, and Spencer based upon that same fraud. Now that FHFA (which was not damaged by the fraud) has obtained those settlements, it has proposed a new rule to prevent the more than 30 million pensioners throughout the 50 States who were damaged by the fraud, as well as other members of the class, from obtaining their just compensation. That effort violates the express provisions of the Housing and Economic Recovery Act of 2008 ( HERA or the Act ), Pub. L. No , 122 Stat. 2654, which requires FHFA to accord tort victims priority equivalent to that of other unsecured creditors. The Agency s Proposed Rule improperly subverts that express statutory priority scheme. Because the Proposed Rule conflicts with the statute, exceeds FHFA s authority, and is otherwise arbitrary, illegal, and unconstitutional, we respectfully request that the Agency reject the Proposed Rule or eliminate the improper provisions discussed below. I. BACKGROUND HERA authorizes FHFA to act as conservator or receiver for regulated entities including Fannie Mae and Freddie Mac. 12 U.S.C. 4617(a)(1). The Act sets forth specific powers the Agency may exercise as conservator or receiver, including power to prescribe such regulations as the Agency determines to be appropriate regarding the conduct of conservatorships and receiverships. Id. 4617(b). But the Act also contains provisions that limit FHFA s exercise of that authority. One such provision is the statutory priority scheme for receivership set forth in 12 U.S.C. 4617(c)(1). Under that provision, [u]nsecured claims against a regulated entity, or the receiver therefor,... shall have priority in the following order : (A) Administrative expenses of the receiver. (B) Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D)). (C) Any obligation subordinated to general creditors (which is not an obligation described under subparagraph (D)). (D) Any obligation to shareholders or members arising as a result of their status as shareholder or members. 2

27 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 4 of 29 FHFA August 25, U.S.C. 4617(c)(1) (emphasis added). Subject to limited exceptions not applicable here, [a]ll creditors that are similarly situated under paragraph (1) shall be treated in a similar manner. Id. 4617(c)(2). The statutory priority scheme thus plainly distinguishes between general creditor claims (subsection (B)) and mere equity interests (subsection (D)). On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac in conservatorship pursuant to HERA. On July 9, 2010, FHFA published the Proposed Rule at issue. See Conservatorship and Receivership, 75 Fed. Reg. 39,462 (proposed July 9, 2010). The Proposed Rule purports to implement HERA for conducting any conservatorship or receivership of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Id. at 39, In fact, however, the Proposed Rule significantly departs from HERA s statutory framework. Section (a) of the Proposed Rule sets forth a revised priority scheme, in which claims in receivership are satisfied in the following order: (1) Administrative expenses of the receiver (or an immediately preceding conservator). (2) Any other general or senior liability of the regulated entity (that is not a liability described under paragraph (a)(3) or (a)(4) of this section). (3) Any obligation subordinated to general creditors (that is not an obligation described under paragraph (a)(4) of this section). (4) Any obligation to current or former shareholders or members arising as a result of their current or former status as shareholders or members, including, without limitation, any Securities Litigation Claim. Proposed 12 C.F.R (a) (emphasis added). The term Securities Litigation Claim is defined very broadly to include any claim, whether or not reduced to judgment, liquidated or unliquidated, fixed, contingent, matured or unmatured, disputed or undisputed, legal, equitable, secured or unsecured, arising from rescission of a purchase or sale of an equity security of a regulated entity or for damages arising from the purchase, sale, or retention of such a security. Proposed 12 C.F.R The Proposed Rule thus classifies securities fraud claims even those reduced to final judgment in federal court as the lowest priority, on par with equity. 3

28 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 5 of 29 FHFA August 25, 2010 The Agency attempts to justify reclassifying securities fraud claims as equity claims on the ground that doing so is fair and appropriate. 75 Fed. Reg. at 39,466. The Agency notes that Section 510(b) of the 1978 Bankruptcy Code expressly subordinates securities litigation claims to the lowest level of priority with shareholder claims in bankruptcy. Id. (citing 11 U.S.C. 510(b)). Although HERA contains no analogous language, the Agency attempts to explain away that omission: HERA does not contain all of the details governing insolvent entities that the Bankruptcy Code does, the Agency asserts, because Congress expected FHFA to fill in the gaps. Id. The Agency contends that its choice is permissible because Congress enacted HERA against the backdrop of... statutory and common law... treating Securities Litigation Claims derived from equity ownership as subordinated to or having the same priority as the underlying equity. Id. at 39, The Agency also claims support from certain appeals court cases, such as Gaff v. FDIC, 919 F.2d 384 (6th Cir. 1990), that have looked to the Bankruptcy Code for guidance on relative priorities of shareholder claims as well as other issues arising in receiverships of financial institutions. 75 Fed. Reg. at 39,467. Having proposed to subordinate the claims of securities fraud victims in receivership, the Agency also proposes corresponding changes to the provisions governing conservatorship. In particular, Section (a), entitled Payment of Securities Litigation Claims while in conservatorship, would provide that [t]he Agency, as conservator, will not pay a Securities Litigation Claim against a regulated entity, except to the extent the Director determines is in the interest of the conservatorship. And Section (a) would provide that, subject to limited exceptions, a regulated entity shall make no capital distribution while in conservatorship, which is also defined to include payments on securities litigation claims. See Proposed 12 C.F.R (3). The Agency explains its nonpayment policy as a corollary of its revised priority scheme: If the Conservator were to authorize payment of Securities Litigation Claims despite the statutory receivership priority system ranking such claims below all other claims, the purpose of the receivership priority system could be thwarted. 75 Fed. Reg. at 39,468. For the reasons explained below, neither the Agency s proposed surgery on the statutory receivership priority scheme, nor its proposal to rely on that revised scheme to refuse to pay even valid judgments in conservatorship, is consistent with 4

29 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 6 of 29 FHFA August 25, 2010 the statute. Neither proposal can be reconciled with general legal principles or basic notions of fairness. And neither will withstand constitutional scrutiny. In short, both are arbitrary, capricious, and unlawful. II. FHFA S PROPOSED PRIORITY SCHEME CONFLICTS WITH THE PRIORITIES CONGRESS EXPRESSLY SET FORTH IN HERA The Proposed Rule should be rejected because subordination of securities fraud claims is directly contrary to the priority scheme Congress enacted. Contrary to the Agency s claim, there is no backdrop of... statutory and common law that allows an agency to treat securities fraud claims even those reduced to judgment as mere equity interests. Rather, under Supreme Court precedent that the Agency does not even deign to cite (let alone attempt to distinguish), securities fraud claims must be treated as creditor claims absent statutory language mandating different treatment. Nothing in HERA supports that different treatment here. To the contrary, the legislative history of the statute on which HERA was modeled shows that Congress specifically considered subordination but overwhelmingly decided against it on a bipartisan basis. Moreover, the sound policy reasons that led Congress to reject subordination of securities fraud claims there that doing so would undermine fraud enforcement and be unfair to private plaintiffs who were innocent victims of wrongdoing apply with compelling force here. As a matter of law and policy alike, the Proposed Rule cannot be adopted. A. UNDER THE SUPREME COURT S DECISION IN OPPEN- HEIMER, SECURITIES FRAUD CLAIMS MUST BE TREATED AS CREDITOR CLAIMS ABSENT STATUTORY LANGUAGE TO THE CONTRARY HERA s statutory priority scheme expressly distinguishes between creditor claims ( Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D)) ) and equity claims ( Any obligation to shareholders or members arising as a result of their status as shareholder or members ), reserving the lowest priority for the latter. 12 U.S.C. 4617(c)(1)(B), (D). Thus, the dispositive question here is whether, under governing legal principles, a defrauded investor s securities fraud claim is properly considered a creditor claim (like any other tort victim s claim against the company) or rather a mere equity interest. 5

30 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 7 of 29 FHFA August 25, Although FHFA does not even bother to cite the case, the Supreme Court directly answered that question over 70 years ago in Oppenheimer v. Harriman National Bank & Trust Co., 301 U.S. 206 (1937). That case stands squarely for the proposition that securities fraud claims are creditor claims, not equity interests, in a receivership, unless Congress provides specific statutory language providing for contrary treatment. Oppenheimer involved a fraud claim by the purchaser of stock in a bank that had become insolvent and entered receivership. 301 U.S. at Much like the class members here, the plaintiff in Oppenheimer claimed he had been defrauded into purchasing stock by the bank officers misrepresentations, and sought rescission. Id. at 208. The court of appeals ordered judgment for the plaintiff, but subordinated his claim to other creditors claims. Id. The fraud victim sought review, and the Supreme Court unanimously reversed. The Court described the issue before it as whether plaintiff s judgment is entitled to share equally in the receivership estate with other unsecured creditors claims. Oppenheimer, 301 U.S. at 213. It answered that question in the affirmative. The fraudulent sale was subject to rescission by the plaintiff, the Court explained, and [n]either lapse of time while plaintiff remained ignorant of the fraud nor insolvency of the bank detracted from its liability. Id. at 214. The plaintiff merely s[ought] to share in the estate as do other unsecured creditors. Id. That, the Court held, he was entitled to do: Securities fraud claimants stand on the same footing as other creditors. Id. at 215. And [d]iscrimination against their claims is not authorized by the statute. Id. It follows, the Court concluded, that plaintiff s judgment is entitled to rank on a parity with other unsecured creditors claims. Id. Oppenheimer thus stands squarely for the proposition that, except where discrimination is expressly authorized by the statute, securities fraud claimants must be treated the same as any other creditor in receivership. 301 U.S. at That 70-year-old holding reflected what was then already well-established law. See Richardson v. Olivier, 105 F. 277, 280 (5th Cir. 1900) ( There is no sound reason, we think, for refusing to give a shareholder the same remedies against the bank on account of its frauds that are given to other creditors. ); Clark v. Boston- Cont l Nat l Bank, 84 F.2d 605, 607 (1st Cir. 1936) (victim of securities fraud participate[s] ratably with other creditors in the distribution of the bank s assets ); 6

