Fannie Mae Ex-Officials Are Sued for Disputed Pay

By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, December 19, 2006

Federal regulators yesterday sued three former Fannie Mae executives, including former chairman and chief executive Franklin D. Raines, to recoup more than $115 million in pay they received while the company's earnings were misstated.

In an administrative complaint, regulators said Raines and the others engaged in a variety of ruses to meet profit goals and boost their compensation. For example, they delayed booking $200 million of expenses one year and used transactions with no economic purpose in other periods simply to shift income into the future, the complaint alleged.

The regulators' discovery of accounting problems in 2004 ultimately led Fannie Mae to pay a $400 million penalty and correct years of financial results, erasing $6.3 billion of previously reported profit.

Charged with Raines were J. Timothy Howard, former chief financial officer of the government-chartered mortgage finance company, and Leanne G. Spencer, former controller.

The former executives "improperly manipulated earnings to maximize their bonuses, while knowingly neglecting accounting systems and internal controls, misapplying over twenty accounting principles and misleading the regulator and the public," James B. Lockhart III, director of the Office of Federal Housing Enterprise Oversight, said in a statement.

The three "did very serious harm to this company," Lockhart said in a conference call with reporters.

Lawyers for the former executives said the allegations were false and politically motivated. OFHEO's director had been warning for weeks that he planned to take action against former Fannie Mae executives, and he has cited the company's problems in calling on Congress to pass legislation giving Fannie's regulators greater power.

Lockhart is using Raines as a prop in his legislative campaign, and his agency has distorted evidence that it has kept from public view, Kevin M. Downey, an attorney for Raines, wrote in a letter yesterday to the OFHEO director.

Lawyers for Howard and Spencer noted that the agency now bringing the charges once vouched for Fannie's soundness, adding that the company's annual financial results were certified by auditor KPMG.

OFHEO's charges are to be reviewed by an administrative law judge, who is to recommend a final decision to the agency's director. Raines's lawyer called on Lockhart to withdraw from the matter, saying he was "fatally biased" because he repeatedly accused Raines of wrongdoing before bringing charges.

The agency is seeking to recoup $84.6 million in bonuses, stock option grants and other awards from Raines alone. In addition, OFHEO is seeking penalties from the three former executives that could total more than $100 million.

Before Fannie's problems came to light, Raines was one of Washington's most prominent businessmen, widely viewed as a potential Treasury secretary. His résumé traced his rise from humble roots to the heights of government and finance: graduate of Harvard College and Harvard Law School, Rhodes Scholar, junior aide to President Jimmy Carter, investment banker at Lazard Freres, chairman of Harvard's Board of Overseers, director of President Bill Clinton's Office of Management and Budget.

He was also a leader of the Business Roundtable, a lobbying group for chief executives of major companies, and he worked to repair corporate America's credibility after accounting scandals at Enron and other companies.

"As a CEO, one of the most offensive things about the corporate scandals that emerged recently was to hear CEOs claim that they did not know, they could not know, and they could not be expected to know about the activities that brought down their companies," Raines wrote in Fannie Mae's 2002 annual report.

In 2004, an OFHEO examination faulted Fannie's accounting and challenged its management, ultimately leading the company to settle charges of fraud and other violations with the Securities and Exchange Commission.

Fannie's accounting problems were so extensive that it took two years and cost more than $1.4 billion for thousands of workers to redo past financial reports. Fannie remains unable to issue current financial statements on a timely basis, one of the basic requirements of any public company, and in the absence of such reports, its shares continue trading on the New York Stock Exchange by special dispensation.

The charges filed yesterday are the first to target the top executives who presided over the company during the accounting debacle.

To unlock maximum executive bonuses for 1998, regulators alleged, Fannie understated expenses by almost $200 million, counted two years of low-income housing tax credits in a single year, and, through a last-minute bookkeeping entry, recorded $3.9 million of "miscellaneous income."

The complaint said Raines has testified that he had no reason to refute Spencer's statement that he signed off on the decision to defer the nearly $200 million of expenses.

Most of Fannie's flawed bookkeeping involved accounting for derivatives, financial instruments Fannie uses to hedge against movements in interest rates. Raines argued in 2004 that the derivatives accounting involved complex issues about which experts could disagree. Regulators said that the issues were black and white and that Fannie deliberately violated the requirements. Other companies have issued corrections over similar mistakes.

Relations between the company and the agency have often been antagonistic. In a May report, OFHEO alleged that Fannie lobbied to keep the agency poorly funded so that Fannie "would essentially be regulated only by itself."

Raines's successor as chief executive, Daniel H. Mudd, distanced himself from Fannie's posture under Raines, telling lawmakers this year that the days "of the arrogant, defiant my-way Fannie Mae had to end."

A Fannie spokesman declined to comment yesterday.

Unlike OFHEO, the SEC has taken no action against any Fannie Mae employee. The SEC's investigation is continuing, SEC spokesman John Nester said.

The Justice Department has said that it does not plan to prosecute Fannie Mae, though it has been investigating whether Raines and Howard committed perjury when they testified about Fannie's accounting at a 2004 congressional hearing.

Fannie, Raines and Howard, meanwhile, are defending themselves against litigation brought by shareholders.

Fannie Mae recently sued its former auditor KPMG, alleging the accounting firm's negligence caused damages of more than $2 billion. KPMG said it plans to pursue claims of its own against Fannie Mae.

A fair review of OFHEO's claims "will demonstrate the propriety in all respects of Mr. Howard's conduct," said his attorney, Steven M. Salky. Spencer's work "was nothing short of outstanding," said her attorney, David S. Krakoff.

OFHEO acted yesterday to meet a two-year statute of limitations. Its charges could take years to resolve. More than three years after an accounting scandal at Fannie's rival Freddie Mac, the agency remains in litigation to recoup pay from former Freddie executives.