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Review Could Have Legal Ramifications

By Kathleen Day
Washington Post Staff Writer
Friday, February 24, 2006

As former senator Warren B. Rudman and his team spent the past 17 months investigating Fannie Mae's multibillion-dollar accounting errors, federal regulators and prosecutors were more than idle spectators.

Lawyers from the Justice Department, the Securities and Exchange Commission, and the Office of Federal Housing Enterprise Oversight, the company's regulator, kept up to date on what Rudman found as he found it, officials said. In weekly conference calls or meetings, sleuths at Rudman's law firm, Paul, Weiss, Rifkind, Wharton & Garrison LLP, delivered detailed information -- and hundreds of documents -- on how the bookkeeping blunders occurred and what role executives, top management, the board and outside consultants played.

Now that Rudman has delivered his findings to Fannie Mae's board, the multiple government probes will shift into high gear to determine who, if anyone, at the giant housing-finance company violated civil or criminal laws, sources familiar with situation said yesterday.

The sources spoke on condition that their names not be used because the investigations are ongoing. They outlined generally the kinds of issues that SEC and Justice Department lawyers are likely to focus on.

A key area will be whether public statements made by former Fannie Mae chairman and chief executive Franklin D. Raines and former chief financial officer J. Timothy Howard differed from what Raines, Howard or other members of the company's board knew, the sources said.

Fannie Mae's troubles began in mid-2003, shortly after Freddie Mac disclosed that its executives had manipulated financial statements for years to deliver the smooth profit growth investors love, contributing to as much as $5 billion of accounting errors and distortions to its financial statements.

The news prompted Wall Street executives, federal regulators and congressional overseers to ask whether similar problems existed at Fannie Mae, given that it is in the same business as Freddie Mac: buying and reselling home loans. Rudman's report found that, behind the scenes, Fannie Mae's board, too, was asking questions about possible similarities with Freddie Mac.

Publicly, to reporters and before Congress, Raines and Howard said Fannie Mae did not have the same problems. Any Fannie Mae official who made misleading public statements -- or allowed misleading statements to be made -- will face scrutiny for possible civil or criminal violations of anti-fraud sections of U.S. laws, the sources said.

At the SEC, there is a new focus on holding individual auditors and other outside "gatekeepers" responsible for failing to uncover problems they could and should have known about. Rudman's report says some outside consultants, including the company's auditor, KPMG LLP, and its main outside legal counsel, Wilmer Cutler Pickering Hale and Dorr LLP, failed to bring important accounting questions and risks to the board's attention.

Fannie Mae's board has quietly replaced Wilmer Cutler with Latham & Watkins LLP as its primary outside counsel on these issues, Fannie Mae chief executive Daniel H. Mudd said in an interview yesterday.

"We're still studying the report," said KPMG spokesman George Ledwith. "However, it does not appear to raise any accounting issues that have not already been disclosed." Wilmer lawyers could not be reached for comment.

Critics of the board have long said directors, too, bear responsibility, especially for allowing Raines and Howard to wield too much power without proper checks and balances. Rudman would not comment on that, but he did say in an interview that Raines, Howard and other senior managers on a number of occasions "either intentionally or negligently misled the board."

Rudman said non-management board members cannot be blamed for having relied on presentations by top company executives and on statements by the outside auditor that the company's books and policies were in good order.

And, of course, government lawyers will be keen to review the many circumstances that led Rudman -- and the Office of Housing Enterprise Oversight, which regulates Fannie Mae and Freddie Mac -- to conclude that Fannie Mae's top officials deliberately ignored generally accepted accounting rules to smooth earnings.

Of specific interest will be whether Raines, Howard or others broke any laws by approving an accounting maneuver for 1998 that enabled the company to meet earnings targets and, in the process, trigger multimillion-dollar bonuses for themselves. Although the five-year statue of limitations has expired, sources said, lawyers can find a way to use such information if it's part of a larger pattern.

Lawyers for Howard and Raines, who left the company in December 2004 after disclosure of its accounting troubles, said their clients did nothing wrong.

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