31 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 8 of 29 FHFA August 25, 2010 Salter v. Williams, 244 F. 126, 130 (3d Cir. 1917) (defrauded investor approaches the receiver like an ordinary creditor ); Williams v. Green, 23 F.2d 796, (4th Cir. 1928); Fla. Land & Imp. Co. v. Merrill, 52 F. 77, (5th Cir. 1892); see also Oppenheimer, 301 U.S. at 215 nn (citing Richardson, Clark, Salter, Williams, and Florida Land). Oppenheimer has never been overruled. And for decades, its holding was understood to govern not only the bank-receivership context the Court addressed, but also bankruptcy proceedings predating adoption of the 1978 Bankruptcy Code. Indeed, for many years, the Securities and Exchange Commission vigorously enforced and defended the Oppenheimer rule in bankruptcy cases. As the Solicitor General urged the Supreme Court on behalf of the SEC in one case: If [securities fraud] claims can be established, they are entitled to rank on a parity with those of other general unsecured creditors. Memorandum for the Securities and Exchange Commission at 19 n.19, Protective Comm. v. Anderson, 390 U.S. 414 (filed March 1967) (citing Oppenheimer); see also SEC v. Ins. Investors Trust Co., No. 5753, 1971 WL 953, at *1-2 (W.D. Ky. Oct. 29, 1971) (granting parity based on (among other things) the specific pronouncements of Oppenheimer to the effect that [defrauded] stockholder claims rank on parity with unsecured creditors ); In the Matter of Four Seasons Nursing Ctrs. of Am., Inc., SEC Release No. CR-310, 1972 WL , at *19 n.32 (Mar. 16, 1972) ( [F]raud claims are on parity with unsecured claims generally.... ); Kenneth B. Davis, The Status of Defrauded Securityholders in Corporate Bankruptcy, 1983 Duke L.J. 1, 9-10 & nn (citing additional authorities). Except when provided otherwise by statute, that remains the law today. 2. In 1978, of course, Congress changed the rule for entities in bankruptcy by adding a new provision in the 1978 Bankruptcy Code for the specific purpose of subordinating securities fraud claims. Section 510(b) of the Bankruptcy Code currently provides: For the purpose of distribution under this title, a claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under section 502 on account of such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except 7

32 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 9 of 29 FHFA August 25, 2010 that if such security is common stock, such claim has the same priority as common stock. 11 U.S.C. 510(b) (emphasis added). That provision by its terms governs only for the limited purpose of distribution under this title, i.e., for bankruptcies under the Bankruptcy Code. And notably, the provision does not say that securities fraud claims are equity claims or otherwise express any disagreement with the underlying logic of Oppenheimer. Instead, it simply directs that this particular class of creditor claims shall be subordinated in bankruptcy. Far from repudiating the reasoning of Oppenheimer, therefore, Congress merely accepted Oppenheimer s invitation to authorize[] by... statute differential treatment of one particular category of creditor claims in the bankruptcy context. For that reason, the Agency s reliance on an analogy to Section 510(b) is misplaced. The existence of that special provision for bankruptcies shows that, when Congress intends to depart from the Supreme Court s Oppenheimer rule, it knows how to do so by specifying different treatment in the statute. Indeed, the Bankruptcy Code s legislative history confirms that Congress, in enacting Section 510(b), consciously departed from prior law and adopted a new and different rule for bankruptcies. The House Report observed that Oppenheimer permits a rescinding security holder to share pari passu in the bankrupt estate with general creditors, and that [t]he Supreme Court has not withdrawn from this position since 1937 (although it declined to reach the issue in one bankruptcy case). H.R. Rep. No , at (1978). The House Report further noted that the SEC had urged retention of the Oppenheimer rule in the bankruptcy context because a security holder who has been defrauded should be treated the same as any other tort victim of the debtor. Id. at But, relying largely on one 1973 law review article that advanced various policy reasons for a different approach, Congress changed the law in the bankruptcy context by adopting Section 510(b). See id. (citing John J. Slain & Homer Kripke, The Interface Between Securities Regulation and Bankruptcy, 48 N.Y.U. L. Rev. 261 (1973)). That article itself likewise recognized that this was a change in the law. See Slain & Kripke, supra, at 261 ( [I]t is currently held that the investor s [fraud] claim either shares pari passu with, or is preferred to, claims of general creditors. ); id. at 281 (noting the contemporary learning that rescinding stockholders share pari passu with... general creditors ); id. at 285 (advocating a reconsideration of the law); id. at 294 (outlining a new approach ). 8

33 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 10 of 29 FHFA August 25, 2010 Section 510(b) thus supersedes Oppenheimer in the bankruptcy context. But that statutory provision does not alter the application of Oppenheimer in other contexts including the bank receivership context that Oppenheimer itself addressed. That point was made clearly in a case relied upon, ironically, by the Agency here In the Matter of Stirling Homex Corp., 579 F.2d 206 (2d Cir. 1978). See 75 Fed. Reg. at 39,466. Homex subordinated securities fraud claims in bankruptcy, relying on the pending enactment of Section 510(b) as well as the Slain & Kripke article (although deciding the case under pre-1978 law). See 579 F.2d at 212, The court specifically distinguished Oppenheimer on the ground that it involved bank receivership rather than bankruptcy: Significantly, the Oppenheimer decision... was made not pursuant to the Bankruptcy Act but under an entirely different statutory scheme the National Bank Act, 12 U.S.C. 1 et seq. 579 F.2d at 211 n.8. That difference mattered because, according to the court, bankruptcy law afforded greater discretion to assure a fair and equitable distribution, as opposed to the strict ratable priority scheme that governs bank receiverships. Id.; see also In re U.S. Fin. Inc., 648 F.2d 515, (9th Cir. 1980) (distinguishing Oppenheimer on the same basis). Homex thus clearly demonstrates that Oppenheimer remains good law outside the bankruptcy context. FHFA claims that courts have looked to the Bankruptcy Code for guidance on relative priorities of shareholder claims as well as other issues arising in receiverships of financial institutions. 75 Fed. Reg. at 39,467. But none of the cases it cites involves a situation like the one here, where the Supreme Court had already established a binding legal principle applicable to receiverships, and Congress had established a statutory departure from that otherwise applicable principle in the Bankruptcy Code that was expressly limited to the bankruptcy context. The cited cases acknowledge that the Bankruptcy Code does not apply of its own force to bank receiverships. See Gaff v. FDIC, 919 F.2d 384, 393 (6th Cir. 1990) ( We recognize that the principles of equitable subordination do not apply to this case directly. This case is not in bankruptcy and the Bankruptcy Code does not govern bank failures. 11 U.S.C. 109(b)(2) (1988). ); Office & Prof l Employees Int l Union, Local 2 v. FDIC, 962 F.2d 63, 68 (D.C. Cir. 1992) (Local 2) ( Bankruptcy Rules, we recognize, do not govern of their own force in a FIRREA liquidation. ). The Supreme Court s Oppenheimer decision has already established the legal rule that governs absent contrary congressional direction. Because Section 510(b) s contrary direction does not apply here, Oppenheimer 9

34 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 11 of 29 FHFA August 25, 2010 does. And Oppenheimer requires defrauded investors to be treated like any other victim of the company s tortious misconduct as creditors, not equityholders. The cases the Agency cites are unsupportive for other reasons as well. As explained below, Gaff is an outlier that has been rejected by three other circuits. And Local 2 involved a narrow procedural question about a union s ability to file claims on behalf of its members without a power of attorney, 962 F.2d at 68 hardly sound authority for the fundamental reconfiguration of priority that FHFA attempts here. FHFA also cites First Empire Bank New York v. FDIC, 572 F.2d 1361, 1368 (9th Cir. 1978). See 75 Fed. Reg. at 39,467. But that case likewise has nothing whatsoever to do with Section 510(b), much less reliance on that provision outside the bankruptcy context. It deals with the provability of claims. 572 F.2d at Most importantly, though, none of the cases involved a situation like this one, where the Supreme Court had already established the general rule and Congress, while enacting a limited departure for the bankruptcy context, did not extend that departure to other contexts. The law under Oppenheimer is clear: Unless different treatment is specifically authorized by the statute, securities fraud claims must be treated as creditor claims, not equity interests. Section 510(b) provides that specific authority in the bankruptcy context. Because the Agency can point to no similar authority in HERA, Oppenheimer compels rejection of its Proposed Rule. B. CONGRESS DID NOT DEPART FROM THE OPPENHEIMER RULE WHEN IT ENACTED HERA Congress was clearly familiar with Oppenheimer s requirement that it expressly provide for subordination of securities fraud claims if that is what it intends. Yet HERA contains no language analogous to Section 510(b) s express subordination of securities fraud claims in bankruptcy. To the contrary, the legislative history shows that Congress consciously rejected subordination when it enacted the statute on which HERA was patterned. Consistent with that rejection, courts have repeatedly rebuffed attempts to import subordination into the receivership context. For multiple reasons, therefore, the Proposed Rule contravenes Congress s plain intent. 1. The Agency cannot assume that Congress intended to depart from otherwise governing Supreme Court precedent absent a clear indication in the 10

