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Nature of Suit Code: 890
Nature of Suit: Other Statutory Actions
Cause of Action: 

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 24, 1997 Decided May 16, 1997

No. 95-5243

UNITED STATES OF AMERICA AND 

GOVERNMENT NATIONAL MORTGAGE ASSOCIATION,

APPELLEES

v.

JOHN C. YORK, ET AL.,

APPELLANTS

Consolidated with 

Nos. 95-5244 and 95-5279

Appeals from the United States District Court 

for the District of Columbia 

(No. 91cv03094) 

(No. 93cv00839)

-

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Louis R. Cohen argued the cause for appellants First 

Commonwealth, FSB, et al., with whom David P. Donovan, 

Leon B. Greenfield, Jonathan J. Frankel and John J. Knapp

were on the briefs.

Stephen D. Gordon argued the cause for appellant USGI, 

Inc., with whom Michael L. Martinez and Gloria B. Solomon

were on the briefs.

Dara A. Corrigan, Assistant United States Attorney, argued the cause for appellee, with whom Eric H. Holder, Jr.,

United States Attorney, and R. Craig Lawrence, Assistant 

United States Attorney, Barbara E. Nicastro, and Jeffrey T. 

Sprung were on the brief. Mark E. Nagle, Assistant United 

States Attorney, entered an appearance.

Before: EDWARDS, Chief Judge, SENTELLE and RANDOLPH, 

Circuit Judges.

Opinion for the Court filed by Circuit Judge SENTELLE.

SENTELLE, Circuit Judge: These consolidated cases come to 

us on appeal from the district court's grant of summary 

judgment in favor of the government. The district court held 

that appellant York Associates' participation in certain transactions violated a fiduciary duty it owed to the Government 

National Mortgage Association ("GNMA"). The district 

court imposed heavy financial penalties on York Associates 

itself and several other involved parties.

We hold that York Associates owed GNMA no duty to 

refrain from participating in the transactions in question. 

The district court's grant of summary judgment to the government is therefore reversed, and the district court is ordered to enter summary judgment in favor of appellants.

Background

GNMA is a wholly-owned government corporation within 

the Department of Housing and Urban Development 

("HUD"). GNMA's statutory mission is to facilitate private 

investment in low to moderate income housing developments. 

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12 U.S.C. § 1716. It accomplishes this goal largely through 

the use of mortgage-backed securities.

A mortgage-backed security is a long-term debt instrument 

that represents the income stream from one or more mortgages. Mortgage banking institutions issue mortgage-backed 

securities and sell them to investors. The cash from these 

sales is used to make mortgage loans. The payments borrowers make on these mortgage loans form the income stream 

for the holders of the securities. The banking institutions 

that originate mortgage loans and issue mortgage-backed 

securities are known as "issuers." Issuers commonly earn an 

administrative fee by servicing the securities, i.e., processing 

loan repayments and directing them to security holders.

Under the program involved in this case, mortgage-banking 

institutions apply to GNMA for approval to issue GNMA 

mortgage-backed securities ("GNMA securities"). GNMA securities are backed by the full faith and credit of the United 

States. Obviously, this makes these securities far more 

attractive in the open market than they otherwise would be. 

The mortgages which underlie the GNMA securities must be 

insured by the Federal Housing Administration ("FHA") or 

some similar government-sponsored insurance program. The 

FHA insures originators of covered mortgages for up to 90% 

of the amount of the loan.

GNMA securities are widely traded in secondary markets. 

Because they are fixed-rate securities their market value 

depends on current market interest rates. If current rates 

are above the fixed rate on the security, it will ordinarily 

trade below face value. If current rates are below the fixed 

rate, it will ordinarily trade above face value.

GNMA securities have one other feature central to this 

case. If the underlying mortgage loan is paid before its 

maturity, the security becomes immediately payable at full 

face value. There are two ways in which an underlying loan 

can be paid before maturity. The first is if the borrower 

happens to come up with the funds. The second is if the 

borrower defaults. In the event of a default, the mortgage 

lender can foreclose upon and sell the property and then 

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collect the FHA insurance for up to 90% of the deficiency 

amount. Once the insurance proceeds are collected, the 

mortgage lender/GNMA security issuer is obligated to pay 

the GNMA security at its full face value. This process takes 

anywhere from six months to two years. If the GNMA 

security holder originally purchased the security below face 

value, payment at full face value results in a potentially 

significant windfall gain.

