WASHINGTON (Legal Newsline) - Federal National Mortgage Association shareholders whose fraud suit anticipated the national financial collapse by four years don't buy the government's claim that "Fannie Mae" can never pay them back.

On Oct. 21, Ohio attorney general Mike DeWine argued in federal court that a poverty plea from Fannie Mae conservators ignores suits they filed against 18 banks.

DeWine, who leads a class action on behalf of public employee pension funds and other investors, opposed a stay that conservators requested on Oct. 7.

He wrote that they seek $196 billion in suits at federal court in New York City, dwarfing the $106 billion that Fannie Mae owes U.S. taxpayers.

"These lawsuits make it possible that Fannie Mae may never need to enter receivership," DeWine wrote.

Even if receivership occurred, Fannie Mae might be able to pay subordinated claims in part, he wrote.

According to DeWine, Federal Housing Finance Agency conservators haven't ruled out other suits and sources of income.

He wrote that a stay would prejudice claims in the same suit against the accounting firm of KPMG and former Fannie Mae chief Franklin Raines.

Lawyers for Fannie Mae's conservators countered that DeWine obtained the $196 billion figure from a misleading headline on a Bloomberg news report.

"As the body of the story shows, $196 billion represents the total original purchase price of the mortgage backed securities that are the subject of claims being made on behalf of both Fannie Mae and Freddie Mac, not an estimate of the likely recovery," they wrote.

Shareholders started suing in September 2004, after federal regulators released a report concluding that Fannie Mae misapplied generally accepted accounting principles.

The stock price, which had peaked at $79.88, would drop to $41.71 in a year.

Raines resigned in December 2004, after Fannie Mae disavowed four years of financial statements and predicted a restatement up to $9 billion.

Fannie Mae discharged KPMG, and comptroller Leanne Spencer resigned.

U.S. District Judge Richard Leon of Washington, D.C., consolidated the shareholder actions in 2005, appointing the Ohio funds to lead the litigation.

Ohio filed a consolidated complaint against Fannie Mae, KPMG, Raines, Spencer, and former chief financial officer Timothy Howard, and moved to certify a class action.

Ohio claimed Raines inflated earnings to increase his compensation.

His lawyers, at Williams and Connolly in Washington, answered that prior to 2004, his accountants and federal regulators approved Fannie Mae's accounting practices.

"Fannie Mae was transparent with regard to its compensation system," they wrote.

They wrote that reports of regulators lacked witness statements that Raines directly or indirectly encouraged improprieties.

Raines opposed class certification in 2007, claiming the administration of President George Bush drove the stock down to gain control over Fannie Mae.

His lawyers, citing a confidential witness, claimed stock declines made chief regulator Steven Blumenthal almost gleeful.

They wrote that regulators announced or leaked negative information throughout 2005.

They wrote that under pressure, Fannie Mae halved its dividend, froze its portfolio, and committed to clearing its decisions with regulators.

"These decisions began a period of quasi receivership for Fannie Mae," they wrote.

Ohio attorney general Marc Dann, who left office in April 2008 over a sexual harassment scandal, answered that the information was material whether regulators or Fannie Mae disclosed it.

Lawyers for Raines replied that Bush Administration officials believed in free market ideology hostile to government sponsored entities.

They wrote that officials considered Fannie Mae a Democratic administration in exile.

The Bush Administration branded the assertions as hearsay, arguing that Raines relied on speculation in news articles quoting anonymous sources.

Raines countered that in May 2004, U.S. Rep. Barney Frank, D-Mass., told stock analysts the administration engaged in a strategy to depress Fannie Mae stock prices.

Leon certified the class in January 2008.

He started the class period on April 17, 2001, when Fannie Mae issued a press release about its earnings.

He ended the period on Dec. 22, 2004, when Raines disavowed statements and resigned.

Later in 2008, the mortgage market collapsed and Congress created a Federal Housing Finance Agency to pick up the pieces.

The agency intervened in the class action, and discovery battles developed.

This March, DeWine told a Congressional committee that Fannie Mae's conservators swindled and bled the taxpayers.

Raines, Spencer and Howard relayed his comments to Leon and wrote, "Plaintiffs seek billions of dollars in this lawsuit."

Their lawyers wrote, "If they were to win such a judgment against Fannie Mae, their winnings (including their contingency fee) presumably would be funded by taxpayers.

"The duration and expense of this litigation is largely attributable to the massive amount of discovery sought by lead plaintiffs themselves."