35 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 12 of 29 FHFA August 25, 2010 statute. Courts will not assume Congress to have intended... a departure from well-established doctrine without a clear expression to disavow it. Dorszynski v. United States, 418 U.S. 424, 441 (1974); see also United States v. U.S. Gypsum Co., 438 U.S. 422, 437 (1978). Congress is deemed to be familiar with [the Supreme Court s] precedents... and [to] expect[] its enactment[s] to be interpreted in conformity with them. N. Star Steel Co. v. Thomas, 515 U.S. 29, 34 (1995). When Congress enacted HERA, the law was clear: Unless different treatment is specifically authorized by the statute, securities fraud claims have the same priority as any other unsecured creditor claim. Oppenheimer, 301 U.S. at Congress provided no indication of any intent to supersede that settled rule in HERA much less a clear expression of its intent to do so. Congress, moreover, knew full well how to depart from the Oppenheimer rule: It needed only to add a provision to HERA similar to Section 510(b) of the Bankruptcy Code. But HERA contains no provision remotely comparable to Section 510(b) s express subordination clause. Congress s provision of an express subordination clause in the Bankruptcy Code and its omission of such a clause from HERA proves that Congress did not intend to grant FHFA power to subordinate securities fraud claims. When Congress includes language in one statutory provision but omits it from another closely related provision, courts presume that Congress acts intentionally and purposely in the disparate inclusion or exclusion. Cf. Burlington N. & Santa Fe Ry. Co. v. White, 548 U.S. 53, (2006) (quotation marks omitted); Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, (1994). The omission of express subordination language comparable to Section 510(b) from HERA thus makes the Agency s position untenable. The Agency strains to extract some indication of Congress s intent to authorize subordination from the language of the statutory priority scheme. See 75 Fed. Reg. at 39,466. But nothing in that scheme evinces any intent to authorize subordination. The statute clearly reserves the lowest priority for obligations to shareholders arising as a result of [the claimant s] status as shareholder. 12 U.S.C. 4617(c)(1)(D). A securities fraud claim does not arise from the plaintiff s status as shareholder. Rather, it arises from the plaintiff s status as a tort victim of a company s fraudulent misrepresentations. See Howard v. Haddad, 916 F.2d 167, 170 (4th Cir. 1990) (securities fraud claims do not... arise out of [the plaintiff s] status as a Bank shareholder but rather from the allegedly fraudulent inducements to buy the stock ). The victim s status as shareholder may be a 11

36 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 13 of 29 FHFA August 25, 2010 consequence of the fraud, but it is not the status out of which the fraud claim arises. And while stock ownership may be a necessary corollary of being a securities fraud victim, cf. 75 Fed. Reg. at 39,466 (proposing a but for test), that is not the statutory test. The test is arising from. 12 U.S.C. 4617(c)(1)(D). Here, the claims arise from fraud not from the mere status of being a shareholder. Howard, 916 F.2d at 170. Shareholders unaffected by the fraud have no claim, and fraud victims may still have a claim even if they are no longer shareholders; status as a shareholder is thus not the basis for the claim. The Agency s broader but for test also proves too much: If a shareholder suffers a slip-and-fall injury due to the company s negligence while attending the annual stockholder s meeting, he is still a tort victim with a creditor s claim, even though he would not have suffered the injury but for his status as a stockholder. 1 Because securities fraud claims do not aris[e] as a result of [the claimant s] status as shareholder, but instead from his status as a fraud victim, the Agency s reliance on the exclusionary language of the senior priority provisions likewise fails. See 75 Fed. Reg. at 39,466. The Agency notes that the statute defines creditor claims to exclude equity claims. See 12 U.S.C. 4617(c)(1)(B) ( Any other general or senior liability of the regulated entity (which is not a liability described under subparagraph (C) or (D)) (emphasis added)). Contrary to the Agency s contention, however, that parenthetical reference is not a subtle attempt by Congress to reclassify securities fraud claims as equity claims. Its obvious purpose is to make clear that genuine equity claims like the right to collect dividends or share in ownership are not general liabilities entitled to creditor priority. Because securities fraud claims do not aris[e] as a result of [the 1 As the Supreme Court has explained, a claim can be said to arise from or under a statute if both the standing and the substantive basis for the presentation of the claim come from the statute. Heckler v. Ringer, 466 U.S. 602, 615 (1984) (emphasis added) (citing Weinberger v. Salfi, 422 U.S. 749, (1975)). Here, securities fraud claimants do not have standing because of their status as shareholders; some may no longer own shares. And the substantive basis for their claims does not come from the rights given them as shareholders. It comes from the right not to be subjected to fraud. Besides, if Congress had meant to subordinate securities class-action claims, it would have used the language it used in Section 510(b): It would have subordinated any claim arising from the purchase or sale of a security of the regulated entity. That Congress did not do so here speaks volumes about its intent. 12

37 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 14 of 29 FHFA August 25, 2010 claimant s] status as shareholder, they are not covered by subsection (D), and the parenthetical language in subsection (B) is irrelevant. Ultimately, the Agency s textual analysis simply fails to come to grips with Oppenheimer. The Agency opines that [c]laims for damages by shareholders could be considered to be creditor claims. 75 Fed. Reg. at 39,466 (emphasis added). That is true only in the same sense that Supreme Court holdings could be considered binding. The more accurate statement of the law would be that [c]laims for damages by defrauded shareholders are considered to be creditor claims, absent statutory language mandating a different treatment. Congress knows how to provide such language as it did in the Bankruptcy Code but Congress did not do so here. Because HERA contains no provision authorizing subordination of securities fraud claims let alone the clear expression necessary to displace well-established doctrine, Dorszynski, 418 U.S. at 441 the Proposed Rule cannot be reconciled with Oppenheimer. 2. While HERA s text provides reason enough to reject the Proposed Rule, its legislative history underscores how far the Agency has strayed from Congress s design. HERA s legislative history clearly indicates that Congress modeled FHFA s powers as conservator and receiver on the pre-existing statutory framework governing the Federal Deposit Insurance Corporation ( FDIC ): The conservatorship and receivership provisions were modeled after similar provisions in the Federal Deposit Insurance Act that apply to federally insured depository institutions. H.R. Rep , at 90 (2007). The influence of that pre-existing regime is clear on HERA s face, since HERA s text closely tracks the FDIC s statute in many respects. Compare, e.g., 12 U.S.C. 4617(a)-(b) with 12 U.S.C. 1821(c)-(d). Congress s reliance on that prior bank receivership statute further undermines any claim that Congress intended to incorporate subordination principles from Section 510(b) of the Bankruptcy Code sub silentio. Oppenheimer rejected securities-fraud subordination in the very context of bank receivership. See 301 U.S. at The Second Circuit in Homex allowed equitable subordination of a securities fraud claim precisely because that case did not involve a bank receivership. See 579 F.2d at 211 n.8. Congress thus modeled HERA on a statute that lies at the core of the Supreme Court s holding in Oppenheimer. By attempting to extend Section 510(b) of the Bankruptcy Code to 13

38 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 15 of 29 FHFA August 25, 2010 HERA, when Congress has not extended Section 510(b) to that context, the Proposed Rule strikes at the very heart of Oppenheimer. The legislative history of the FDIC s statute makes that even more clear. When Congress granted the FDIC receivership and conservatorship authority in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ( FIRREA ), Pub. L. No , 103 Stat. 183, it considered, but consciously rejected, subordinating certain securities fraud claims. A proposed Senate amendment would have subordinated shareholders claims against directors and officers of failed financial institutions to the FDIC s own claims. It provided: In any proceeding related to any claim acquired under section 11 or 13 of this Act against an insured financial institution s director, officer, employee, agent, attorney, accountant, appraiser, or any other party employed by or providing services to an insured financial institution, any suit, claim, or cause of action brought by the Corporation shall have priority over any such suit, claim, or cause of action asserted by depositors, creditors, or shareholders of the insured financial institution.... This priority shall apply to both the prosecution of any suit, claim, or cause of action, and to the execution of any subsequent judgments resulting from such suit. S. 774, 101st Cong., 1st Sess. 214(o)(1) (1989). That provision was deleted, however, from the bill that became law. See Pub. L. No , 103 Stat Members of Congress explained that they deleted the subordination provision in conference because subordination was fundamentally unsound as a policy matter. 135 Cong. Rec. 18,571 (1989) (Rep. Glickman). [G]iving the FDIC an absolute priority [over securities fraud claims] would undermine fraud enforcement, would be potentially unfair to private plaintiffs who were innocent victims of wrongdoing, and would be at cross-purposes with the thrust of the savings and loan legislation. Id. [P]rivate parties would have little chance of recovery and as a result would no longer bring fraud suits, eliminating a necessary supplement to the enforcement efforts of the SEC and the Department of Justice, which do not have the resources to enforce the law on their own. Id. [T]here was no evidence that [subordination] would benefit the American taxpayers in any meaningful way, especially in view of the likelihood of increased fraud. Id. And subordination would be a disincentive to investment in savings 14