Appellant York Associates was a GNMA-approved issuer. 

At all times relevant to this case, appellant John York was a 

65% shareholder as well as President and chief executive 

officer of York Associates. This consolidated case arises out 

of two transactions in GNMA securities in which York Associates was involved:

1. The Quail Run Transaction

DRG Funding Corp. ("DRG") was a mortgage banking 

institution unrelated to any of the appellants in this case. 

DRG was a large-scale issuer of loans and securities in the 

GNMA program. In 1988 DRG defaulted under its guaranty 

agreements with GNMA, and its mortgages and securities 

became the responsibility of GNMA.

GNMA sought bids from other approved issuers for a subservicing contract for the DRG portfolio. York Associates 

submitted a bid and won the contract. It entered into a SubContract Servicing Agreement ("Agreement") with GNMA in 

September 1988. The Agreement gave York Associates servicing responsibilities for the DRG portfolio and custody of all 

of DRG's loan records.

On October 27, 1988, John York and his partner met with 

an official from appellant USGI, Inc. ("USGI"), a mortgage 

banking institution. The parties at this meeting discussed an 

arrangement whereby they would seek opportunities to acquire GNMA securities that were likely to prepay. One 

element of the discussed arrangement was that USGI would 

purchase securities that York Associates serviced. USGI 

would get information from York Associates about which of 

the loans in its portfolio were likely to prepay. The parties 

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discussed splitting profits from the redemption of these securities 75% to York Associates and 25% to USGI.

Shortly after this meeting, USGI learned of the availability 

of a GNMA security backed by a Wyoming property called 

Quail Run. USGI contacted York Associates about the status 

of the Quail Run security. York Associates told USGI that 

the Quail Run security was part of the DRG portfolio that 

York Associates now serviced. It also told USGI that the 

Quail Run loan had already been foreclosed and that a claim 

for FHA insurance benefits was being prepared. The security was therefore extremely likely to prepay. York Associates 

garnered this information from the DRG loan records it 

acquired as part of its Sub-Contract Servicing Agreement 

with GNMA.

On December 9, 1988, USGI purchased the Quail Run 

security from Salomon Brothers ("Salomon") and on the same 

day sold it to appellant First Commonwealth Savings Bank 

("First Commonwealth"). John York was Chairman of the 

Board and a 65% shareholder of First Commonwealth.

On January 20, 1989, York Associates, as sub-servicer for 

GNMA on the DRG portfolio, filed a claim for FHA coinsurance on the Quail Run mortgage. FHA disbursed the 

insurance proceeds to York Associates in October 1989. At 

this point, the security was eligible to be redeemed at par.

Prior to redemption, however, First Commonwealth had 

sold the Quail Run security back to USGI. The redemption 

payment was therefore made to USGI. First Commonwealth 

and USGI split the redemption profits, i.e., the difference 

between the price at which USGI bought the security from 

Salomon and its redemption price, 75%-25%.

York Associates never informed the government that its 

affiliate had an ownership interest in a security it serviced. 

No government regulation expressly forbids this practice. 

The government stipulated that GNMA suffered no direct 

financial loss as a result of the transactions in the Quail Run 

security among Salomon, USGI, and First Commonwealth.

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2. The Forest Isle Transaction

In 1985, York Associates made a HUD-coinsured loan to an 

investor in the Forest Isle Apartments and issued a GNMA 

security in the face amount of the loan. In 1987, the investor 

informed York Associates that he would default on the loan. 

York, which stood to lose that portion of its loan that was not 

FHA-insured, restructured the loan by purchasing the project 

through an affiliated partnership, making a new FHA-insured 

loan to the partnership, and issuing a new GNMA security. 

York sold the Forest Isle security to Salomon.