Fannie Mae's conservators played their ace in August, suing 17 banks that packaged mortgages and financed them through Fannie Mae.

On Aug. 22, as those suits started running at federal court in New York City, Raines asked Leon for summary judgment in the class action.

Kevin Downey, of Williams and Connolly, wrote that Raines, Spencer and Howard believed their accounting complied with generally accepted principles.

Downey wrote that "they continue to stand by those beliefs and judgments."

"Discovery has established no link between any improper accounting decision and compensation or benefits to Mr. Raines," Downey wrote.

"It bears emphasis that, as the chief executive officer of Fannie Mae, Mr. Raines had numerous responsibilities; technical accounting was not among them.

"Nevertheless, Mr. Raines made sure that Fannie Mae had in place a thorough process, involving dozens of people, in which any questions about accounting, internal controls, or integrity could be raised and addressed prior to any financial statements or quarterly or annual reports being released to the public."

Meanwhile, in July, Federal Housing Finance Agency had published a rule clarifying that securities litigation claims would have the lowest priority in receivership.

On Aug. 26, DeWine sued in Leon's court to invalidate the rule.

On Oct. 7, Federal Housing Finance Agency moved to stay the class action.

Joseph Aronica, of Duane Morris in Washington, wrote that it was extremely unlikely that shareholders would be able to collect any judgment they might obtain.

Aronica wrote that continuing the proceedings would impose unnecessary and excessive costs on U.S. taxpayers.

He wrote that in receivership, the United States would be repaid before any other shareholders receive anything.

"(T)he value of the shares other than those held by the United States has effectively been eliminated," he wrote.

"Receivership would require that the existing class be decertified and that each class member individually exhaust his or her claims.

"At this point, of course, no receivership has occurred, but it remains a highly probable outcome for Fannie Mae.

"It would have occurred already but for the extraordinary intervention of the U.S. government using taxpayer dollars."

DeWine answered that the agency wouldn't have moved for a stay if it believed no recovery was possible.

He wrote that the agency could take a default judgment, enter a consent judgment, or let KPMG bear the burden of mounting a defense.

He wrote that the agency ignored the fact that the case is against multiple defendants.

"Under current law, nothing forecloses plaintiffs from recovering on a judgment against Fannie Mae during conservatorship," DeWine wrote.

"FHFA's claim that it will likely move Fannie Mae from conservatorship to receivership at some undefined point in the future cannot justify a stay now."

He wrote that pending claims against banks are potentially worth more than Fannie Mae owes the United States.

KPMG opposed a stay on Oct. 24, arguing that it would delay decision of summary judgment motions.

"KPMG has been waiting several years for a full airing of the facts," wrote Joseph Warin, of Gibson, Dunn and Crutcher in Washington.

"Plaintiffs have survived thus far by making accusations, very stridently and very publicly, and relying on procedural rules under which courts must take what the plaintiff asserts as truth," he wrote.

"They are not truth, and the current motions will make that clear."

Fannie Mae itself remains in the case, separately from its conservators.

On Nov. 1, lawyers at O'Melveny and Myers in Washington told Leon that Fannie Mae couldn't meet a deadline to respond to a shareholder motion for summary judgment.

"Fannie Mae has experienced an unrelated emergency that will make filing its opposition on November 4 extremely difficult, if not impossible," they wrote.

On Nov. 3, Leon granted Fannie Mae a two week extension.

Aronica renewed his plea for a stay on Nov. 7, writing that conservators addressed misconceptions after Bloomberg valued the suits against the banks at $196 billion.

He quoted their statement to the press that using unpaid principal balance as a measure of potential recovery was incorrect because it didn't equate with losses incurred or reflect principal payments that already occurred or the remaining value of the securities.

"In their misplaced desire to rely on the overblown Bloomberg headline, plaintiffs simply ignore this important clarification," Aronica wrote.

He wrote that the agency's suits against the banks constitute an exercise of its responsibilities as conservator to preserve and conserve assets.

He wrote that they weren't undertaken to create a fund to compensate shareholders.

He wrote that authorizing a default judgment or a consent judgment would be a reckless abdication of the conservator's mandate to preserve and conserve assets.

He wrote that shareholders shouldn't assume that conservators would indemnify individual defendants for a judgment in the case.

"Their misguided hope of reaching taxpayer money through the back door of a judgment against the individual defendants does not justify denying a stay of this case."

Leon has allowed the parties to file summary judgment briefs under seal.

He wrote in August that they must "work in good faith to agree to unseal as many of the pleadings and exhibits as is possible by the conclusion of briefing."

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