WASHINGTON — One year after the government took over and bailed out Freddie Mac, the giant mortgage finance company, federal regulators are blocking former employees from revealing information to investors who are suing the company for fraud, lawyers for shareholders say.
The Treasury has propped up Freddie Mac with more than $50 billion in taxpayer money since the company nearly collapsed more than a year ago, and officials warn that the company will probably need additional billions in the months ahead.
Federal prosecutors in Virginia and the Securities and Exchange Commission are already investigating whether the company misled investors about the risks it was taking with securities backed by subprime mortgages and no-document loans.
But in a battle that will surface on Friday in a federal courtroom in New York, the company and its primary government overseer, the Federal Housing Finance Agency, are trying to enforce secrecy agreements that scores of former employees signed as a condition for receiving severance payments when they left the company.
In their class-action lawsuit against Freddie Mac, three big union-based pension funds charge that Freddie Mac executives defrauded investors by concealing the company’s exposure to high-risk mortgages, its mounting losses and its inadequate capital position.
At the hearing on Friday, lawyers for shareholders will argue that Freddie Mac’s secrecy agreements amount to buying silence from willing witnesses who may have crucial information about what the company’s top executives knew at the time they were assuring investors that all was well. The lawyers will ask a judge to invalidate the restrictions, a move that Freddie Mac and federal regulators will say the court has no right to do.
“Federal dollars are being used to bribe people, to buy their silence,” said David George, a lawyer representing the pension funds in a class-action lawsuit.
Under the secrecy provisions, former employees would be permitted to answer questions from government prosecutors and investigators in any criminal case or in a regulatory proceeding.
But, barring a court order, the former employees are prohibited from cooperating with anyone involved in a civil lawsuit against Freddie Mac.
Several former employees, who insisted on anonymity, confirmed that they were eager to talk with the shareholder group and said they might have valuable information.
“I would say more, but I don’t want somebody knocking on my door and asking for $50,000 back,” said one former employee who worked on Freddie Mac’s internal financial controls. “It’s almost like bribery; I felt that I was supposed to sign the agreement, take the money and keep all their secrets.”
The severance deals were so strict, according to former employees, that they prohibited those who accepted them from saying almost anything about their old jobs or even about the secrecy pledges themselves.
“I was told that in volunteering to take a buyout, I couldn’t even talk about the agreement or it would be off the table,” said an 18-year veteran of Freddie Mac, who insisted on anonymity because of the restrictions. “I was told that you don’t talk about the terms of agreement, you don’t talk to the news media and you don’t talk to attorneys involved in lawsuits against the company.”
Lawyers for pension funds that have filed a class-action lawsuit against the company say the secrecy provisions have already muzzled at least two dozen former employees with potentially important information.
Spokesmen for both Freddie Mac and the Federal Housing Finance Agency said they could not comment on the case because it is in litigation.
In a legal brief filed in August, the Federal Housing Finance Agency refused to confirm that the secrecy pacts even existed, saying their existence was “hypothetical.” But if the restrictions did exist, the agency continued, neither shareholders nor the courts had any authority to interfere with them.
Though secrecy provisions have become a common feature of corporate severance deals, legal experts said this appeared to be the first time that federal regulators have invoked them to thwart investors. And because Freddie Mac is now effectively owned by the government and is receiving a vast taxpayer bailout, the case has already raised alarms among some public officials.
Rob McCord, Pennsylvania’s state treasurer, said his state had lost millions of dollars on Freddie Mac shares that became almost worthless in 2008. Though Mr. McCord is not a party to the class-action lawsuit, he said Freddie Mac’s secrecy agreements were thwarting taxpayers as well as shareholders, and making it harder to prevent similar debacles in the future.
“I would be greatly concerned if Freddie Mac, by conditioning departing employees’ severance payments on contractual gags, is preventing investors from learning what really happened,” Mr. McCord wrote in a letter on Wednesday to Freddie Mac and to many members of Congress.
He added, “Given that Freddie Mac is supported by tax dollars, the public has a right to hear from former employees.”
The dispute highlights the conflicts that face federal policy makers as the government tries to rescue giant corporations ranging from Freddie Mac to the American International Group to General Motors.
On one hand, the government has a responsibility to uncover fraud and other corporate misconduct, especially at companies being bailed out by taxpayers. At the same time, officials are trying to protect taxpayers by rehabilitating the companies as quickly as possible. Paying out money to shareholders, even if they were defrauded, increases the cost to taxpayers.
Freddie Mac and its sister company, Fannie Mae , are government-sponsored corporations that finance and guarantee trillions of dollars worth of home mortgages. Both companies became insolvent after the housing market and financial markets imploded, and both were taken over by the government in September 2008.
Lawyers for shareholders, citing provisions obtained from former employees, said the secrecy provisions explicitly prohibit employees from voluntarily helping anybody trying to sue Freddie Mac.
Stephen Singer, a shareholder lawyer who has led class-action lawsuits against numerous subprime mortgage lenders, said the Freddie Mac restrictions could, if upheld in court, make it difficult for shareholders to sue companies for fraud and misrepresentation.
“These restrictions are more sweeping than anything I’ve seen before,” said Mr. Singer, who is not involved with the Freddie Mac case. If they were upheld, he added, shareholders would find it much more difficult to sue corporations because courts will generally not force company executives to testify or to produce documents until after the shareholders have provided solid evidence of fraud and misrepresentation from voluntary witnesses, often former employees.