Withdraw and Correct the Error of Thy Ways: The Perry Capital Opinion
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In my previous two posts on Forbes.com, found here and here, I have attacked for a variety of reasons the recent memorandum opinion of Judge Royce Lamberth in Perry Capital LLC v. Lew, which he issued before discovery and without hearing oral arguments from either. In this post, still writing as a consultant for several institutional investors, I refer to those statutory provisions that Judge Lamberth (the Perry Capital opinion) either ignored or misconstrued. In my judgment, these errors of omission and misinterpretation, when joined with the mistakes I referred to in the earlier posts, are so serious and one-sided, that he should withdraw his decision, in order to reconsider this position.
More specifically, the Perry Capital opinion plays fast and loose with the statutory framework of the 2008 Housing and Economic Recovery Act (HERA) in ways that paint a totally false picture of its treatment of three key points. First the opinion seriously misstates the rights and duties of the Federal Housing Finance Agency (FHFA) as a conservator. Second, it seriously misstates the authority of Treasury under HERA. Third, he refuses to allow any evidence on the possible collusion between FHFA and Treasury in fashioning the Third Amendment.
First, let’s examine FHFA’s rights and duties. In his opinion, Judge Lamberth quotes 12 U.S.C. § 4617(a)(2), which provides “[FHFA] may, at the discretion of the Director, be appointed conservator or receiver for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated entity.” His implication is that both conservators and receivers have all the powers listed in this section. But he fails to quote the provision that deals exclusively with the duties of FHFA as conservator:
12 U.S.C. 4617(b)(2) (D) Powers as conservator
The Agency may, as conservator, take such action as may be—
(i) necessary to put the regulated entity in a sound and solvent condition; and
(ii) appropriate to crry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.
Note that this last provision does not refer to any ability of the conservator to “wind up” the operations, which is a power given exclusively to a receiver. Nor does it contemplate in the slightest, as Judge Lamberth suggests in footnote 20 any “fluid progression” that allows FHFA secretly to morph itself from a conservator to a receiver, without going through any formal process to work that change. It is wholly incorrect for him to write “FHFA can lawfully take steps to maintain operational soundness and solvency, conserving the assets of the GSEs, until it decides that the time is right for liquidation. See 12 U.S.C. § 4617(b)(2)(D) (“[p]owers as conservator”).” The cited section, quoted in full above, negates that fanciful suggestion. That conclusion is reinforced by 12 U.S.C. § 4617(b)(2)(E), immediately following, which addresses separately the “additional powers as receiver” to organize a liquidation of assets. The choice of form matters. The FHFA needs to initiate a formal proceeding to make the shift from one role to the other, which it has never attempted.
Second, Treasury’s authority under HERA. Indeed, the stringent limits on FHFA referred to above fit into the parallel limitations that HERA imposes on Treasury. In footnote three the Perry Capital opinion has this to say about the key provisions in HERA:
The purpose of HERA’s provision authorizing Treasury to invest in the GSEs was, in part, to “prevent disruptions in the availability of mortgage finance”—disruptions presumably due to the challenges confronting the GSEs in 2008. See 12 U.S.C. § 1455(l)(1)(B); 12 U.S.C. § 1719(g)(1)(B) (“Emergency determination required[.] In connection with any use of this [purchasing] authority, the [Treasury] Secretary must determine that such actions are necessary to—(i) provide stability to the financial markets; (ii) prevent disruptions in the availability of mortgage finance; and (iii) protect the taxpayer.”
The passage is accurate insofar as it goes, but it does not go far enough, because it ignores the sections just before and just after it. Thus Judge Lamberth does not deal with 12 U.S.C. § 1719(g)(1)(A), which makes it clear that any bailout requires the “mutual agreement between the parties,” such that the Secretary cannot unilaterally impose a deal. Similarly he ignores 12 U.S.C. § 1719(g)(1)(C), which lists among the relevant considerations “[t]he corporation’s plan for the orderly resumption of private market funding or capital market access,” and further “[t]he need to maintain the corporation’s status as a private shareholder-owned company. The Third Amendment, which precludes any return to the private market, is flatly inconsistent with these provisions. Nor does he mention that there is not one single reference to a receiver or receivership in this entire section of HERA that deals with Treasury’s powers. Any modification of the initial 2009 deal to impose a receivership is beyond the powers of Treasury. The same fate should await the de facto liquidation under the Third Amendment.
Third, Treasury’s oversight of FHFA. The Perry Capital opinion does quote section 4617, (a)(1)(7) which notes that when acting “When acting as conservator or receiver, the Agency shall not be subject to the direction or supervision of any other agency of the United States or any State in the exercise of the rights, powers, and privileges of the Agency.” That provision appears to preclude FHFA from taking directions from Treasury as the plaintiffs alleged. Nonetheless, this section is dismissed in the opinion as irrelevant because of defect in the plaintiff’s pleadings.
However, “records” showing that Treasury “invented the net-worth sweep concept with no input from FHFA” do not come close to a reasonable inference that “FHFA considered itself bound to do whatever Treasury ordered. The plaintiffs cannot transform subjective, conclusory allegations into objective facts.
The Perry Capital opinion appears to concede indirectly that the Treasury came up with this idea on its own but, nonetheless, dismisses the plaintiff’s contention as “conclusory allegations.” It is at this point, that the procedural posture of the claim matters. At no point, did Judge Lamberth allow for any discovery to establish the nature of that connection. That seems wrong. And, at no point does the opinion make reference to the Jeffrey Goldstein memo of December 20, 2010, reported by Gretchen Morgenson of the New York Times, with its bald assertion that “’the administration’s commitment to ensure existing common equity holders will not have access to any positive earnings from the G.S.E.’s in the future.” Nor has anyone proffered any independent work by FHFA preparatory to the Third Amendment that might bear on the supervision issue. Judge Lamberth should have surely allowed for discovery on this key issue, which he refused to do.
I regard these deficiencies as incurable, and Judge Lamberth should rethink this opinion. He already senses the uneasiness of the situation when he writes:
It is understandable for the Third Amendment, which sweeps nearly all GSE profits to Treasury, to raise eyebrows, or even engender a feeling of discomfort. But any sense of unease over the defendants’ conduct is not enough to overcome the plain meaning of HERA’s text.
Judge Lamberth’s decision flunks his own test. It is not possible to show fidelity to HERA’s text by ignoring or misreading its most salient provisions. If Judge Lamberth does not reconsider his opinion, the Court of Appeal should instruct him to do so in no uncertain terms. And in the interim, Judge Margaret Sweeney should continue with her discovery on all disputed questions of fact until the full record comes out.
Richard A. Epstein is the Laurence A. Tisch professor of Law at NYU, senior fellow at the Hoover Institution, and senior lecturer at the University of Chicago Law School.