Later in 1987 Salomon contacted John York and made an 

offer to sell a portion of the Forest Isle security. Thinking 

that the property was likely to prepay and that he would 

therefore be able to benefit from the difference between the 

purchase price and par value, York decided to buy the Forest 

Isle security. On February 11, 1988, he arranged for First 

Commonwealth to purchase from Salomon all but a $500,000 

share of the Forest Isle security. A religious organization 

owned the remaining portion. On March 9, 1988, Salomon 

bought the remaining portion of the security and on that 

same day sold it to First Commonwealth.

Around this same time, John York concluded that Forest 

Isle could not generate sufficient revenue to sustain its debt 

servicing requirements and that the mortgage would have to 

default. He discontinued further advances by York Associates for the project's operating deficits. This caused a default under the loan. In April 1988, York Associates filed a 

claim for FHA coinsurance benefits on the Forest Isle project. In October 1988, HUD paid these benefits to York 

Associates. This payment triggered redemption of the Forest Isle GNMA security that First Commonwealth now 

owned. First Commonwealth collected $765,681 more in redemption proceeds than it paid for the security. The government stipulated that GNMA suffered no direct financial loss 

as a result of the transaction in the Forest Isle security 

between Salomon and First Commonwealth.

Proceedings Below

York Associates initiated these proceedings. Between 

1983-89, it made numerous FHA-insured mortgage loans that 

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went into foreclosure. It received FHA mortgage insurance 

proceeds on these loans but sued HUD claiming that it was 

statutorily entitled to receive an additional amount in interest. 

The district court issued a declaratory judgment that York 

Associates was entitled to this interest. York Assocs., Inc. v. 

HUD, 820 F. Supp. 14 (D.D.C. 1993).

The court declined, however, to order HUD to pay York 

Associates immediately. In an amended answer and counterclaim, the government asserted that York Associates had 

engaged in "breach of contract, insider trading, and unjust 

enrichment" and had "unclean hands" because it had purchased the Forest Isle certificate while in possession of 

"material, non-public information" that the security would 

prepay. The amended answer made similar allegations about 

trading in the Quail Run security. In addition, the government filed a new suit charging that John York, First Commonwealth, and USGI had each "induced" York Associates' 

breach of duty and were therefore jointly liable. Because the 

resolution of the government's charges could affect what York 

Associates was owed, the court did not make the government 

pay immediately. It instead consolidated the two cases.

Each side filed for summary judgment in the consolidated 

case. The court ruled for the government. It first held that 

York Associates violated a fiduciary duty it owed to GNMA 

when it purchased the Quail Run certificate, because it "acquir[ed] an interest in conflict with the interests of the United 

States." United States v. York, 890 F. Supp. 1117, 1126 

(D.D.C. 1995) (citing United States v. Carter, 217 U.S. 286 

(1910)). The court ordered disgorgement of the profit York 

Associates made on the trading of the Quail Run certificate. 

Finding that disgorgement was "not a sufficient remedy to 

"provide a means of enforcing the loyalty of [the government's] agents,' " the district court also ordered forfeiture of 

the $5,874,531.87 in fees York Associates earned under the 

Sub-Contract Servicing Agreement. Id. at 1131-32 (quoting 

United States v. Kearns, 595 F.2d 729, 734 (D.C. Cir. 1978)) 

(alteration in original).

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1 York Associates, John York, and First Commonwealth submitted a single brief. 

The court further held that John York, First Commonwealth, and USGI had induced the breach and were therefore 

jointly and severally liable for the disgorgement. Id. at 1128 

n.15. It also held these other parties jointly and severally 

liable for the $5.9 million in fees. Id. at 1139.

The court then turned to the Forest Isle transaction. It 

first held that issuers of GNMA securities are GNMA's 

agents. Id. at 1132. An agent owes its principal a fiduciary 

duty. "York Associates' purchase and redemption of the 

Forest Isle security created a conflict of interest in violation 

of its fiduciary duty owed GNMA as an issuer of [GNMA] 

securities." Id. at 1135.

It then held that York Associates' participation in these two 

transactions gave it "unclean hands" in its statutory claim for 

interest on the FHA insurance proceeds. Id. at 1137. The 

court therefore refused to order HUD to pay York Associates 

the approximately $4.6 million in interest to which it was 

otherwise statutorily entitled.

Appellants moved the court to alter or amend the judgment. The district court denied their requests in a separate 

memorandum opinion. Id. at 1139-43. This appeal followed.

