James C. Cacheris, UNITED STATES DISTRICT COURT JUDGE.
The matter before the Court questions whether a preferred stockholder retains the right to inspect Freddie Mac's corporate records despite a conservator succeeding to "all rights, titles, powers, and privileges ... of any stockholder ... with respect to [Freddie Mac] and the assets of [Freddie Mac]." The Court concludes that the statutory transfer of power to the conservator destroyed the stockholder's right to inspect corporate records. Accordingly, the Court will dismiss Plaintiff's Complaint.
The Federal Home Loan Mortgage Corporation, or "Freddie Mac," is a federally chartered corporation created by Congress, but owned by stockholders.
Plaintiff Timothy J. Pagliara ("Pagliara" or "Plaintiff") is the beneficial owner of approximately 346,000 shares of Freddie Mac's junior preferred stock, which he purchased in 2009. Pagliara is also the founder of "a coalition of private investors from all walks of life, committed to the preservation of shareholder rights for those invested in Freddie Mac and Fannie Mae." (Compl. [Dkt. 1-1] ¶ 22.) Pagliara brings this lawsuit seeking to inspect corporate records in his individual capacity as a beneficial owner of Freddie Mac preferred stock.
To understand the present dispute, it is necessary to discuss Freddie Mac's origins and recent history. Congress created Freddie Mac in 1970 to bring competition to the market for secondary mortgages.
As a response to the financial crisis, Congress passed the Housing and Economic Recovery Act of 2008 ("HERA").
The day after FHFA became conservator in 2008, FHFA caused Freddie Mac to enter into a senior preferred stock purchase agreement with the U.S. Department of the Treasury. Under the agreement, Treasury purchased one million shares of newly created senior preferred Freddie Mac stock with a liquidation preference of $1 billion. In exchange, Freddie Mac received the right to withdraw up to $100 billion from Treasury. Between 2008 and 2012, Freddie Mac withdrew $71.3 billion, raising Treasury's liquidation preference in Freddie Mac to $72.3 billion. By 2012, Freddie Mac showed signs of financial growth. According to Pagliara, Freddie Mac's recovery threatened Treasury's ability to control and extract dividends from Freddie Mac. At the same time, the national debt ceiling was constraining Treasury's reserves. Those concerns allegedly caused Treasury to decide "to take money from Freddie Mac and Fannie Mae stockholders" by entering into a "Third Amendment" to the senior preferred stock purchase agreement. (Compl. ¶¶ 91-92.)
The Third Amendment to the stock purchase agreement contains a "Net Worth Sweep" provision, which entitles Treasury to receive a quarterly dividend from Freddie
In January 2016, Pagliara sent a "Demand" letter to Freddie Mac's board of directors seeking to enforce his stockholder right to inspect Freddie Mac's corporate books and records. (See Demand [Dkt. 1-1] at 40-52.)
Pagliara sought to inspect Freddie Mac's records "primarily for the purpose of investigating potential claims arising from the `Net Worth Sweep.'" (Compl. ¶ 4; see also id. ¶ 43 ("Stockholder is investigating potential claims with respect to the Net Worth Sweep and other conduct of Freddie Mac, the Board, FHFA, and Treasury, as further described below.").) The Demand explained Pagliara's belief that the Net Worth Sweep potentially gives rise to several claims against FHFA, Freddie Mac's directors, and Treasury. Principal among those claims are lawsuits against Freddie Mac's directors for breaches of fiduciary duties of care and loyalty, statutory duties governing when dividends may issue, and corporate waste, among others. The Demand also strongly suggested that Freddie Mac's directors may be personally liable for those violations.
Freddie Mac's board did not respond to Pagliara's Demand. Instead, on January 28, 2016, FHFA sent Pagliara a letter explaining that Freddie Mac's directors serve on behalf of FHFA and do not owe any fiduciary duties to stockholders. (See Response Letter [Dkt. 1-1] at 69.) Thus, according to FHFA, the state law duties Pagliara discussed in his Demand and Dividend Letter "are simply not applicable." (Id.)
