Judge Moves Forward Fannie Mae Stock Drop Suit

October 23, 2012 (PLANSPONSOR.com) – A federal judge has determined participants in the Federal National Mortgage Association’s (FNMA) Employee Stock Ownership Plan (ESOP) can move forward with a lawsuit concerning company stock investments.

U.S. District Judge Paul A. Crotty of the U.S. District Court for the Southern District of New York said the plaintiffs plausibly alleged that defendants named in the lawsuit knew both the causes of the price drop of FNMA stock and the reasons it was imprudent to retain the plan’s investment in FNMA stock. The plaintiffs argued that the defendants knew or should have known of external warnings indicating dire circumstances, including: the growing rate of foreclosures as reported by FNMA itself; concerns about the viability of the housing market; regulators’ concerns about lessened underwriting standards; claims that the housing bubble had “burst” and there would be further deterioration; and commentary regarding the prudence of FNMA’s increasing participation in the subprime market.   

The plaintiffs also alleged FNMA’s risk control officers issued internal warnings. Crotty found that the defendants knew of FNMA’s publicly disclosed deteriorating financial condition. FNMA itself was disclosing facts pertinent to the market-wide decline. Defendants also must have been aware of the decline in the value of the plan’s assets, which fell from approximately $116 million to $85 million in 2007 and dropped to $17.5 million by April 2008. By December 31, 2008, the plan’s assets were valued at approximately $1.29 million.   

The benefit plan committee defendants argued that they cannot be found liable for a breach of their duty of prudence because divesting the plan’s assets of FNMA’s stock would involve trading on insider information; alternatively, disclosure of non-public information before divesting would have caused the very decline in stock price that plaintiffs sought to avoid. Crotty noted that this argument has been “regularly rejected … as a justification for avoiding fiduciary duties under ERISA.” Citing a previous court ruling, Crotty said defendants could have “taken a variety of steps that would not have been violations of the securities laws, including independently evaluating the prudence of the maintenance of the [company] stock fund as an investment option under the plans, ceasing new investments in the [company] stock fund, questioning the valuation of in-kind stock contributions to the plans, [or] considering whether public disclosure of material information would have been in the best interests of the plans’ participants … .”  

Crotty denied FNMA’s motion to dismiss the suit; however, he did dismiss claims against director defendants who became board members after FNMA was place into conservatorship.  

The opinion in In Re Fannie Mae 2008 ERISA Litigation is here.