39 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 16 of 29 FHFA August 25, 2010 institutions, since an investor would have no recourse if his investment was procured through fraud. Id.; see also id. at 18,575 (Rep. Staggers) (making the same points). The House conferees thus voted overwhelmingly, on a bipartisan basis, to delete the subordination provision, and the Senate conferees agreed. Id. at 18,575. In modeling FHFA s authority on FDIC s power under FIRREA, Congress followed a template that consciously excluded subordination of securities fraud claims. All the reasons legislators mentioned for rejecting subordination in FIRREA, moreover, are equally potent responses to FHFA s Proposed Rule here. By pursuing the rule nonetheless, the Agency thwarts Congress s plain intent. 3. Consistent with the legislative history discussed above, cases interpreting the FDIC s authority under FIRREA have repeatedly refused to grant the FDIC power to subordinate securities fraud claims. In FDIC v. Jenkins, 888 F.2d 1537 (11th Cir. 1989), the Eleventh Circuit held that the FDIC lacked authority to subordinate private securities fraud claims against officers and directors of a failed bank to its own claims. While not disputing that preservation of the permanent insurance fund is vital to the continued health of the nation s banking system, the court saw no indication of an intention to authorize subordination in the statute, and refused to approve of judicial expansion of the [FDIC s] express powers. Id. at Rejecting the FDIC s invitation to act on arguments based in equity or on implicit powers, the court opined that a decision to give the FDIC [subordination power] is more properly within the domain of Congress. Id. at 1541 n.6. Congress s rejection of the proposed subordination amendment provided still further support. See id. at 1538 n.1. Two other circuits have followed the Eleventh Circuit s lead. In Howard v. Haddad, the Fourth Circuit refused to allow the FDIC to subordinate a private securities fraud claim, expressly adopt[ing] the Eleventh Circuit s analysis in Jenkins. 916 F.2d at 170. The court rejected the FDIC s argument that a shareholder s securities fraud claim was no different from the claims of any other shareholder. Id. [The plaintiff s] claims on the defendants assets do not... arise out of his status as a Bank shareholder, the court reasoned; it was the allegedly fraudulent inducements to buy the stock that form the basis of his claims. Id. The Third Circuit then agreed with Jenkins and Howard in Hayes v. Gross, 982 F.2d 104 (3d Cir. 1992), a case that involved the parallel receivership authority of the Resolution Trust Corporation. See id. at & n.6. The court 15

40 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 17 of 29 FHFA August 25, 2010 stated: We believe the RTC s statutory policy argument is, in essence, a claim that Congress, in enacting FIRREA, impliedly amended the Exchange Act so as to subordinate the latter to the former. We find nothing in the text or legislative history of FIRREA to support this proposition and therefore reject it. Id. at 110; see also Greenfield v. Shuck, 867 F. Supp. 62, (D. Mass. 1994). Courts have thus overwhelmingly rejected the notion that FIRREA the statute HERA is based on authorizes the subordination of securities fraud claims. There is no reason for a different result under HERA. Ignoring the overwhelming weight of authority, the Agency s Notice of Proposed Rulemaking relies on a single Sixth Circuit case, Gaff v. FDIC, 919 F.2d 384 (6th Cir. 1990), modified, 933 F.2d 400 (6th Cir. 1991). As courts have noted, Gaff stands alone in reaching the result it did. See Greenfield, 867 F. Supp. at 69 ( The majority of other courts that have considered the issue... have declined to create an absolute priority for the FDIC, contrasting Gaff with Jenkins, Howard, and Hayes); Hayes, 982 F.2d at 109 n.5 (identifying Gaff as the only authority supporting the FDIC s subordination argument and noting that Jenkins and Howard rejected it). FHFA offers no reason to follow an outlier decision on the short end of a 3-1 circuit split. Gaff, moreover, is unpersuasive on its face. First, the court relied by analogy on Section 510(b) of the Bankruptcy Code a provision expressly limited to bankruptcy cases but did not even cite the Supreme Court s Oppenheimer decision, which rejected subordination in the precise context of bank receivership. See 919 F.2d at 394. Neither the Sixth Circuit nor FHFA can overrule Supreme Court precedent simply by ignoring it. Second, the court refused to attach any significance to Congress s decision not to enact the subordination amendment in FIRREA, relying on the patently erroneous assertion that the legislative history says nothing about why the Senate did not include this proposal and that the best explanation is that Congress thought it best that the law of priorities in bank receiverships should be developed by the federal courts on a case-by-case basis. Id. at As already explained, the legislative history explains precisely why Congress did not adopt that proposal: Because it was bad policy, would harm innocent securities fraud victims, and would undermine the important objectives the securities laws seek to achieve. Finally, Gaff attempted to distinguish Jenkins in part on the ground that Jenkins involved causes of action granted by statute, namely the state and federal securities laws, whereas Gaff involved only state common-law mismanagement and related fraud claims that 16

41 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 18 of 29 FHFA August 25, 2010 affected the corporation generally. Id. at 396. For that reason, it is not even clear that the Sixth Circuit s holding applies to the violations of the federal securities laws at issue here. The overwhelming weight of authority refusing to subordinate securities fraud claims under FIRREA is powerful evidence of Congress s intent under HERA. It is a settled principle of statutory interpretation that, where Congress adopts a new law incorporating sections of a prior law, Congress normally can be presumed to have had knowledge of the interpretation given to the incorporated law. Lorillard v. Pons, 434 U.S. 575, 581 (1978); see also Hibbs v. Winn, 542 U.S. 88, (2004); Pollard v. E.I. du Pont de Nemours & Co., 532 U.S. 843, 853 (2001). When Congress enacted HERA in 2008, it was legislating against a twenty-year backdrop of near-unanimous refusal to read subordination powers into bank receivership statutes where those powers were not expressly set forth in the statutory text. By consciously modeling HERA on that prior law, Congress must be presumed to have intended the same result here. 4. The Agency cannot overcome those authorities by claiming to fill in the gaps in the statute pursuant to Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). 75 Fed. Reg. at 39,466. The Proposed Rule does not fill in any gap. It revises an express priority scheme Congress set forth in the statute. Chevron does not permit an agency to fill in the gaps when Congress has already filled the gaps for it. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. 467 U.S. at That perfectly describes the statute here. Congress set forth an express priority scheme that gives higher priority to creditor claims than equity interests. 12 U.S.C. 4617(c)(1)(B), (D). Under the settled Oppenheimer rule, which Congress was deemed to be familiar with, securities fraud claims have the same priority as other creditor claims unless Congress specifically directs otherwise. Congress did not direct otherwise here. Congress has thus made its intent clear. It left no gap for the Agency to fill. In determining whether a statute leaves gaps, moreover, courts consider not only the ordinary meaning of the text, but also the principles of statutory construction that elucidate Congress s intent. Only if the statute remains unclear 17

42 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 19 of 29 FHFA August 25, 2010 after application of those canons is deference to the agency s views appropriate. In FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120 (2000), for example, the Court refused to defer to the FDA s determination that it could regulate cigarettes as drug delivery devices under the Food, Drug, and Cosmetic Act, 21 U.S.C. 301 et seq. The Court looked beyond the Act s bare text to the various tobacco-related laws over the previous 35 years and determined that Congress had clearly excluded regulation of tobacco products from the FDA s jurisdiction. 529 U.S. at It emphasized in particular that Congress had rejected legislative proposals that would have granted the FDA clear authority to regulate tobacco products. See id. at ; see also, e.g., Nat l Credit Union Admin. v. First Nat l Bank & Trust Co., 522 U.S. 479, (1998) ( established canon[s] of construction made clear that Congress had directly spoken to the precise question at issue ). Accordingly, in evaluating whether Congress left gaps to fill in HERA, a reviewing court would consider not only the bare text of HERA s priority scheme, but also all the usual canons of construction that shed light on Congress s intent. Those canons include the principle that Congress is presumed not to depart[] from well-established doctrine without a clear expression to disavow it. Dorszynski, 418 U.S. at 441; see U.S. Gypsum, 438 U.S. at 437. Here, the wellestablished doctrine was that Congress must provide for subordination of securities fraud claims if that is what it intends. Those canons also include the principle that Congress is presumed to act intentionally and purposely in the disparate inclusion or exclusion of language in different statutory provisions. Burlington N. & Santa Fe Ry., 548 U.S. at (quotation marks omitted); see Cent. Bank of Denver, 511 U.S. at Here, Congress included specific language departing from Oppenheimer in the bankruptcy context but omitted any such language from HERA. Those canons also include the principle that, where Congress adopts a new law incorporating sections of a prior law, Congress normally can be presumed to have had knowledge of the interpretation given to the incorporated law. Lorillard, 434 U.S. at 581; see Hibbs, 542 U.S. at ; Pollard, 532 U.S. at 853. Here, Congress modeled HERA on bank receivership statutes like FIRREA that have repeatedly been held not to allow subordination. For half a century, the SEC has championed the Oppenheimer rule as not just compelled by law, but fair and just. Nothing in HERA authorizes FHFA to reject all that established precedent and substitute its own policy preferences instead. 18