About six weeks after receiving FHFA's response, Pagliara filed suit in a Virginia circuit court seeking an order under Virginia Code § 13.1-773
Freddie Mac removed the case to this Court pursuant to 12 U.S.C. § 1452(f),
II. Standard of Review
Defendant challenges Plaintiff's standing to bring this suit pursuant to Federal Rule of Civil Procedure 12(b)(1). Defendant raises a facial challenge to Pagliara's standing, arguing that the Complaint fails to allege facts upon which Pagliara has standing, thereby precluding the Court's subject matter jurisdiction. When reviewing a facial challenge to subject matter jurisdiction, courts must take the facts alleged within the complaint as true. Kerns v. United States, 585 F.3d 187, 192 (4th Cir.2009).
Defendant also raises a 12(b)(6) challenge to whether Pagliara has sufficiently alleged his right to inspect corporate records under the Virginia Stock Corporation Act. This motion is reviewed under the same standard described above. See id. Accordingly, the court "must accept as true all of the factual allegations contained in the complaint," drawing "all reasonable inferences" in the plaintiff's favor. E.I. du Pont de Nemours & Co. v. Kolon Indus.,
Before discussing the substance of parties' arguments, the Court must address an issue of taxonomy. Defendant argues throughout its briefing that the Court should dismiss this case because Pagliara lacks the "right" to inspect Freddie Mac's corporate records. Defendant frames this argument as a 12(b)(1) standing challenge to Pagliara's ability to allege an injury-in-fact or because Pagliara attempts to enforce a right that is not his own. (See Def.'s Mem. in Supp. at 4 (quoting Valley Forge Christian Coll. v. Ams. United for Separation of Church & State, Inc., 454 U.S. 464, 474, 102 S.Ct. 752, 70 L.Ed.2d 700 (1982) ("[T]he plaintiff generally must assert his own legal rights and interests...."); Burke v. City of Charleston, 139 F.3d 401, 405 (4th Cir.1998) (discussing constitutional requirement of an injury-in-fact)).) Defendant likely styled its motion under 12(b)(1) because many courts have proceeded under the standing rubric when discussing whether HERA or a substantively similar statute destroyed stockholders' standing to bring a derivative lawsuit on behalf of a corporation. In the present context, however, Defendant's argument is better framed as a merits challenge to the existence of the right Pagliara asserts, rather than a question of his standing to pursue that right.
It is well recognized that a merits inquiry into the existence of a right and the standing inquiry into the allegation of an injury-in-fact are often difficult to separate. See 13A Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 3531.4 (3d ed.) ("The question whether there is an injury quickly becomes blended with the question whether to recognize the asserted interest that has in fact been impaired."). Fortunately, the Fourth Circuit has provided guidance on separating those inquiries. In Pitt County v. Hotels.com, L.P., 553 F.3d 308 (4th Cir. 2009), a district court dismissed a county's case for lack of standing after concluding that the county lacked the statutory right to tax online hotel retailers. Under the district court's reasoning, the county's lack of a right to tax meant the county suffered no injury when online retailers failed to pay county taxes. The Fourth Circuit criticized that reasoning as "improperly conflat[ing] the threshold standing inquiry with the merits of the County's claim." Id. at 312. The court noted that a plaintiff "need not prove the merits of [its] case in order to demonstrate that [it] ha[s] Article III standing." Id. (alteration in original) (quoting Am. Library Ass'n v. F.C.C., 401 F.3d 489, 493 (D.C.Cir.2005)). Instead, a "district court has jurisdiction if `the right of the [plaintiffs] to recover under their complaint will be sustained if the [applicable laws] are given one construction and will be defeated if they are given another.'" Id. (alternation in original) (quoting Steel Co. v. Citizens for a Better Env't, 523 U.S. 83, 89, 118 S.Ct. 1003, 140 L.Ed.2d 210 (1998)). Applying that standard, the Fourth Circuit concluded that the county's lack of a right to tax defeated its claim on the merits, but not its standing to allege a right to collect taxes to begin with. "To hold otherwise would reduce all merits inquiries in cases of this type into standing inquiries." Id. The same is true here.