Analysis

The district court's opinion is based on two legal conclusions. The first is that York Associates was acting as 

GNMA's agent in both the Forest Isle and the Quail Run 

transactions. The second is that York Associates' participation in these transactions breached a fiduciary duty it 

owed to its principal, GNMA.

In their brief to this court, the York parties1challenge 

both of these conclusions. They first contend that issuers of 

GNMA securities are not necessarily GNMA's agents. While 

the Sub-Contract Servicing Agreement may have created an 

agency relationship as regards Quail Run and the other 

securities in the DRG portfolio, there is nothing to suggest 

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that York Associates was acting as GNMA's agent in issuing 

and servicing the Forest Isle security. They next contend 

that even if York Associates had been GNMA's agent for 

purposes of both securities, nothing it did in either transaction breached any duty it owed to GNMA. In this second 

contention they are joined by appellant USGI.

The government disagrees. It argues that York Associates 

was GNMA's agent as regards both the Quail Run and the 

Forest Isle securities. York Associates violated the fiduciary 

duty it owed to its principal GNMA by trading in these 

securities. The government, following the district court, relies on United States v. Carter, 217 U.S. 286 (1910). Carter

held that a government agent breaches its fiduciary duty 

when it "acquires any interest adverse to [its] principal, 

without a full disclosure." Id. at 306.

We hold in favor of appellants. Even assuming arguendo

that York Associates was GNMA's agent as regards both of 

these securities, the government can identify no duty that 

was breached. It repeatedly asserts that York Associates' 

position was adverse to that of GNMA, but it never defensibly 

articulates how this is so. The government concedes that the 

York parties' involvement in these transactions caused 

GNMA no direct financial loss. It must therefore develop an 

alternate theory of the duty that York Associates breached. 

See United States v. Kearns, 595 F.2d 729, 734 (D.C. Cir. 

1978) ("Valid policy concerns underlie the insistence that a 

plaintiff in an action for breach of fiduciary duty need not 

demonstrate actual damage or abuse of office."). There are 

at least four possibilities. None of the four, however, ultimately succeeds.

The first possibility is that York Associates had a duty to 

keep confidential the loan default information from the DRG 

portfolio that it received as part of the Sub-Contract Servicing Agreement. If York Associates had such a duty, it 

breached it when it shared information with USGI. The 

government argues that the Agreement itself established this 

duty. It points in particular to the sentence that reads 

"[York Associates] shall receive all such property and information for the purpose of performing its duties under this 

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Agreement." The government interprets this sentence to 

mean that the information was given to York Associates for 

the purpose of performing its duties under the Agreement, 

and for that purpose alone. The district court interpreted 

this sentence in a similar fashion. York, 890 F. Supp. at 1127.

The government and the district court misinterpret the 

Agreement. The relied-upon sentence says nothing about 

confidentiality. Given GNMA practice at the time, it would 

be irrational to interpret the sentence to create a duty of 

confidentiality. Far from demanding that issuers keep loan 

information confidential, GNMA actually required issuers to 

disclose this information to holders of GNMA securities who 

requested it. GNMA Prospectus, Appendix 25 to GNMA 

Handbook 5550.1 Rev. 6 (April 1984) ("The accounts and 

records [of the issuer] relating to the pooled mortgages shall 

be maintained in accordance with sound accounting practices 

and in a manner that will permit representatives of GNMA at 

any reasonable time to examine and audit such accounts and 

records."). In addition, Robert P. Kalish, the Executive Vice 

President of GNMA, testified that GNMA generally left it up 

to the issuer whether loan default information should be 

disclosed to third parties. Deposition of Robert P. Kalish, 

Executive Vice President of GNMA, February 4, 1994, at 12. 

The Sub-Contract Servicing Agreement did not impose a 

duty to keep loan default information confidential.

