By Terence O'Hara
Washington Post Staff Writer
Friday, February 24, 2006

When Tom Gerrity -- head of Fannie Mae's audit committee and the man ultimately responsible for making sure Fannie's numbers didn't lie -- put in a call to Fannie's head of internal auditing in the spring of 2004, it was standard operating procedure in the post-Enron world.

To J. Timothy Howard, Fannie's chief financial officer, it was forbidden.

The story of the phone call Gerrity placed to Sam Rajappa, the internal auditor, and Howard's furious reaction to it, uses very little ink in the lengthy report released yesterday on Fannie's numerous accounting and corporate governance failures from 1998 until 2004. But it looms large as an example of the acrid environment fostered by Howard -- and of the control one man could wield over so much of the massive company.

The Sarbanes-Oxley Act of 2002 required audit committee members on boards of directors to do exactly what Gerrity did in calling Rajappa: get the facts himself. Gerrity, a seasoned executive, wanted to know more about criticism he was hearing from Fannie regulators about outdated, non-integrated accounting systems that required corrections to be typed in by hand. But to Howard, who tightly controlled what -- and how -- information was presented to the board, such end runs were a threat to his authority.

"I just got off the phone with Sam. I made it 'blisteringly clear' to him that on any future calls he gets from the chairman of the audit committee on accounting-related issues he must run the question or issue by you before he or anyone else gets back to Gerrity," Howard wrote in a March 3, 2004, e-mail to Leanne G. Spencer, Fannie's comptroller and a key subordinate of Howard's. "He said he got the message and would do so in the future."

When investigators told Gerrity of Howard's e-mail last year, he said he was "shocked."

Beginning in 2000, Fannie began consolidating its credit and interest-rate risk policy functions under Howard, meaning he assumed responsibilities over both Fannie's credit risk and its interest-rate risk -- in effect putting him in control of a part of the business crucial to its bottom line as well as the part devoted to reporting the bottom line accurately. The report concluded that there was some logic to these consolidations under one person but "that executive should not have been Howard."

The "critical checks-and-balances function . . . was undermined" when Howard took both roles, the report said.

Howard and a half-dozen executives who reported to him in Fannie's key accounting departments were singled out for intense criticism in yesterday's report, authored by former senator Warren B. Rudman, who was hired by the company's board in 2004 to get to the bottom of the biggest accounting restatement in history. Howard, however, was the only senior executive at the company, past or present, who refused to answer any questions about what happened. Spencer, the comptroller, gave Rudman's investigators four interviews before clamming up in June, when they confronted her with documents she authored that appeared to directly contradict her statements to them. Six other non-senior managers under Howard also refused to talk to investigators.

The Rudman report details numerous employee surveys in recent years that lambasted the divisions under Howard -- particularly Spencer's comptroller's department -- for lack of staffing and poor morale in recent years, a period when the mushrooming size and blinding complexity of Fannie's $1 trillion balance sheet placed ever more demands on his team.

These demands, ironically, put Howard in a position of unrivaled influence within the company as more of Fannie's business and performance relied on arcane accounting rules governing even more arcane financial matters, such as derivatives and mortgage amortization assumptions. It was a position that swelled Howard's ego, according to statements by various of his fellow senior executives.

Howard has declined to comment on the matters that led Fannie to restate more than $10 billion in past results. His attorney, Steve Salky, said he and his client "reject the report's mischaracterization of Mr. Howard's motives and conduct." He added that Howard "consistently acted in accordance with the highest standards of integrity and in the best interest of shareholders."

The controller's office under Spencer was hit hard by Rudman's report. The 230-employee division was the main compiler of financial data at the company, key to the accuracy of financial reports both internal and to investors. Yet Rudman found it was woefully understaffed and had a paucity of qualified staff. It also had inadequate systems to do its work. Both of these assertions were central to allegations made by a former comptroller's office employee, Roger L. Barnes, who first raised questions about Fannie's accounting policies in 2003 and is considered a whistle blower by the Office of Federal Housing Enterprise Oversight, the government agency that oversees Fannie Mae and Freddie Mac. Barnes quit in 2003 and threatened to sue Fannie for racial discrimination; he and Fannie Mae reached a settlement.

Spencer had been at the company since 1991 in a variety of financial reporting positions. The office had "morale issues," Rudman said, citing numerous employee surveys that cited a fear of open, frank discussion, and a perception that dissension from the company line could mean punishment. "You're either on the team or you're not," one comptroller's office employee said in an employee survey.

Spencer, who ran the comptroller's office from 1999 until she left the company last year, was not a certified public accountant. Her attorney, David Krakoff, said last night that he and his client "vigorously dispute" the report's allegations. "Ms. Spencer worked tirelessly to maintain accurate accounting records for the company," he said. "The complex accounting judgments were the product of widespread consensus, based on the advice of internal experts and the review of the external auditors."

"Clearly, one of the lessons learned is separation of duties between financial and business aspects," Fannie chairman and 10-year board member Stephen B. Ashley said yesterday in an interview. But under Howard, those two aspects of Fannie Mae's business were mixed in a way that brought one of the country's largest financial institutions to a state of crisis before Howard was fired in December 2004.

The report confirms publicly what many current and former executives at Fannie Mae have long described in private: a culture in which dissent was frowned upon, arrogance ruled, information was hoarded. To some extent, it was a culture that predated Franklin D. Raines, who became chief executive in 1999 after James Johnson retired. In fact, some of the accounting irregularities date to Johnson's watch.

The report found that key areas of the company under the sole authority of Howard -- compliance, risk management, accounting -- were so lacking in written procedures that even if the board had asked for them, he couldn't have produced them.

Staff writer Annys Shin contributed to this report.