If Pagliara's interpretation of HERA is correct, then he unquestionably seeks to assert his own right as a stockholder to inspect Freddie Mac's corporate records. Thus, if Pagliara's interpretation
Pagliara Lacks the Right to Inspect Freddie Mac's Corporate Books and Records
Turning now to the parties' arguments, Defendant contends that the Court should dismiss this Complaint for records inspection because Pagliara no longer possesses any right to inspect Freddie Mac's records. Specifically, Defendant argues that HERA transferred Pagliara's inspection right to FHFA when FHFA became Freddie Mac's conservator. Defendant principally relies upon 12 U.S.C. § 4617(b)(2)(A)(i), which declares that FHFA, upon appointment as conservator, immediately succeeds to "all rights, titles, powers, and privileges ... of any stockholder" of Freddie Mac.
Pagliara interprets HERA far more narrowly. Pagliara emphasizes that § 4617(b)(2)(A)(i) only transfers stockholders' rights "with respect to the regulated entity and the assets of the regulated entity." According to Pagliara, that phrase means HERA merely transferred a stockholder's right to bring a derivative lawsuit
As described below, the Court agrees with Defendant that HERA divested Freddie Mac stockholders of the right to inspect corporate records. Accordingly, the Court will dismiss this case.
The existence or nonexistence of Pagliara's right to inspect corporate records is a question of statutory interpretation. As such, the Court must begin with the relevant statutory language. See King v. Burwell, 759 F.3d 358, 368 (4th Cir. 2014). "[W]hen the statute's language is plain, the sole function of the courts — at least where the disposition required by the text is not absurd — is to enforce it according
The relevant statutory language appears in 12 U.S.C. § 4617(b)(2)(A)(i) and states the following:
As many courts have recognized, the language "all rights, titles, powers, and privileges ... of any stockholder" is extremely broad and evidences Congress's intent "to shift as much as possible to the FHFA." In re Fed. Nat'l Mortg. Assoc. Sec., Derivative, & ERISA Litig., 629 F.Supp.2d 1, 3 (D.D.C.2009); Kellmer v. Raines, 674 F.3d 848, 851 (D.C.Cir.2012) (noting by reference to FIRREA that "nothing was missed"); Perry Capital LLC v. Lew, 70 F.Supp.3d 208, 225 (D.D.C.2014) (discussing the "extraordinary breadth of HERA's statutory grant to FHFA"); Esther Sadowsky Testamentary Trust v. Syron, 639 F.Supp.2d 347, 350 (S.D.N.Y.2009) ("[U]nder the plain language of HERA, `all rights, titles, powers, and privileges' of Freddie Mac's shareholders are now vested in the FHFA."). In other words, the language means what it plainly says; HERA transferred "all rights previously held by Freddie Mac's shareholders." In re Fed. Home Loan Mortg. Corp. Derivative Litig., 643 F.Supp.2d 790, 795 (E.D.Va. 2009), aff'd sub nom. La. Mun. Police Emps. Ret. Sys. v. Fed. Hous. Fin. Agency, 434 Fed.Appx. 188 (4th Cir.2011).