The second possibility is that GNMA has administratively 

imposed on issuers a duty to refrain from trading in their own 

securities. At the time the transactions in question took 

place, no formal rule prohibited this behavior, nor has any 

such rule since been promulgated. The government argues, 

however, that it administratively established this prohibition 

in 1976, when it sent a letter censuring an issuer who solicited 

sales of securities about which it had inside information. This 

letter, however, was never published. York cannot be held 

accountable for adherence to a GNMA policy that was never 

made public. Satellite Broad. Co., Inc. v. FCC, 824 F.2d 1, 3 

(D.C. Cir. 1987) ("Traditional concepts of due process incorporated into administrative law preclude an agency from penalizing a private party for violating a rule without first providUSCA Case #95-5244 Document #272583 Filed: 05/16/1997 Page 10 of 13
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ing adequate notice of the substance of the rule."). GNMA 

has not administratively imposed on issuers a duty to refrain 

from trading in the securities they issue.

The third possibility is that the securities laws and their 

accompanying regulations impose a duty on issuers to refrain 

from trading in the securities they issue and service. The 

government, however, does not make this argument. The 

Securities and Exchange Commission investigated York Associates' involvement in these transactions, but declined to take 

any action.

A theoretical fourth possibility is that York Associates 

breached a fiduciary duty by undermining GNMA's statutory 

goal of encouraging private investment in low to moderate 

income housing. This theory is based on a novel and unconvincing economic argument advanced by the government. By 

"cherry-picking" those securities that were just about to pay 

a premium, so the theory goes, York Associates deterred 

others from investing in the GNMA security market. If 

investors know that subservicers and issuers are able to take 

advantage of their position to harvest pre-payment premiums 

for themselves, then the incentive to invest will be diminished. 

York Associates' involvement in these transactions therefore 

directly undermines GNMA's goal of generating funds for the 

housing market through private investment in GNMA securities. York Associates' position is adverse to that of its 

principal. Under Carter, this is enough to establish a breach 

of the government agent's fiduciary duty to its principal.

The district court relied on this theory as an alternate 

ground for its holding of liability. In doing so, the court 

noted that "based on the record alone, this harm to the 

market is speculative." York, 890 F. Supp. at 1130. Nothing 

in the record supports the government's theory that York 

Associates' involvement in these transactions harmed the 

market for GNMA securities. In the absence of such support, we cannot use this theory to find that York Associates 

breached a fiduciary duty by taking a position that was 

"adverse" to that of its principal GNMA. We will not simply 

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assume that introducing this category of buyers into this 

securities market would suppress investment in that market.

Our conclusion, therefore, is that York Associates owed 

GNMA no duty to refrain from the behavior that the government now challenges. No contractual provision, GNMA 

regulation, or federal law prohibited York Associates from 

disclosing information from the DRG portfolio or purchasing 

securities for which it served as issuer or subservicer. York 

Associates did not assume a position that was "adverse" to 

that of its principal GNMA. The government concedes that 

York Associates' involvement in the Quail Run and the Forest Isle transactions did not cause GNMA any direct financial harm. There is inadequate record support for the contention that York Associates' behavior directly or indirectly 

weakened the market for GNMA securities.

Finding that York Associates breached no duty it owed to 

GNMA, we reverse the district court's grant of summary 

judgment to the government. We order instead that summary judgment be entered in favor of appellants. First 

Commonwealth, John York, York Associates, and USGI are 

freed of all liability. The case is remanded to the district 

court for calculation of the precise amount of mortgage 

insurance interest that York Associates is owed. See York 

Assocs., 820 F. Supp. 18.

Because we find that York Associates owed GNMA no duty 

to refrain from engaging in these transactions, we need not 

reach the portion of the district court's opinion dealing with 

damages. We note, however, that the district court applied 

novel interpretations of, inter alia, the law of disgorgement, 

the concept of joint and several liability, and the doctrine of 

unclean hands. Our failure to discuss this portion of the 

opinion is not to be interpreted as endorsement of the district 

court's analysis.

Conclusion

The district court's grant of summary judgment for the 

government was based on its holding that York Associates 

breached a fiduciary duty it owed to its principal GNMA. 

Concluding that York Associates owed GNMA no duty to 

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refrain from engaging in the behavior that is challenged in 

this case, we reverse the district court's grant of summary 

judgment in favor of the government and order instead that 

summary judgment be entered in favor of appellants. The 

case is remanded to the district court for a precise calculation 

of the amount of HUD insurance interest that York Associates is owed.

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