43 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 20 of 29 FHFA August 25, 2010 Finally, still another canon trumps agency discretion: the rule of constitutional avoidance. Even where a statute might otherwise leave gaps, courts will not permit an agency to fill those gaps in a way that approaches constitutional bounds. See Solid Waste Agency of N. Cook County v. U.S. Army Corps of Eng rs, 531 U.S. 159, (2001); Edward J. DeBartolo Corp. v. Florida Gulf Coast Bldg. & Constr. Trades Council, 485 U.S. 568, (1988); cf. Kent v. Dulles, 357 U.S. 116, 129 (1958) (courts must narrowly construe statutes that would otherwise curtail or dilute constitutional rights). As explained below, the Proposed Rule raises substantial constitutional concerns on multiple fronts. A reviewing court will not defer under those circumstances. Wholly apart from constitutional constraints, moreover, courts will not presume that Congress intends to authorize retroactive rulemaking absent clear statutory authority. See, e.g., Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, (1988); INS v. St. Cyr, 533 U.S. 289, 320 n.45 (2001); Nat l Mining Ass n v. Dep t of Labor, 292 F.3d 849, 860 (D.C. Cir. 2002). As further explained below, the Proposed Rule is impermissibly retroactive and for that reason too will not be afforded deference. Chevron will not shield the Agency s unlawful Proposed Rule from judicial correction. * * * * * In short, the Agency fails to marshal any authority to support its claim that Congress authorized subordination of securities fraud claims, contrary to the settled law governing bank receiverships set forth in Oppenheimer. Every indication is to the contrary: The text of the statute, the legislative history, and the overwhelming weight of judicial authority refute the Agency s proposal. The Proposed Rule thus flouts the unambiguous intent of Congress and should be rejected. III. FHFA S PROPOSED REFUSAL TO PAY VALID CLAIMS DURING CONSERVATORSHIP ALSO VIOLATES HERA 1. In addition to rearranging the statutory receivership priority scheme, the Agency proposes to refuse to pay valid securities fraud claims even those reduced to judgments by a federal court decree during conservatorship. Proposed 12 C.F.R (a),.13(a). The Agency attempts to justify that proposal as necessary to give effect to its revised priority scheme: The statutory receivership priority scheme, as implemented by [the Proposed Rule], provides that claims derived from ownership of an equity security of an Enterprise are sub- 19

44 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 21 of 29 FHFA August 25, 2010 ordinated to all other claims. If the Conservator were to authorize payment of Securities Litigation Claims despite the statutory receivership priority system ranking such claims below all other claims, the purpose of the receivership priority system could be thwarted Fed. Reg. at 39,468. For the reasons given above, however, FHFA s proposed effort to revise the receivership priority scheme is arbitrary, capricious, and contrary to law. FHFA cannot rely on an unlawful change to the receivership priorities to justify new rules for conservatorship. To the contrary, because the revisions to the receivership priorities are unlawful, FHFA s avowed effort to give those illegal priorities effect by limiting payments during conservatorship is necessarily unlawful as well. 2. Even apart from that fatal flaw, the proposed conservatorship provisions are contrary to the statute. Nothing in HERA authorizes FHFA, as conservator, to refuse to pay valid claims. The statute carefully enumerates FHFA s powers during conservatorship, including authority to operate the regulated entity with all the powers of the shareholders, the directors, and the officers of the regulated entity. 12 U.S.C. 4617(b)(2)(B), (D). But nowhere among those powers did Congress grant authority to disregard valid court judgments or other claims. As one author stated regarding the pre-2008 conservatorship provisions governing Fannie Mae and Freddie Mac, a conservator has [no] statutory authority to require creditors to exchange debt for equity or to accept only partial payment of their claims. Richard Scott Carnell, Handling the Failure of a Government-Sponsored Enterprise, 80 Wash. L. Rev. 565, 613 (2005). This conclusion follows from the terms of the conservator s authority: the statute granting the conservator the powers of the [regulated entity s] shareholders, directors, and officers and the absence of any statute specifically authorizing the conservator to restructure or impair creditors claims. Id. Thus, if a [regulated entity s] assets fall short of its liabilities, the conservator lacks statutory power to resolve the shortfall. Id. at Those observations are no less true following the 2008 amendments: FHFA still has authority to exercise powers of the [regulated entity s] shareholders, directors, and officers, but there still is no provision authorizing refusal to pay valid claims in conservatorship. The Agency discerns such authority in its duty to preserv[e] and conserv[e] the assets and property of the regulated entity. 75 Fed. Reg. at 39,468 (quoting 12 U.S.C. 4617(b)(2)(D)). But it cites no authority suggesting that this generic preserve and conserve power includes the prerogative of defying federal court judgments and other claims in conservatorship. Neither of the cases it cites is 20

45 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 22 of 29 FHFA August 25, 2010 supportive. In re Federal National Mortgage Association Securities, Derivative, & ERISA Litigation, 629 F. Supp. 2d 1 (D.D.C. 2009), did not concern nonpayment of claims at all, but rather merely affirmed the conservator s exclusive authority to prosecute derivative claims on behalf of the entity. See id. at 4 & n.4. And Gibralter Financial Corp. v. Federal Home Loan Bank Board, No. CV , 1990 WL (C.D. Cal. June 15, 1990), while recognizing a conservator s discretion over the precise timing of payments, reaffirmed that the conservator had to pay all valid credit obligations of the association. See id. at *5 & n.9 (quoting former 12 U.S.C. 1729(b)(1)(B)). That case thus refutes rather than supports the Agency s position. Simply put, if Congress had wanted to grant FHFA the extraordinary power to refuse to pay valid claims during conservatorship indeed, to defy court judgments the statute would say so. It does not. To the contrary, the very fact that Congress created a priority scheme for receivership, but not conservatorship, belies the Agency s theory that Congress intended it to pick and choose among creditors while an entity is merely in conservatorship. See 12 U.S.C. 4617(c)(1). If the Agency wishes to deny certain creditors payment on their valid debts, it must put the entity into receivership and then distribute assets according to the statutory priority scheme. It cannot simply invoke the statutory priority scheme for receivership (let alone its own unlawful revised receivership priority scheme) to deny payment on valid claims during a potentially lengthy conservatorship. 3. Other provisions of HERA make it clearer still that Congress did not grant FHFA as conservator unilateral authority to defy federal court judgments and other claims. For example, Section 4617(b)(11)(C) states that [n]o attachment or execution may issue by any court upon assets in the possession of the receiver... of a regulated entity for which the Agency has been appointed receiver. 12 U.S.C. 4617(b)(11)(C) (emphasis added). The provision thus suspends execution of court judgments during receivership. But there is no corresponding provision suspending execution during conservatorship. Given that omission, the Proposed Rule would be totally ineffectual: Even if the Agency refused to pay a securities fraud claim during conservatorship, the plaintiff could simply reduce his claim to judgment and then use the traditional means of execution to seize the entity s assets involuntarily. Nothing in HERA authorizes the Agency to suspend those means of execution during conservatorship means that are provided by other provisions of law over which FHFA has no authority. See, e.g., Fed. R. Civ. P. 69(a)(1). 21

46 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 23 of 29 FHFA August 25, 2010 The irrationality of that outcome proves that Congress did not intend to authorize the Agency to refuse payment of valid claims during conservatorship. Congress could not rationally have granted FHFA authority to deny payment while simultaneously preserving a creditor s right to execute on assets involuntarily. Indeed, the notion that Congress intended to allow FHFA to hold on to its funds in the face of valid creditor claims, while at the same time permitting creditors to seize those same funds out from under the Agency, borders on the absurd. The statute plainly contemplates that FHFA will continue to pay valid claims during conservatorship. Only once the entity enters receivership may the Agency refuse to pay claims, and even then, only according to the statutory priority scheme Congress enacted. 4. The Agency finally seeks support from the Preferred Stock Agreements that Fannie Mae and Freddie Mac executed to receive funding from the Treasury. 75 Fed. Reg. at 39, The HERA provision authorizing those agreements, however, makes no mention of securities fraud claims. See Pub. L. No , 1117, 122 Stat. 2654, 2683 (2008) (codified at 12 U.S.C. 1719(g)). The only statutory provision even arguably addressing priorities is one requiring the Secretary of the Treasury to take into consideration the need for preferences or priorities regarding payments to the Government in deciding whether to purchase securities. 12 U.S.C. 1719(g)(1)(C) (emphasis added). The Agency points out that the particular agreements it negotiated with the Treasury, allegedly pursuant to that statutory authority, exclude from the Treasury s funding obligation securities fraud claims that the Conservator determines shall be subordinated. 75 Fed. Reg. 39, (emphasis added) (citing Amended and Restated Senior Preferred Stock Purchase Agreement 1 (Sept. 26, 2008)). But that contract provision says nothing at all about the antecedent question of whether the conservator can or should subordinate such claims (let alone refuse to pay them during conservatorship). A contract between Treasury and FHFA cannot possibly give FHFA subordination authority that HERA withholds. And it is impossible to fathom how the particular terms of agreements that FHFA and Treasury negotiated after HERA s enactment shed any light on what authority Congress intended to confer when it passed that statute. The actual financial terms of those Treasury Agreements speak volumes about FHFA s lack of ability or inclination to operate the companies in the interests of fraud victims. As has recently been reported, Fannie Mae and Freddie Mac 22

