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Fannie Accused of Illegal Escrow A/C Earnings


Fannie Accused of Illegal Escrow A/C EarningsPlaintiffs want Texas lawsuit certified as class action

February 14, 2008


A lawsuit filed nearly four years ago against Fannie Mae now faces the possibility of being certified as a class action. The plaintiffs allege the company illegally took millions of dollars in interest on escrow funds for itself instead of providing them to apartment developers, as required by the U.S. Department of Housing and Urban Development.

The suit, filed by two developers and one owner of multifamily housing in Texas and Ohio insured under sections 221 (d) (3) and 236 of the National Housing Act, is currently in the hands of U.S. District Court Judge David Folsom of the Eastern District of Texas, who is set to rule on whether to grant class action status.

There are approximately 2,000 potential class members throughout the United States, according to the original complaint.

The judge has already rejected a claim by the Washington, D.C.-based company that the suit cannot be maintained as a class action. He has also repeatedly ruled against a series of motions asking that the case be dismissed with prejudice and that summary judgment be made that Fannie did not breach any legal duty it had, and denied motions that those decisions be reconsidered — in one case rejecting a motion seeking reconsideration of the denial of summary judgment the same day the motion was filed.

In his response to one motion by the government sponsored enterprise for summary judgment, he wrote, “The motion reads as though Fannie Mae had in front of it some complaint other than the one filed by plaintiffs.” And he pointed out that the plaintiffs “have raised genuine issues of material fact as to their breach of fiduciary duty and unjust enrichment claims, unrebutted by Fannie Mae.”

In his rejection of Fannie’s motion to dismiss, Folsom wrote that “the court finds plaintiffs are entitled to pursue their claims against Fannie Mae.”

The complaint alleges that Fannie, who the plaintiffs refer to as “their fiduciary,” unjustly made gains “by secretly taking their money from mortgage escrow accounts, investing and using their money as its own, and keeping the hidden profits for its own benefits.”

The suit seeks to recover those gains.

“Since [Fannie Mae] held in trust the money plaintiffs deposited into these [escrow] accounts, [Fannie Mae] owed a fiduciary obligation of plaintiffs,” the complaint alleges. “Without the required permission of the commissioner of the FHA or the consent of the plaintiffs, [Fannie Mae] . . . regularly emptied cash from uninvested funds, commingled plaintiffs’ money with its own and with that of other mortgagors, and used that money to invest, to operate its business, as part of its own capital base, and in any other way [Fannie Mae] saw fit.”

And it says that Fannie, also known as the Federal National Mortgage Association, lacked HUD’s consent to use the money in this manner.

In this way, the complaint maintains, the GSE “has been unjustly enriched by its breaches of fiduciary duty.”

Fannie, in its initial response to the complaint, maintained that HUD rules and regulations “did not include an affirmative duty to invest escrow account balances” and that “the relationship between Fannie Mae and the named plaintiffs does not qualify for fiduciary status under the common law.” Further, Fannie argued, “the escrow accounts at issue were established for the benefit of HUD rather than for the named plaintiffs’ benefit.” And it maintains that “the challenged conduct was expressly approved by HUD.”

But the HUD Handbook, in a section that is applicable to all HUD-insured multifamily projects, states that any interest accrued on reserve or escrow accounts must be credited to the project accounts, HUD spokesman Lemar C. Wooley told Further, HUD’s mortgagee letter of October 25, 1983, also states that interest belongs to the project but goes further by requiring the investment of the funds in interest-bearing accounts. Previously, according to that letter, investment was an option, except for funds involved with Section 8 program, which were required to be invested.

And, in a similar case cited by the plaintiffs that brought against the secondary lender and others that involved earnings from escrow accounts on FHA-insured mortgages, the Pennsylvania Supreme Court, in a 7-2 decision made in 1988, declared that a trust relationship did exist and that Fannie should have paid interest or other compensation on escrow accounts. The firm agreed to pay an undisclosed amount.

In addition to seeking class action, the suit also seeks an accounting of Fannie’s use of all funds deposited into plaintiffs’ accounts, and seeks damages, attorneys’ fees and costs, and additional relief.

Mark Lanier, lead attorney for the plaintiffs, has estimated that Fannie could be responsible for millions of dollars in funds.

The suit was originally filed on June 2, 2004. The last hearing on the issue of class action certification was held on July 21, 2006, according to court records.

The plaintiffs in the case are Texas Medlock Southwest Management Corp., Jasper Housing Development Co., and the Porkolab Family Trust and its members as owners of an apartment complex in Lorain, Ohio.

Fannie has also brought the issue of attorney-client privilege into the picture, seeking to determine the exact date when an attorney for plaintiff Alfred Porkolab was actually hired because that privilege wouldn’t have existed before that date. This move also was denied by Judge Folsom.

Medlock Southwest Management v. Federal National Mortgage Association
Case No. 04cv129 (U.S. District Court, Eastern District of Texas, Texarkana)

Fannie Mae profile

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