By MARCY GORDON
The Associated Press
Wednesday, May 24, 2006; 8:39 AM
WASHINGTON -- Federal regulators issued a blistering report about mortgage giant Fannie Mae on Tuesday, alleging accounting manipulation aimed at lining executives' pockets and lying to investors about smooth growth in profits and earnings. The government-sponsored mortgage company was fined $400 million and agreed to limit its growth.
The long-awaited report by the Office of Federal Housing Enterprise Oversight came as Fannie Mae, which has not filed an earnings statement since late 2004, corrects its accounting and struggles to emerge from an $11 billion scandal. The product of an extensive three-year investigation, the housing oversight agency's report is tougher in its criticism than an assessment ordered by Fannie Mae's board that was released in February.
The OFHEO review, involving nearly 8 million pages of documents, details what the agency describes as an arrogant and unethical corporate culture, calling Fannie Mae's image of company prestige and excellence a sham. It said Fannie Mae employees manipulated accounting so that senior executives could collect millions in bonuses from 1998 to 2004.
OFHEO and the Securities and Exchange Commission announced a $400 million civil penalty against Fannie Mae, the largest U.S. buyer and guarantor of home mortgages, in a settlement over the alleged accounting manipulation. Of that amount, the $350 million assessed by the SEC _ one of its biggest penalties ever in an accounting fraud case _ will go to compensate Fannie Mae investors damaged by the alleged violations.
The company also agreed to limit the growth of its multibillion-dollar mortgage holdings, capping them at $727 billion, and to make top-to-bottom changes in its corporate culture, accounting procedures and ways of managing risk.
Twenty-nine current and former executives and employees _ including former chairman and chief executive Franklin Raines and former chief financial officer Timothy Howard _ will be reviewed for possible disciplinary action or termination.
Daniel Mudd, the company's president and CEO, will lead the review. His conduct already has been examined by the board and found to present no problems, company officials said.
"It is very important that we look at Dan through the leadership that he has given this company over the last 18 months," Fannie Mae Chairman Stephen Ashley said during a conference call Tuesday with analysts. The review of Mudd "gives us no reason to express anything other than complete confidence in Dan Mudd's leadership of this company," he said.
Washington-based Fannie Mae neither admitted nor denied wrongdoing under the settlement but did agree to refrain from future violations of securities laws.
The report details a series of events in the fall of 2003 involving Mudd, who was then the chief operating officer, in which an employee named Michelle Skinner expressed serious concerns in an e-mail to him about the company's accounting. The issues were similar to those raised by then-Fannie Mae accountant Roger Barnes to other company officials about a month earlier. Mudd did not deal appropriately with Skinner's concerns and "missed an opportunity" to recognize potential problems, the report says.
That was a year before the OFHEO regulators brought to light Fannie Mae's accounting-rule violations and alleged earnings manipulation to meet Wall Street targets _ disclosures that stunned the financial markets. In December 2004, the SEC ordered the company to restate its earnings back to 2001 _ a correction expected to reach an estimated $11 billion. The Justice Department has been pursuing a criminal investigation.
Raines and Howard were swept out of office by Fannie Mae's board in December 2004.
"The image of Fannie Mae as one of the lowest-risk and 'best in class' institutions was a facade," James B. Lockhart, OFHEO's acting director, said in a statement as the report was released. "Our examination found an environment where the ends justified the means. Senior management manipulated accounting, reaped maximum, undeserved bonuses, and prevented the rest of the world from knowing."
The report also faulted Fannie Mae's board of directors for failing to discover "a wide variety of unsafe and unsound practices" and to act independently of Raines.
From 1998 to mid-2004, the smooth growth in profits and precisely hit earnings targets that Fannie Mae reported each quarter were "illusions" deliberately created by senior management using faulty accounting, the report says.
The Bush administration has been pushing for legislation to reduce the massive mortgage portfolios of Fannie Mae and its smaller government-sponsored sibling, Freddie Mac.
The report "shows that Fannie Mae's faults were not limited to violating accounting and corporate governance standards, but included excessive risk-taking and poor risk management as well," Randal Quarles, Treasury undersecretary for domestic finance, said in a statement. "OFHEO's findings are a clear warning about the very real risk the improperly managed investment portfolios of (Fannie Mae and Freddie Mac) pose to the greater financial system."
Fannie Mae said its board has read the report and is committed to making the changes required under the deal with the regulators.
"We are glad to resolve these matters. We have all learned some powerful lessons here about getting things right and about hubris and humility," Mudd said in a statement. "We are a much different company than before. But we also recognize that we have a long road ahead of us."
The accounting manipulation tied to executives' bonuses occurred from 1998 to 2004, according to the report, a much longer period than was previously known. It "made a significant contribution" to Raines' compensation, which totaled more than $90 million from 1998 to 2003, the report says, including some $52 million directly tied to the company hitting earnings targets.
OFHEO levied a record $125 million fine in 2003 against Freddie Mac for misstating earnings _ mostly underreporting them _ by $5 billion for 2000-2002.
On the Net:
Fannie Mae: http://www.fanniemae.com
Freddie Mac: http://www.freddiemac.com
Office of Federal Housing Enterprise Oversight: http://www.ofheo.gov
Securities and Exchange Commission: http://www.sec.gov