Small Linked To Scandal at Fannie Mae

By Kathleen Day and Jacqueline Trescott
Washington Post Staff Writers
Thursday, May 25, 2006

Smithsonian Secretary Lawrence M. Small has been barraged with criticism lately from Congress, historians and filmmakers who say his annual salary of $813,000 is too big and a secret contract barring much of the public from the institution's vast, taxpayer-supported archives unfair.

Now Small is being scrutinized in another drama, his role in the accounting fraud scandal at the Federal National Mortgage Association, where he was president, chief operating officer and board member from 1991 to 2000.

A new government report says Small was among a handful of senior Fannie Mae executives who set an improper "tone at the top," encouraging employees to hit profit targets above all else so that managers would receive the largest annual bonuses possible.

The report, released this week by the Office of Federal Housing Enterprise Oversight, says the result was a company that engaged in "extensive financial fraud" over six years, doctoring earnings by $10.6 billion so executives could collect tens of millions of dollars in bonuses. Fannie Mae settled civil charges with OFHEO and the Securities and Exchange Commission by agreeing to pay a $400 million fine and to make vast changes in how it does business.

Now the SEC and OFHEO are focusing on former and current employees named in the report to assess the role each played in the company's problems and who if anyone will be forced to return millions of dollars in what the regulators call "ill-gotten" bonuses.

The report details that in the two years before Small left Fannie Mae to join the Smithsonian, he was avid in reminding executives of the need to meet earnings targets and in encouraging and suggesting ways to do it, including some methods regulators now say violated generally accepted accounting rules and misled investors. Small did not return calls seeking comment.

Another report, prepared for the Fannie Mae board by former senator Warren Rudman and released in February, found only one instance where it said the evidence was clear that Fannie Mae managers manipulated earnings to trigger and increase their annual bonuses. Small is mentioned in the report as part of that effort.

By contrast, the report released by federal regulators this week found multiple years, from 1998 to 2004, when reported profits were manipulated by management. It gives far more detail of Small's role in 1998 and 1999, before he left to join the Smithsonian.

In the summer of 1998, for example, Small wrote to Fannie Mae Chairman Franklin Raines concerned that the year's target wouldn't be met using the company's "piggy bank" or various "magic bullets."

"The bonus pool will be noticeably lower than in 1997," he wrote to Raines. "A fact which will, of course, be rapidly observed by officers and directors in January."

In another memo written about the same time, Small commended then-Chief Financial Officer J. Timothy Howard for using stock buybacks as a tool to manage earnings: If profits couldn't be increased, then outstanding stock could be cut so earnings-per-share goals could be met to the penny.

"Obviously, we recognize that our buyback pace has to be calibrated to fit our desired [earnings per share] growth rate," he wrote Howard.

At the end of 1998, Small gave a slide-show presentation to company officers during a retreat in the Biltmore Hotel and Resort in Phoenix, where he underlined the consequences of being even a penny short of the company's $3.23 earnings-per-share target.

"Now you can see," he said, "that each cent here on the slide is worth about $1.8 million to the bonus pool. So being two cents down . . . would mean that we have $3.6 million less in the pool."

The company eventually met its 1998 target exactly.

Raines and Howard were forced out at the end of 2004 in response to the company's unfolding financial reporting scandal.

Small, the ranking administrator at the Smithsonian since January 2000, has been controversial nearly from the beginning of his tenure.

His plan to close a highly regarded research facility for endangered animals drew the ire of Congress, as well as the scientific staff at the Smithsonian. The plan was dropped.

Smithsonian curators protested his acceptance of a $38 million donation to the institution by philanthropist Catherine B. Reynolds because of the conditions she set on the money's use. She eventually withdrew most of the donation.

In the past two months a contract he championed for television productions with Showtime Networks, using Smithsonian materials and experts, has come under scrutiny from Congress and scholars because its terms haven't been made public. It limits the access of researchers to Smithsonian archives if they plan to use the information in a significant way in a commercial venture.

Loudly criticizing the plan and the fact that it was reached without congressional consultation, the House Appropriations Committee cut $20 million from its proposed 2007 Smithsonian budget of $644.3 million. Last year the institution received $621.3 million from Congress. The committee also added an amendment to the appropriations bill saying no compensation package at the museum should be higher than the $400,000 the president of the United States is paid.

According to public records, Small's compensation package in 2003, including salary, housing allowance and other perks, was $813,000.

The Showtime contract was with Smithsonian Business Ventures, a unit created in 1998 to increase nonrestricted earnings for the Smithsonian. The Smithsonian inspector general is conducting an audit into the workings and salaries of its officers. A list given to the Appropriations Committee by the Smithsonian said that SBV Chief Executive Gary Beer received $558,075 in 2005.

As a private citizen, Small pleaded guilty to violating the Migratory Bird Treaty Act in January 2004 for buying in 1998 a $400,000 collection of Amazonian tribal artifacts that included banned rare feathers. Small was sentenced to two years' probation and 100 hours of community service.

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