47 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 24 of 29 FHFA August 25, 2010 are paying steep dividends to the government in return for the aid, and [t]he dividend rate, 10 percent, is far more than the companies would pay to raise money in the capital markets. Zachary A. Goldfarb, Freddie s Loss Narrows, But Firm Needs More Aid, Wash. Post, Aug. 10, 2010, at A14 (emphasis added). After the latest round of assistance, Freddie will be required to pay $6.4 billion in annual dividends to the government, an amount that exceeds the company s annual historical earnings in most periods. Id. Those dividends are forcing Fannie and Freddie to borrow money from the Treasury to repay taxpayers, creating a cycle of ever-increasing demands for government infusions of money and dividend payments. Id. FHFA s ongoing fleecing of the two enterprises to pay dividends to the government at 10% at a time when market rates are much less underscores the wisdom of Congress s decision not to grant the Agency authority to refuse to pay valid claims in conservatorship. IV. THE PROPOSED RULE IS UNCONSTITUTIONAL AND SHOULD BE REJECTED TO AVOID CONSTITUTIONAL DOUBT The Proposed Rule should also be rejected because it violates the Constitution, or at the very least raises substantial constitutional questions. Administrative agencies, no less than courts, have a duty to ensure that their actions comply with the Constitution. See Meredith Corp. v. FCC, 809 F.2d 863, (D.C. Cir. 1987). And it is settled law that, where an otherwise acceptable construction of a statute would raise serious constitutional problems, the statute must be construed to avoid such problems unless such construction is plainly contrary to the intent of Congress. Edward J. DeBartolo Corp., 485 U.S. at 575. Here, the Proposed Rule raises serious constitutional doubts in at least three respects: (1) it deprives securities fraud victims of their property in violation of the Fifth Amendment s Takings Clause; (2) it violates securities fraud victims Fifth Amendment due-process rights by retroactively changing the law; and (3) it violates separation-of-powers principles by granting an executive-branch officer authority to decide whether to honor judgments issued by Article III courts. 1. The Fifth Amendment s Takings Clause provides that private property shall not be taken for public use, without just compensation. U.S. Const. amend. V. The Proposed Rule would violate that provision by allowing the Agency to take securities fraud victims property rights in pending claims against a regulated entity in receivership while paying no compensation let alone just compensation for that taking. 23

48 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 25 of 29 FHFA August 25, 2010 Several courts have held that, for purposes of the Takings Clause, claims for compensation are property interests that cannot be taken for public use without compensation. In re Aircrash in Bali, Indonesia on April 22, 1974, 684 F.2d 1301, 1312 (9th Cir. 1982); see also Greyhound Food Mgmt., Inc. v. City of Dayton, 653 F. Supp. 1207, (S.D. Ohio 1986), aff d, 852 F.2d 866 (6th Cir. 1988); Edwardsen v. Morton, 369 F. Supp. 1359, 1379 (D.D.C. 1973); cf. Logan v. Zimmerman Brush Co., 455 U.S. 422, 428 (1982) (it is affirmatively settled that a cause of action is a species of property ); First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279, (Fed. Cir. 1999) (bank shareholder ha[d] a property interest in any eventual liquidation surplus following FDIC receivership sufficient to support standing for takings claim). Securities fraud claims filed against the regulated entities before those entities entered conservatorship are thus vested property interests protected by the Takings Clause. The Proposed Rule would take those interests without just compensation in violation of the Clause. As the Supreme Court made clear in Lucas v. South Carolina Coastal Council, 505 U.S (1992), it is a per se taking to deprive a property owner of all economically beneficial uses of its property. Id. at Subordinating securities litigation claims to the lowest priority in receivership would have precisely that effect here: If the regulated entities do not have sufficient assets to pay their creditors (such as the Treasury), relegating judgment creditors and other tort victims to the priority of stockholders is tantamount to expropriating their claims without any compensation at all. Even if no per se taking has occurred, a court may well conclude that the subordination of securities fraud claims in receivership or the indefinite refusal to pay such claims in conservatorship constitutes a taking under the balancing test of Penn Central Transportation Co. v. City of New York, 438 U.S. 104 (1978). Under Penn Central, a court looks to a variety of factors including [t]he economic impact of the regulation on the claimant, the extent to which the regulation has interfered with distinct investment-backed expectations, and the character of the governmental action. Id. at 124. Here, the economic impact of the Proposed Rule is devastating: The rule will eviscerate the ability of millions of defrauded tort victims to obtain meaningful redress. Moreover, investors purchased Fannie Mae stock based on the reasonable investment-backed expectation that they were not being defrauded, and the Proposed Rule would undermine their ability to seek 24

49 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 26 of 29 FHFA August 25, 2010 satisfaction for the frustration of that expectation. Finally, the character of the government action supports finding a taking here because the Proposed Rule forc[es] [fraud victims] alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole. Lingle v. Chevron U.S.A. Inc., 544 U.S. 528, 537 (2005) (quotation marks omitted). At the very least, those burdens should be borne pro rata by all the regulated entities unsecured creditors, as they have been in bank receiverships for decades, without singling out one disfavored class of tort victims for discriminatory treatment. 2. The Proposed Rule also violates due process restrictions on retroactive legislation. The Fifth Amendment s Due Process Clause provides that [n]o person shall... be deprived of life, liberty, or property without due process of law. U.S. Const. amend. V. Due process concerns are particularly acute when a statute operates retroactively. Government action operates retroactively if it changes the legal consequences of acts completed before its effective date, Miller v. Florida, 482 U.S. 423, 430 (1987) (quotation marks omitted), or attaches new legal consequences to events completed before the law takes effect, Landgraf v. USI Film Products, 511 U.S. 244, 270 (1994). Retroactivity is not favored in the law, Bowen, 488 U.S. at 208, because it can deprive citizens of legitimate expectations and upset settled transactions, General Motors Corp. v. Romein, 503 U.S. 181, 191 (1992). As a result, the Supreme Court has given careful consideration to due process challenges to legislation with retroactive effects. E. Enters. v. Apfel, 524 U.S. 498, 547 (1998) (Kennedy, J., concurring in judgment). The Proposed Rule violates those principles by attempting to eliminate fraud victims already-accrued causes of action, including claims that accrued before HERA s enactment. The Proposed Rule would retroactively deprive fraud victims of their legitimate expectation that tort law would provide compensation for fraud based on accrued causes of action. Several courts have held that, where government action upsets such expectations, due process provides protection. See, e.g., Bourgeois v. A.P. Green Indus., Inc., 783 So. 2d 1251, 1259 (La. 2001) ( Plaintiffs contend retroactive application of Act 989 to their claims would contravene due process guarantees by divesting them of their vested rights in their causes of action which accrued prior to the effective date of the Act. We agree. ); Resolution Trust Corp. v. Fleischer, 892 P.2d 497, (Kan. 1995) (retroactive legislation affecting accrued causes of action constitutes violation of state-law due process clause). Due process violations are especially likely to be found where, as here, retroactive legislation does not merely impair a party s expectations but strips 25

50 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 27 of 29 FHFA August 25, 2010 away a remedy completely. Cf. Crane v. Hahlo, 258 U.S. 142, 147 (1922) ( No one has a vested right in any given mode of procedure and so long as a substantial and efficient remedy remains or is provided due process of law is not denied by a legislative change. (emphasis added)). Because the Proposed Rule violates those restrictions on retroactive lawmaking, it also violates the Due Process Clause. 3. Finally, the Proposed Rule disregards fundamental separation-ofpowers principles. It is a longstanding principle, dating back to the Nation s founding, that Congress cannot vest review of the decisions of Article III courts in officials of the Executive Branch. Plaut v. Spendthrift Farm, Inc., 514 U.S. 211, 218 (1995) (citing Hayburn s Case, 2 U.S. 408 (1792)). The firm and unvarying practice of federal courts has been to render no judgments... that are subject to later review or alteration by administrative action. Chicago & S. Air Lines, Inc. v. Waterman S.S. Corp., 333 U.S. 103, 113 (1948). The Proposed Rule purports to establish precisely that arrangement by vesting FHFA s Director with discretion either to satisfy or to repudiate federal court judgments. Under the Proposed Rule, [t]he Agency, as conservator, will not pay a Securities Litigation Claim against a regulated entity, except to the extent the Director determines is in the interest of the conservatorship. Proposed 12 C.F.R (a) (emphasis added). The Director likewise has broad discretion to determine whether to authorize the capital distribution necessary to effect payment, subject to specified criteria. Proposed 12 C.F.R , (3). Securities Litigation Claims are defined to include claims whether or not reduced to judgment. Proposed 12 C.F.R The Proposed Rule thus gives the Agency s Director an executive official sole discretion to determine whether judgments of Article III courts will be given effect. The Director s decision not to pay a claim in conservatorship would be tantamount to reversal of the court s judgment, particularly given the Proposed Rule s relegation of such claims to the lowest priority in receivership and the almost certainty that Fannie Mae will not have sufficient assets to pay the lowest priority claims if put into receivership. That is precisely the sort of authority the Constitution prohibits Congress from vesting in an executive officer and, a fortiori, prohibits an executive officer from arrogating to himself. 4. The foregoing constitutional infirmities also foreclose the Agency s Proposed Rule under the doctrine of constitutional avoidance. Clearly, there is an otherwise acceptable construction of the statute here that would avoid the 26

