Fannie Mae, Freddie Mac, and Due-Diligence Failures: Should Comparative Responsibility Be Imposed on a Government-Sponsored Entity's Claims Brought Under Sections 11(a) and 12(a)(2) of the Securities Act of 1933?

• Author: Alexander S. Bonander
• Position: J.D. Candidate, The University of Iowa College of Law, 2013
• Pages: 835-862

835

Fannie Mae, Freddie Mac, and Due-

Diligence Failures: Should Comparative

Responsibility Be Imposed on a

Government-Sponsored Entity’s Claims

Brought Under Sections 11(a) and

12(a)(2) of the Securities Act of 1933?

Alexander S. Bonander

ABSTRACT: In the lead up to the 2008 financial crisis, Fannie Mae and

Freddie Mac lowered their underwriting and due-diligence standards for

qualifying mortgages and mortgage-backed securities. Currently, the Federal

Housing Finance Agency, their conservator, has filed claims under sections

11(a) and 12(a)(2) of the Securities Act of 1933 against many of the

nation’s largest banks. The Federal Housing Finance Agency claims that a

material misrepresentation or omission occurred in the registration

statements and prospectuses of securities purchased by Fannie Mae and

Freddie Mac. Under current law, the security issuer will be held to strict

liability and those parties associated with the registration statements and

prospectuses will be held to near-strict liability. This Note argues that a

comparative-responsibility standard—due to Fannie Mae’s and Freddie

Mac’s unique status as government-sponsored entities—should be applied

when allocating responsibility for errors under sections 11(a) and 12(a)(2).

I. THE FEDERAL HOUSING FINANCE AGENCY SUES THE NATION’S

LARGEST BANKS ..................................................................................... 837

II. GROWTH OF THE RESIDENTIAL-MORTGAGE INDUSTRY .......................... 839

A. HOME MORTGAGE LENDING ENVIRONMENT FROM 2000 TO 2006 ..... 839

B. SECURITIZATION AND THE ORIGINATE-TO-DISTRIBUTE MODEL ........... 841

C. FANNIE MAE AND FREDDIE MAC AND THEIR ROLE IN THE CRISIS ........ 842

 J.D. Candidate, The University of Iowa College of Law, 2013; B.A., Luther College,

2009. I would like to thank the editors and writers of Volumes 97 and 98 of the Iowa Law Review

for their work. I would also like to thank my parents for their continued support.

836 IOWA LAW REVIEW [Vol. 98:835

III. FANNIE’S AND FREDDIE’S SUBPRIME COURSE OF CONDUCT .................. 844

A. REGULATORY AND EXECUTIVE PRESSURE CONFRONTING FANNIE AND

FREDDIE ........................................................................................... 845

B. CONGRESSIONAL PRESSURE CONFRONTING FANNIE AND FREDDIE ........ 849

C. PRIVATE INDUSTRY AND SHAREHOLDER PRESSURE CONFRONTING

FANNIE AND FREDDIE ........................................................................ 851

D. SECURITIES AND EXCHANGE COMMISSION LITIGATION ....................... 853

IV. SECTIONS 11(a) AND 12(a)(2) OF THE SECURITIES ACT OF 1933 ........ 854

A. RELEVANT PROVISIONS OF SECTIONS 11(a) AND 12(a)(2) .................. 854

B. INADEQUACY OF ISSUER-ONLY STRICT LIABILITY ................................ 856

V. A NEW WAY FORWARD: COMPARATIVE RESPONSIBILITY......................... 857

A. COMPARATIVE RESPONSIBILITY: AN EQUITABLE ALLOCATION OF

LIABILITY ........................................................................................ 858

B. COMPARATIVE RESPONSIBILITY: A CHECK ON GSES ........................... 859

1. Reduction of Systemic Market-Failure Risks ........................ 859

2. Promotion of Robust Mortgage-Underwriting Standards ... 860

3. Promotion of Investment Due Diligence ............................. 861

VI. CONCLUSION ......................................................................................... 861