In late 2007, due to a decline in value of Freddie Mac’s assets and increase in liabilities, Freddie Mac found itself massively undercapitalized. As a result, the company decided to raise $6 billion through the issuance of Preferred Stock, Series Z. To underwrite the Offering, Freddie Mac retained the services of Goldman Sachs, J.P. Morgan and Citigroup Global Markets, Inc. Thereafter, an Offering Circular was distributed in connection with the Initial Offering of the Freddie Mac Preferred Stock Z. The Offering Circular provided:
The capital raised from the sale of the Preferred Stock will be used to bolster our capital base in light of actual and anticipated losses necessitated by GAAP accounting requirements and help us meet the 30% surplus going forward. We expect to deploy such proceeds for the purchase of residential mortgages or mortgage-related securities (subject to regulatory constraints), for the financing of growth in our mortgage guarantee business and for other corporate purposes consistent with evolving business and market conditions.
In addition to the above-disclosure, the Offering Circular stated that Freddie Mac Preferred Stock Z carried additional risks, including “markets uncertainty and volatility”, and inability to “manage effectively all of the risks to which” Freddie Mac is subject, and “material weaknesses and significant declines in our internal controls that require remediation.”
However, the Offering Circular failed to disclose a number of additional risks associated with Freddie Mac Preferred Stock Z. Specifically, the Offering Circular failed to disclose that Freddie Mac:
Seven months after the Offering, in July of 2008, the U.S. Federal Government provided Freddie Mac and Fannie Mae with an unlimited credit line at the U.S. Treasury, and authorized the U.S. Treasury to purchase equity shares in the two entities, if necessary. A little over a month later, in September of 2008, the U.S. Federal Government seized control of Freddie Mac and Fannie Mae in order to avoid a complete financial collapse.
We believe that Goldman Sachs, J.P. Morgan and Citigroup Global Markets, Inc., in connection with the issuance of the Offering Circular and underwriting of Freddie Mac Preferred Stock Z, failed to properly disclose the true risks associated with Freddie Mac Preferred Stock Z and the true financial condition of Freddie Mac itself.