51 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 28 of 29 FHFA August 25, 2010 constitutional doubt. Edward J. DeBartolo, 485 U.S. at 575. The Agency need only follow the statute s plain terms. Consequently, the statute must be construed to avoid such problems. Id. A reviewing court will not allow the Agency to adopt an expansive construction of its authority under the statute that needlessly raises significant constitutional concerns when an alternative construction that raises no such concerns is clearly possible. For that reason too, the Proposed Rule s reconfiguration of the statutory priority scheme and authorization of nonpayment during conservatorship must be rejected. V. CONCLUSION FHFA s current rulemaking proceeding is not an ordinary fill in the gaps exercise. It is a transparent attempt to avoid payment of legitimate securities fraud claims against Fannie Mae, which accrued prior to HERA s enactment, by revising the statutory receivership priority scheme that Congress enacted in HERA. FHFA then uses that unlawful change to receivership priorities as a reason for corresponding changes to the payment regime in conservatorship. Both changes disregard decades of precedent and authority evidencing Congress s contrary intent. FHFA simply does not have power under current law to promulgate rules that relegate securities litigation claims to the lowest level of priority in receivership and allow the Director to refuse payment of claims even court-approved judgments in conservatorship. Overwhelming authority refutes FHFA s claimed power to subordinate securities fraud claims. That same authority also explains convincingly why FHFA s contrary construction is not just unlawful, but also bad and inequitable policy. The Proposed Rule would discourage the private securities fraud suits that have long played an instrumental role in enforcement of the Nation s securities laws. And it would deny recovery to innocent investors who, while accepting the risk of business failure, never accepted the risk of fraud and misrepresentation. Millions of public service pensioners throughout the 50 States, and the many other victims of fraud, should not be denied their just compensation. Those investors were substantially harmed by the regulated entities wrongful conduct, and they are entitled to their day in court and to have any resulting judgments paid along with other creditor claims. 27

52 Case 1:11-cv RJL Document 1-2 Filed 08/26/11 Page 29 of 29

53 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 1 of 9 EXHIBIT C

54 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 2 of 9 "TAITE, SCHNEIDER, BAYLESS & CHESLEY CO., L.P.A. STA~LEYM. CHESLEY WAI'l'E. SCIINEIDEH. BAYLESS & CHESLIi.:Y CO. L.I'.A. O~E WES'I' FOUWI'H STREET' CI:-':CI~:"'NrI.OHIO '1': :i h7 F: :il: h2 STAXC",,;sLEYrQ1WSBC I.AW.CO:\[ l\iorton ROSENBERG. LITIGATION CONSULTANT 33 Elon Overlook Rockville, MD T: September 7, 2010 Mr. Alfred M. Pollard General Counsel Attention: Comments/RIN 2590-AA23 Federal Housing Finance Agency Fourth Floor 1700 G Street, N.W. Washington, D.C Re: Proposed Rule Regarding Conservatorship and Receivership 75 Fed. Reg. 39,462 (July 9,2010); RIN 2590-AA23 Dear Mr. Pollard: On behalf of Lead Plaintiffs Ohio Public Employees Retirement System and State Teachers Retirement System of Ohio and the Class in the currently pending federal securities fraud class action against Fannie Mae, Franklin Raines, Timothy Howard, and Leanne Spencer (In re Fannie Mae Securities Litigation, Consolidated Case No. 04-cv-1639 (D.D.C.)), we submit the following further comments and objections to the Rule proposed by the Federal Housing Finance Agency (FHFA) regarding Conservatorship and Receivership, 75 Fed. Reg. 39,462, RIN 2590-AA23 (the "Proposed Rule"), to supplement our comments filed on August 25, We submit these comments to emphasize another defect: Any final rule would be invalid for lack of a validly appointed officer heading FHFA. The issuance of binding regulations with the force and effect of law is one of the core functions of the Executive Branch. Neither the Constitution nor the

55 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 3 of 9 FHFA September 7, 2010 relevant statutes permits the issuance of such regulations where, as here, the agency lacks a properly appointed federal officer as its head. ANY FINAL RULE WOULD BE INVALID BECAUSE FHFA DOES NOT HAVE A PROPERLY APPOINTED FEDERAL OFFICER AS ITS HEAD The Proposed Rule should be rejected because FHFA, lacking the validly appointed principal officer that the Appointments Clause of the U.S. Constitution requires, cannot issue regulations that have the force and effect of law. The Appointments Clause, one of "the significant structural safeguards of the constitutional scheme," Edmond v. United States, 520 U.S. 651, 659 (1997), provides as follows: [The President] shall nominate, and by and with the Advice and Consent of the Senate, shall appoint... all... Officers ofthe United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments. U.S. Const. art. II, 2, cl. 2. As the Supreme Court has explained, "any appointee exercising significant authority pursuant to the laws of the United States is an 'Officer of the United States,' and must, therefore, be appointed in the manner prescribed by 2, cl. 2. ofthat Article." Buckley v. Valeo, 424 U.S. I, 126 (1976) (per curiam) (emphasis added). A. FHFA-an independent agency, 12 U.S.C (a)-is supposed to have as its head a Director that is "appointed by the President, by and with the advice and consent of the Senate." Id. 4512(b)(1). The Director serves for five years, subject only to for-cause removal by the President. Id. 4512(b)(2). Those statutory provisions were designed to be consistent with the constitutional requirement quoted above. The Appointments Clause requires all "Officers of the United States" to be appointed "by and with the Advice and Consent of the Senate." There is an exception for "inferior Officers," who may be appointed by the President, the courts, or the Heads of Departments. But, as the Supreme Court explained in Edmond v. United States, 520 U.S. 651, (1997), "[w]hether one is an 'inferior' officer depends on whether he has a superior"-"'inferior 2

56 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 4 of 9 FHFA September 7, officers' are officers whose work is directed and supervised at some level" by other officers appointed by the President with the Senate's consent. Here, the Director's work is not "directed and supervised" by any other officer. To the contrary, the Director answers only to the President himself. As a result, under the Appointments Clause, the Director must be appointed by the President and confirmed by the Senate. That constitutional requirement has not been met. FHFA does not have a Senate-confirmed Director. Rather, "[o]n August 25, 2009 President Obama designated Edward J. DeMarco the Acting Director of the Federal Housing Finance Agency (FHFA),... effective September 1, 2009." FHFA, Meet the Director, DeMarco thus has served as Acting Director for over a year. No nomination for FHFA Director has been submitted to the Senate for confirmation. B. FHFA's statute allows the President to "designate" an Acting Director. 12 U.S.C. 4512(f). Even if that provision was properly invoked here, it cannot justify Mr. DeMarco's extended tenure. Courts have allowed an exception to the Appointments Clause's requirements to permit the President to appoint an acting official to serve in the role ofprincipal officer temporarily so that the government can operate continuously pending the appointment and confirmation of the principal officer. But, consistent with the purposes of that judicially recognized exception, the President does not have unfettered ability to appoint temporary officers for extended periods of time. To the contrary, such temporary "acting" appointments can last only a reasonable period of time-a period that has long since passed in this case. 1. Courts have regularly recognized that "acting" agency heads CalIDot serve indefinitely but rather may serve only a reasonable period in view of the circumstances justifying the absence of a permanent head. For example, in Williams v. Phillips, 360 F. Supp (D.D.C. 1970), the district court enjoined the Acting Director of the Office of Economic Opportunity from taking any future action because he served in that position illegally. The court held that, "[w]hatever the merits of the argument finding an interim appointment power in the President may be,... that power, if it exists at all, exists only in emergency situations." Id. at The court stated that "a Presidential power to appoint officers temporarily in the face of statutes requiring their appointment to be confirmed by the Senate... would avoid the nomination and confirmation process of officers in its entirety." Id. On appeal, the D.C. Circuit denied the government's motion for 3

