FHFA Proposes Dropping Reputational Harm in Counterparty Suspensions

The Federal Housing Finance Agency (FHFA) announced a proposed rulemaking on Monday, published in the Federal Register, to remove "reputational harm" as a criterion for suspending firms and individuals that conduct business with Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The agency stated that eliminating this standard would "eliminate redundancy" and emphasize that counterparty oversight should focus on "material and measurable risks." If the proposal is finalized, the FHFA would issue a suspension order solely when covered misconduct is likely to result in significant financial harm to a regulated entity or jeopardize its safe and sound operations.

Under the current Suspended Counterparty Program, government-sponsored enterprises (GSEs) are mandated to report instances where a counterparty has been convicted of or administratively sanctioned for specific types of misconduct related to mortgages, mortgage securities, or other lending products within the preceding three years. The FHFA can initiate a proposed suspension based on these reports, referrals from its Office of Inspector General, or other available information. A final suspension order compels the regulated entities to cease business with the suspended party, with respondents retaining the right to appeal to the FHFA director.

The existing rule permits the FHFA to issue a final order if the evidence indicates that the misconduct is likely to cause "significant financial or reputational harm" to a regulated entity, or otherwise endanger its safe and sound operations. "Covered misconduct" encompasses a range of offenses including fraud, embezzlement, theft, conversion, forgery, bribery, perjury, false statements or claims, tax evasion, and obstruction of justice, when these are connected to mortgage or other lending activities.

The FHFA's experience in administering the program has led it to conclude that the reputational-harm component is unnecessary and introduces subjectivity. The agency's perspective is that misconduct severe enough to be classified as "covered" inherently implies financial risk or a threat to operational safety and soundness, rendering the separate consideration of reputational harm redundant.