The only limiting language within § 4617(b)(2)(A)(i) that Pagliara identifies is the clause "with respect to the regulated entity and the assets of the regulated entity." Pagliara interprets this phrase to mean FHFA succeeded to only the right to bring a derivative lawsuit. Pagliara derives this argument from courts that have interpreted HERA
The derivative-versus-direct distinction discussed in the cases Pagliara cites, however, has little bearing on the issue in this case. The "right" at issue in the cases
Transferring the derivative-versus-direct distinction from the context in which it arose to a completely different question of whether an underlying right even exists would have obvious adverse implications. There are many stockholder rights, in addition to the right to inspect records, that are arguably enforceable through a direct lawsuit. For example, before the conservatorship Freddie Mac's common stockholders possessed the right to elect directors, Va. Code § 13.1-675; Bylaws § 3.7(a), to seek removal of directors, § 13.1-680; Bylaws § 4.16, to petition a court to force Freddie Mac to hold an annual meeting, § 13.1-656; Bylaws § 3.1(b), and to call a special meeting, § 13.1-655(A)(1); Bylaws § 3.2(a). See Principles of Corporate Governance § 7.01 cmt. c (listing "actions to enforce the right to vote," and "actions to require the holding of a shareholders' meeting" as "properly considered" as direct actions). If the Court were to adopt Pagliara's derivative-versus-direct distinction wholesale, the Court must also likely accept that common stockholders continue to possess those other rights enforceable through a direct lawsuit. To read the above list of rights is to understand that a stockholder's exercise of at least some of those rights would directly conflict with HERA's clear intention to transfer as governance authority to FHFA as possible. That undesirable consequence supports the Court's conclusion that the derivative-versus-direct distinction should remain confined to the limited context that fostered its creation, namely inquiries into a stockholder's standing to pursue a claim.
The statutory context of 12 U.S.C. § 4617(b)(2)(A)(i) also cuts against Pagliara's interpretation. Cf. King v. Burwell, 759 F.3d 358, 368 (2014) ("[T]he meaning — or ambiguity — of certain words or phrases may only become evident when placed in context." (citation omitted)). HERA grants an extraordinary amount of authority to FHFA as conservator, including the power to "operate the regulated entity with all the powers of the shareholders, the directors, and the officers of the regulated entity and conduct all business of the regulated entity," 12 U.S.C. § 4617(b)(2)(B)(i), to take any actions "appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity," § 4617(b)(2)(D)(ii), and to immediately succeed to "title to the books, records, and assets of any other legal custodian of" Freddie Mac, § 4617(b)(2)(A)(ii). FHFA also received all "incidental powers as shall
In light of the foregoing, the Court will not rely upon a distinction that was adopted in a completely different interpretive context, that has absurd implications in the present context, and that runs counter to HERA's context and intent. Instead, the Court will apply the plain meaning of "with respect to." Cf. Levin, 763 F.3d at 673 (Hamilton, J., concurring) (finding it "not obvious" that "with respect to" "must be interpreted so narrowly"). "With respect to" plainly means "about or concerning" or "relating to." See, e.g., Dan's City Used Cars, Inc. v. Pelkey, ___ U.S. ___, 133 S.Ct. 1769, 1778-79, 185 L.Ed.2d 909 (2013) (interpreting "with respect to" to mean "concerning" in the context of the Federal Aviation Authorization Act of 1994 ("FAAA")); Cal. Tow Truck Ass'n v. City & Cty. of San Francisco, 807 F.3d 1008, 1021 (9th Cir.2015) ("[T]he phrase `with respect to' is generally understood to be synonymous with the phrase[ ] `relating to.'") (interpreting FAAA); Merriam Webster Dictionary, available at www.merriam-webster.com/dictionary/with%respect%20to (defining "with respect to" as meaning "about or concerning" or "in relation to").
The above definition points persuasively to the conclusion that a stockholder's right to inspect corporate records is a stockholder right with respect to Freddie Mac or its assets. To assert that right, the individual must be a stockholder and must have a purpose of protecting his rights as a stockholder. See Retail Prop. Investors, Inc. v. Skeens, 252 Va. 36, 471 S.E.2d 181, 183-84 (1996). Thus, the right is conferred by stock ownership and relates to Freddie Mac by requiring Freddie Mac to disclose its own records, which expressly concern its own operation. As such, that right was transferred to FHFA upon its appointment as conservator. Because Pagliara no longer possesses the right to inspect, the Court must dismiss this Complaint.
Pagliara does not persuade the Court that the above interpretation poses a serious risk of implicating the Fifth Amendment's Takings Clause.
To summarize, HERA's plain language evidences Congress's intent to transfer as much power as possible to the FHFA when acting as Freddie Mac's conservator. Within that context, the Court may only reasonably read the transfer of "all rights, titles, powers, and privileges" of "any stockholder ... with respect to the regulated entity and the assets of the regulated entity" to include a stockholder's right to inspect Freddie Mac's corporate records. Accordingly, the Court must dismiss this case because Pagliara does not possess the right he seeks to enforce.
