The filing of civil fraud charges against Fortress Investment Group CEO Daniel Mudd should not have come as a big surprise to the hedge fund company, given that U.S. securities regulators informed him earlier this year he could be subject to an enforcement action.
Mudd is one of six former top executives at Fannie Mae and Freddie Mac sued by the U.S. Securities and Exchange Commission on Friday, in a case stemming from the role government-sponsored mortgage firms played in the financial crisis.
In May, almost two years after being named chief executive of Fortress, the SEC sent a Wells Notice to Mudd, formally notifying him that he could face civil fraud charges.
Along with former Freddie Mac CEO Richard Syron, Mudd is accused of misleading investors over their companies' exposure to soured subprime mortgages through 2008. Both companies were bailed out by almost $170 billion in federal rescue funds.
Mudd, 53, was CEO of Fannie Mae from June 2005 until he was ousted in September 2008. In August 2009 he was named CEO of Fortress, of which he had been board member since 2007.
Legal experts say that a Wells Notice doesn't serve as a definitive trigger for an executive's removal. However, it is often the case that notices do result in a person being placed on a leave of absence until the matter is resolved, not only because it is a distraction to the running of the business, but entails other risks.
"First and foremost, it can be deemed a distraction," said Ron Geffner, who works with hedge funds as a partner at law firm Sadis & Goldberg. "It can also taint more people. If someone has the flu, it's healthier for the office if that sick person stays out so as not make the rest of the staff sick."
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Mudd remained on active duty at the hedge fund despite the notice.
"This lawsuit may have been a surprise to Fortress," said John Coffee, a law professor at Columbia University. "This is the first time since the metltown the SEC has brought any action against senior executives. may have been convincing themselves a suit would not be brought."
"I'm not sure the last shoe has dropped in terms of what Fortress' response will be," he added. "The consequence of the SEC lawsuit, if they do litigate, is that Mudd could be barred for life from being the director of a public company - that's the relief the SEC is seeking."
Gordon Runte, a spokesman for Fortress Investment Group, said the complaint filed against Mudd "does not relate to Fortress and this matter has not impacted our company or our business operations." He added that the hedge fund is "undertaking a thorough review of the matters addressed in the complaint."
Fannie and Freddie have both entered into non-prosecution agreements with the agency, the SEC said. This is bad news for Mudd, Coffee of Columbia University said.
"Usually you have the reverse situation, in which individuals cooperate against the companies," said Coffee. "This time all the entities are cooperating with the SEC. They will turn over all the documents, all communications."
Fortress shares rose on Friday after the civil charges were made public, but closed 0.9 percent lower at $3.40 on the New York Stock Exchange.
(Reporting By Katya Wachtel; Additional reporting by Svea Herbst-Bayliss in Boston; Editing by Matthew Goldstein and Richard Chang)