WASHINGTON – An extensive investigation of embattled Fannie Mae (FNM) points to its former finance chief and controller as mainly responsible for the accounting failures at the mortgage giant now struggling to emerge from an $11 billion scandal, said a report released Thursday.
The report by a team of investigators led by former Sen. Warren Rudman also found that former chairman and CEO Franklin Raines, while not sharing direct responsibility, contributed to a culture of arrogance at the government-sponsored company. The report comes about 17 months after the revelation that federal regulators had discovered violations of accounting rules and earnings manipulation by the company to meet Wall Street targets.
The board of Fannie Mae, which finances one of every five home-mortgage loans in the United States, hired Rudman, a former member of the Senate from Vermont, as independent counsel to launch an investigation at the time of the stunning disclosures in September 2004.
Fannie Mae executives — especially former chief financial officer Timothy Howard — gave the board incomplete and sometimes misleading information regarding the company's accounting and finances, the report found. Howard and longtime CEO Raines were ousted by the board in December 2004.
The report also concluded that Howard and former controller Leanne Spencer, who resigned last year, "were primarily responsible" for the flawed accounting practices in their overzealous drive to have the company show smooth earnings growth and meet Wall Street analysts' expectations.
As for Raines, who was one of the most influential and politically savvy figures in Washington, the Rudman investigation did not find that he knew that Fannie Mae's accounting practices violated rules.
"We did find, however, that Raines contributed to a culture that improperly stressed stable earnings growth and that ... he was ultimately responsible for the failures that occurred on his watch," the report says.
The long-awaited report terms Fannie Mae's accounting systems "grossly inadequate." It runs more than 600 pages, based on a review of millions of documents by Rudman's team of investigators and auditors drawn from his law firm, Paul, Weiss, Rifkind, Wharton & Garrison, and from Huron Consulting Group.
Daniel Mudd, Fannie Mae's chief executive, called the report "strong but good medicine."
"Fannie Mae is a different company than a year ago," Mudd said in a statement. "We have been humbled, even embarrassed. But we have begun to make significant changes."
In December 2004, the Securities and Exchange Commission ordered Washington-based Fannie Mae to restate earnings back to 2001, a correction expected to reach some $11 billion. As the company works to clean up its books and overhaul its accounting practices, it has been unable to file a financial report since mid-2004. Its stock price has dropped. The Office of Federal Housing Enterprise Oversight, which initially discovered the problems, continues its review and the Justice Department is pursuing a criminal investigation.
Revelations of alleged improprieties at Fannie Mae, the nation's second-largest financial institution after Citigroup Inc. (C), have continued to cascade.
The former director of OFHEO told Congress that Fannie Mae employees falsified signatures on accounting transactions that helped the company meet earnings targets for 1998, allowing $27 million in bonuses to be paid to top executives. The regulator, Armando Falcon, also said that Fannie Mae broke accounting rules by keeping the most desirable mortgage-based securities for itself and selling the less attractive ones to investors.
Fannie Mae and Freddie Mac (FRE), its smaller rival in the $8 trillion home-mortgage market, buy and guarantee repayment of billions of dollars of home loans each year from banks and other lenders, then bundle them into securities that are resold to investors worldwide.
The findings of the Rudman report may provide additional fuel for Fannie Mae's critics in Congress.
Both Fannie Mae and Freddie Mac, long two of the most politically influential and aggressively lobbying companies operating in the capital, have been facing a legislative onslaught that could bring a tighter government hand over them as well as a mandated reduction of their massive mortgage holdings.
The companies have for years fended off attempts to crimp their privileges or rein in their operations. But the recent accounting scandals at both companies — Freddie Mac's surfaced in June 2003 — have given traction to the legislative push, driven by Republicans in Congress.
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