Pagliara Lacks a Proper Purpose for Inspecting Freddie Mac's Corporate Books and Records
Even if Pagliara did retain the right to inspect corporate records, he has not satisfied the statutory requirements for exercising that right in this case. Virginia Code § 13.1-771(D) governs when a stockholder may inspect the records that Pagliara seeks.
The only element challenged in this motion to dismiss is whether Pagliara made his demand for a proper purpose. According to the Virginia Supreme Court, "proper purpose" means a shareholder is "acting in good faith to protect his rights as a shareholder and that the relief he seeks will not adversely affect the corporation's interests." Id. at 183; see also Bank of Giles Cty. v. Mason, 199 Va. 176, 98 S.E.2d 905, 908 (1957). When evaluating a shareholder's purpose, it is appropriate to consider his primary purpose, rather than some secondary or ulterior purpose.
As an initial point, the Court concludes that it is not a proper purpose to investigate a lawsuit that a stockholder lacks standing to bring. This conclusion follows naturally from the Virginia Supreme Court's statement that a proper purpose must protect the inspector's "rights as a shareholder." Skeens, 471 S.E.2d at 183. When interpreting nearly identical language in Delaware's records-inspection statute, the Delaware Supreme Court has noted that inspection into a lawsuit that cannot be effectuated due to lack of standing is not a proper purpose. United Techs. Corp. v. Treppel, 109 A.3d 553, 559 & n. 31 (Del.2014). The reasoning behind that rule is simple, a "purpose is not reasonably related to [a plaintiff's] interest as a stockholder as [he] would not have standing to pursue a derivative action based on any potential breaches." Polygon Global Opportunities Master Fund v. W. Corp., No. Civ. A. 2313-N, 2006 WL 2947486, at *5 (Del.Ch. Oct. 12, 2006); Graulich v. Dell, No. 5846-CC, 2011 WL 1843813 (Del.Ch. May 16, 2011); W. Coast Mgmt. & Capital, LLC v. Carrier Access Corp., 914 A.2d 636, 645-46 (Del.Ch.2006). By Pagliara's own admission, he lacks standing to pursue a derivative claim. Accordingly, if the purpose of his inspection is the pursuit of such a claim, that purpose is not proper.
The face of the Complaint reveals that Pagliara "seeks these corporate records primarily for the purpose of investigating potential claims arising from the `Net Worth Sweep.'" (Compl. ¶ 4.) Those anticipated claims are lawsuits for breaches of fiduciary and statutory duties by Freddie Mac directors, along with claims regarding Treasury and FHFA's involvement in the Board's operation. As even Pagliara's briefing appears to contemplate, those are derivative claims.
Pagliara also seeks to investigate claims for breaches of rights arising from the contractual relationship between a stockholder and Freddie Mac. Although it may be possible to formulate those claims as direct lawsuits, Pagliara's hypothetical standing to pursue such claims does not persuade the Court of Pagliara's proper purpose.
The only purpose Pagliara identifies that is unaffected by the two deficiencies discussed above is Pagliara's desire to value his shares. Although courts have permitted records inspection based on that purpose,
In sum, the Court concludes that Pagliara does not retain the right to inspect corporate records. Even if Pagliara did possess that right, the Court will dismiss the Complaint because Pagliara does not have a proper purpose. Because the Court will not order Freddie Mac to permit inspection into its records, the Court need not decide whether 12 U.S.C. § 4617(f) would bar such an order. Additionally, because the Court will dismiss this Complaint, it need not consider FHFA's alternative motion to be substituted as plaintiff.
For the foregoing reasons, the Court will dismiss Pagliara's Complaint seeking to inspect the corporate books and records of the Federal Home Loan Mortgage Corporation.
An appropriate order will issue.
(Compl. ¶ 30.)
Va. Code § 13.1-773(B).