Fannie To Settle Charges, Pay Fine

By Kathleen Day and Annys Shin
Washington Post Staff Writers
Tuesday, May 23, 2006

Mortgage giant Fannie Mae will pay about $400 million in penalties under an agreement with two federal agencies to settle charges related to its $10.8 billion accounting scandal, sources said yesterday.

The agreement is scheduled to be announced today by the Securities and Exchange Commission, which polices publicly traded companies, and the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae.

At the same time, OFHEO plans to impose new restrictions on the company's business, according to sources familiar with the agreement.

The settlement would end a nearly three-year investigation by the SEC and OFHEO into widespread accounting manipulation by the company -- including the use of improper accounting techniques to maximize bonus pay for top executives. It would not cover potential SEC action against individuals involved in Fannie Mae's problems, nor does it end a criminal investigation by the Justice Department.

But for the company, it could mark a step toward resolving a controversy that has undermined its credibility as well as its stock price and has fueled efforts in the White House and Congress for stricter regulation. As they announce the agreement, OFHEO officials will release a report detailing what they found in their Fannie Mae investigation.

Fannie Mae's rival in the mortgage industry, Freddie Mac, agreed to pay OFHEO a $125 million civil penalty after its own accounting scandal in 2003. It admitted no wrongdoing. Officials at the company, the SEC and OFHEO declined to comment yesterday. Fannie Mae has not filed up-to-date accounting statements since 2004. The company has scheduled a conference call with investors for tomorrow afternoon.

The company's troubles were first made public in 2004 after a preliminary probe by OFHEO alleged that Fannie manipulated earnings between 1998 and 2004 to smooth the growth of profits it reported to investors. Sources said the report scheduled for release today will be far more detailed in its examination of key issues such as whether top executives -- including former chairman and chief executive Franklin D. Raines and former chief financial officer J. Timothy Howard -- violated generally accepted accounting principles, in part to trigger multimillion-dollar bonuses.

A separate probe, prepared for the Fannie Mae board by former senator Warren B. Rudman and released in February, concluded that the company manipulated earnings throughout the period under review and found that in one case it was done to maximize bonus payments.

In addition to reviewing the extent to which Fannie Mae executives manipulated the books to trigger bonus pay, OFHEO investigators focused on how much blame the Fannie Mae board of directors deserves for the firm's missteps. Sources say the OFHEO report will be harsher on directors than the Rudman report. The document largely exonerated the board, saying directors were told by auditors, lawyers and, most especially, top executives that the company's accounting practices were sound.

The sources spoke on condition of anonymity because they are not supposed to be talking about the settlement or the OFHEO report publicly.

Last week, Fannie Mae said it will replace Thomas P. Gerrity as head of its audit committee at the end of the year. Gerrity, a professor of management and former dean of the Wharton School of the University of Pennsylvania, has been audit committee chairman for seven years.

Since the scandal broke in 2004, corporate governance watchdogs have urged Fannie Mae to replace its audit committee, which is responsible for overseeing the company's accounting and financial practices and the performance of its outside auditor. Most of the committee has turned over in the past two years. Xerox chairman and chief executive Anne M. Mulcahy left in September 2004. Then Thayer Capital Partners' Frederic V. Malek retired from the board at the end of last year. Presidential appointees William R. Harvey and Taylor C. Segue III were not reappointed. Joe K. Pickett, a mortgage banker and director since 1996, remains on the committee.

District-based Fannie Mae is a shareholder-owned company created by Congress to make mortgage funding plentiful, which it does by buying mortgages from banks and other lenders and either holding them or pooling them into securities for sale to investors.

Staff writer Terence O'Hara contributed to this report.

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