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Study Finds 'Extensive' Fraud at Fannie Mae

The agreement requires the company to invest in up-to-date computer technology and human expertise. It bars the company from growing one of its most profitable but risky business lines, that of buying and holding home loans for its own investment portfolio.

It also requires Fannie Mae to review the conduct of former and current executives. That includes its current chief executive, Daniel H. Mudd, and current Chairman Stephen B. Ashley. Both were on the board of the company during the six years when the accounting problems occurred.

And the company must specifically consider retroactively firing Raines and Howard, a change in status that would deprive them of millions of dollars in compensation. At the end of 2004, in the wake of an embarrassing SEC ruling that Fannie Mae's accounting was wrong, the board pressured Raines and Howard to leave. Raines was allowed to retire and Howard to resign, preserving severance packages for the two.

The OFHEO report is the second in recent months to criticize the company's management, but it goes substantially beyond the first study, which was commissioned by the board of directors, which hired Warren B. Rudman, a former Republican senator from New Hampshire, to write it. Where Rudman, applying a stricter legal standard, found only one year in which earnings were manipulated to trigger bonuses, OFHEO, using a looser burden of proof, concluded that the company consistently arranged its books to hit earnings-per-share targets almost to the penny.

The company's consistent performance was not an "uncanny coincidence," investigators wrote, but a product of executives willing to dip into "cookie jar" reserves to make up a shortfall, then push excess earnings off into the future as a cushion for the next bonus cycle.

The Rudman report essentially absolved the board from blame, saying most directors relied on lawyers and accountants who misled them. In contrast, OFHEO's report says the board was responsible for creating a system that allowed them to be misled by giving Raines and Howard too much power.

Rudman said OFHEO's report and his agree on the facts. "Their comments on the tone at the top, the arrogance of the corporation, tracks with what we said," Rudman said. "The two reports don't disagree that the board was at times misled, either intentionally or unintentionally, and was given bad information."

OFHEO concludes that the board actually helped create the problems by failing to act independently of Raines and Howard and by failing to correct accounting and internal control problems even after similar problems emerged in 2003 at Freddie Mac, which eventually paid $125 million in penalties to OFHEO to settle charges of accounting fraud.

The report cites example after example of transactions that it says Fannie Mae made solely to push earnings up or down to meet profit targets expected by Wall Street. The two transactions with Goldman Sachs in 2001 and 2002, for example, had no economic purpose beyond manipulating earnings and that purpose was not clearly articulated to investors, the report said. In a prepared statement, a Goldman Sachs spokesman disagreed with that conclusion.

Mudd said yesterday that in retrospect he should have done some things differently but that in general he felt he acted appropriately. Ashley, in a conference call with investment banking analysts, said the board supports Mudd.

Thomas P. Gerrity, a Fannie Mae director and chairman of its audit committee for the past seven years, last week said he would step down from the board at year's end.

The OFHEO report also included a new, detailed account of the actions taken by Raines and other insiders, including current chief executive Mudd, to thwart OFHEO's investigation. For example, Fannie Mae tried to insert language into an appropriations bill to cut the agency's budget until then-OFHEO Director Armando Falcon Jr. was replaced, it said.

Mudd, who was promoted to chief executive after Raines resigned in 2004, was criticized in the report for not taking more steps to address internal control problems when he became aware of them.

"This report . . . is strong medicine," Mudd said yesterday. "It is what Fannie Mae needed, and strong medicine is certainly what we received today."

Staff writers Annys Shin and Terence O'Hara contributed to this report.

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