57 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 5 of 9 FHFA September 7, 2010 stay. 482 F.2d 669 (D.C. Cif. 1973) (per curiam). Citing the Appointments Clause, the court concluded that the government had failed to show "sufficient likelihood ofsuccess on the merits to warrant a stay." ld. at 670. The court stated that, "[e]ven if the court should sustain" the view that the President had an implied power to appoint an acting director for a reasonable time period, "that would not establish that the President was entitled, for a period of four and a half months from the date the President obtained the resignation of the incumbent director, to continue the designation of Phillips as acting director without any nomination submitted for Senate consideration." ld. at Other cases likewise recognize that the Appointments Clause's express requirement-that principal officers be nominated to their position by the President and confirmed by the Senate-eannot be evaded by appointing an "acting" agency head for an indefinite period. In Olympic Federal Savings & Loan Ass 'n v. Director, Office of Thrift Supervision, 732 F. Supp (D.D.C. 1990), appeal dismissed as moot, 903 F.2d 837 (D.C. Cir. 1990), the court granted the plaintiffs "motion for a preliminary injunction prohibiting the Acting Director ofots or any officer at OTS from appointing a receiver or conservator for [the plaintiff] until a new Director of OTS ha[d] been nominated by the President and confirmed by the Senate." ld. at I 187. Citing the D.C. Circuit's decision in Williams, the court concluded that, "if the President has any inherent authority to appoint temporary officers, his authority is limited." Id. at The President had no such authority in that case, in part because "the government ha[d] not argued that any emergency existed beyond the general emergency which exists whenever a regulatory body charged with important functions is left without its primary officer." Id. at The court thus concluded that there was a "strong likelihood" that the plaintiff would "succeed on the merits ofits Appointments Clause challenge." [d. at The Executive Branch likewise has recognized that a temporary principal officer, designated to head an agency without Senate confirmation, can exercise that power only for a limited, reasonable period, pending confirmation of a permanent head. For example, the Office of Legal Counsel has concluded that, even though the Deputy Director of OMB is confirmed by the Senate, he may not later serve as Acting Director "indefinitely," even when "there is no express statutory limit on the length of such tenure." Status ofthe Acting Director, Office ofmanagement and Budget, lop. Off. Legal Counsel 287, (1977). The Office of Legal Counsel concluded that a three-month period as Acting Director was "reasonable" and thus permissible under the circumstances. ld. at 290. Those circumstances included the fact that the Senate had already adjourned, so "it would 4

58 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 6 of 9 FHFA September 7, 2010 clearly be reasonable for the President to wait until the Senate reconvene[d]" one month later before sending a nomination to the Senate. Id.; see also Designation of Acting Director ofthe Office ofmanagement and Budget, 2003 WL , at *4 n.2 (O.L.C. June 12, 2003). One year later, the Office of Legal Counsel again recognized that temporary designees may serve as "acting" agency heads, without Senate confilmation, only for a reasonable period of time. See Department of Energy-Appointment of Interim Officers-Department ofenergy Organization Act (42 U.S.c. 7342), 2 Op. Off. Legal Counsel 405 (1978). That opinion concluded that (1) nvo temporary appointments that collectively spanned nine months (from September 1977 to at least May 1978) were "reasonable" because "[t]heir extended acting service [was] due exclusively to delay in the confirmation process"; and (2) tv. o other temporary appointments from the same time period were reasonable even though the nominations were not submitted to the Senate until January 1978 because of the "difficulty of finding suitable candidates for the complex and responsible positions in the Department of Energy," the "uncertainties created by delays in the enactment of the pending energy legislation," and a one-month period when the Senate was in recess. Id. at In 1996, the Office of Legal Counsel conducted a thorough review of Appointments Clause issues and again confirmed that, where the President designates an "acting" agency head to serve without Senate confirmation, such an officer can serve only for a reasonable period given the circumstances. Noting the importance of a pending nomination, the Office stated that it "would not currently view a four-and-a-half-month temporary appointment as necessarily exceeding a reasonable duration, provided that a nomination is submitted to the Senate." The Constitutional Separation ofpowers Between the President and Congress, 20 Op. Off. Legal Counsel 124,163 (1996) (emphasis added). Those decisions make clear that Mr. DeMarco's tenure as "acting" Director crosses the constitutional line. If the President could not, consistent with the Appointments Clause, appoint an acting director and continue that designation "for four and a half months" from the "resignation of the incumbent director" in Williams, the President certainly cannot appoint Mr. DeMarco and continue his designation here for more than a year following his putative predecessor's resignation. If four and a half months was permissible in OLC's view "provided that a nomination is submitted to the Senate," then Mr. DeMarco cannot serve for more than three times that time with no nomination on the horizon. Indeed, Mr. 5

59 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 7 of 9 FHFA September 7, 2010 DeMarco's tenure exceeds even the nine months OLC (grudgingly) deemed permissible where the pennanent agency heads were tied up in the nomination process, and statutory reforms made finding replacements difficult. To the contrary, no permanent head has been nominated for more than a year, and no compelling circumstances for that inordinate delay are apparent. 3. Congress itself has recognized that temporary appointments of "acting" principal officers must be just that-temporary. In determining how long an acting officer may be in place, i.e., what constitutes a "reasonable" period, courts have sometimes sought guidance in statutes that authorize time-limited, acting appointments. In Williams, 482 F.2d at 671, for example, the D.C. Circuit concluded that a reasonable time period for a temporary appointment would be 30 days, consistent with the then-limitation in the Vacancies Act, 5 U.S.C (1970). Even if reasonableness were tied to the current limitation in the Vacancies Act, the pennissible period would be 210 days, 5 U.S.C. 3346(a)(l)-a period that lapsed more than 150 days ago. It is difficult to imagine what kind of "emergency" would justify evading the Appointments Clause for over a year, much less doing so without so much as presenting a permanent successor to the Senate for confinnation. C. Any Final Rule would also violate the Appointments Clause for a second reason-it is inconsistent with FHFA's organic statute in multiple ways. 1. First, Mr. DeMarco's extended tenure is contrary to the statute's structure. Congress designated FHFA to be an independent agency; it accomplished that goal by making FHFA's head-the Director-removable only for cause. See 12 U.S.C (a)-(b). Currently, however, an Acting Director, who is removable at will, has headed FHFA for over a year. That is wholly at odds with Congress's effort to establish an independent agency headed by an officer subject only to for-cause removal. And allowing an Acting Director to serve for over a year undennines Congress's authority in yet another way. The Constitution and the statute establishing FHFA both give the Senate an important role in the selection of the principal officer who heads FHFA-such an officer, after being selected by the President, must be confinned by the Senate. Allowing an Acting Director, whom the Senate never confirmed as agency head, to run FHFA indefinitely deprives the Senate of the authority over agency-head selection-i.e., to confirm or not-that the Appointments Clause and the statute afford it. 6

60 Case 1:11-cv RJL Document 1-3 Filed 08/26/11 Page 8 of 9 FHFA September 7, Second, the appointment of the current Acting Director is not authorized by the terms of the statute. In appointing the current Acting Director, the President invoked 12 U.S.C. 4512(f). That provision states: "In the event of the death, resignation, sickness, or absence of the Director, the President shall designate either the Deputy Director of the Division of Enterprise Regulation, the Deputy Director of the Division of Federal Home Loan Bank Regulation, or the Deputy Director for Housing Mission and Goals, to serve as acting Director until the return of the Director, or the appointment of a successor pursuant to subsection (b)." 12 U.S.C. 4512(f) (emphasis added). That provision by its terms requires first that there be a lawfully appointed FHFA Director (i.e., one appointed by the President and confirmed by the Senate pursuant to Section 4512(b)(1 )-(2)). Then, in the event of the "death, resignation, sickness, or absence of the Director," a temporary Acting Director may be appointed. Id. 4512(f). In other words, the appointment of an Acting Director is permissible only after there has been a validly appointed Director. The statute permits an Acting Director to be appointed where the Director becomes unable to fulfill his duties-not where no validly appointed Director has ever been in place at all. Cf Olympic, 732 F. Supp. at (similar conclusion under the Vacancies Act). Here, FHFA has never had a properly appointed principal-officer Director as its head. The first official to run the agency, who preceded the current Acting Director, obtained his position pursuant to 12 U.S.C. 4512(b)(5), which designated "the person serving as the Director of the Office of Federal Housing Enterprise Oversight of the Department of Housing and Urban Development" as the first FHFA Director. That designation inadvertently crossed constitutional boundaries because the legislature cannot, by statute, appoint a principal officer to a new position. Instead, principal officers such as the initial FHFA Director must be appointed through presidential nomination and Senate confirnlation. See Olympic Federal, 732 F. Supp. at I 19 I -93. As the D.C. District Court observed in invalidating a similar effort, a contrary rule would allow Congress to "exercise[] the kind of decisionmaking about who will serve in the Executive department posts that the Constitution says it cannot." Id. at Since the first Director "required re-nomination and re-confirmation before he could constitutionally take office as [FHFA] director," that Director "never constitutionally took office." Id. As Olympic Federal recognizes, the absence of a validly appointed initial director precludes the exercise of statutory authority to appoint an "acting" official as his successor. Id. at Congress limited the authority to appoint an Acting Director to the circumstances where there previously had been a validly appointed Director in office. That congressional limit must be respected. 7