Last Friday, Judge Crotty denied the attempt of three former Fannie Mae executives to dismiss the SEC’s charges that they mislead investors about the company’s exposure to subprime mortgages. Judge Crotty found that the SEC had adequately alleged that Fannie Mae’s “quantitative subprime disclosures were misleading” because “they failed to include all loans that fell within [Fannie Mae’s] subprime and Alt-A description.” In allowing the SEC’s civil fraud suit to proceed, Judge Crotty rejected the defendants’ argument that they were exempt from liability because the Securities Exchange Act of 1934 does not apply to employees of any “independent establishment of the United States,” and Fannie Mae, as a government-sponsored enterprise chartered by the federal government, qualifies as such an establishment. Although Judge Crotty held that Fannie Mae is a government instrumentality, he concluded that it is not an “independent establishment” within the meaning of the Act given that it is a publicly-traded corporation managed and controlled by a Board of Directors elected by its shareholders.
The defendants had also argued that Fannie Mae’s elaborate disclosure process and public discussions about its loan programs undermined and were inconsistent with the SEC’s allegations they acted intentionally to mislead investors about the company’s subprime exposure. But Judge Crotty found that this argument, which raised factual issues, was premature at this stage of the litigation. Judge Crotty also refused to dismiss the SEC’s claim under Section 17(a)(2) of the Securities Act of 1933, adopting Judge Rakoff’s expansive interpretation of the statute from the Stoker case, which we blogged about here. Judge Crotty, like Judge Rakoff, held that to state a claim under Section 17(a)(2), it is sufficient to allege either that the defendant directly “obtained money or property for his employer while acting as its agent,” or, alternatively, that the defendant “personally obtained money indirectly from the fraud.” As Alison Frankel of Reuters has pointed out, this expansive interpretation has the potential to “sweep in every employee who participated in a money-making fraud, without regard for their personal profit motive.”