Accounting & Tax

Fannie Mae to Pay $400 Million in Settlement

The mortgage giant's corporate culture, asserts the SEC, ''placed significant emphasis on stable earnings growth and avoidance of income statement ...
Stephen TaubMay 23, 2006

The Federal National Mortgage Association (FNMA, or Fannie Mae) has agreed to pay $400 million to settle charges relating to its $10.8 billion restatement.

In its settlement with the Securities and Exchange Commission and Office of Federal Housing Enterprise Oversight (OFHEO), the mortgage giant neither admitted nor denied the government’s allegations. The company also agreed to the entry of a final judgment that permanently enjoins it from violations of the anti-fraud, reporting, books and records, and internal controls provisions of the federal securities laws.

“Fannie Mae’s departure from proper accounting practices allowed it to present to its shareholders and the marketplace financial statements showing stable and predictable earnings,” said Linda Chatman Thomsen, the SEC’s director of enforcement, in a statement. “But the impression created by the company’s financial statements was a false one. Transparency and accurate disclosure are the keys to good corporate governance and should be the rule, not the exception.”

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Indeed, the commission asserted that the “root cause” of Fannie’s accounting fraud was “a corporate culture that placed significant emphasis on stable earnings growth and avoidance of income statement volatility, and insufficient emphasis on ensuring compliance with applicable accounting regulations and federal securities laws.”

In one instance at the end of 1998, the SEC elaborated, Fannie Mae senior management “manipulated the company’s earnings” to obtain bonuses they otherwise would not have received. The agency also accused those managers of intentionally understating expenses and overstating pretax income by $199 million, and of making two additional adjustments that offset nearly half the company’s $240 million amortization expense adjustment.

Meanwhile, OFHEO, which oversees both Fannie Mae and Freddie Mac, on Tuesday issued a long-awaited report that accused Fannie Mae senior management of committing or tolerating “a wide variety of unsafe and unsound practices and conditions.” The regulator also criticized Fannie Mae’s board for failing to be sufficiently informed; failing to act independently of its chairman, then-CEO Franklin Raines, and senior management; and failing to exercise appropriate oversight.

“The board’s failures continued in the wake of revelations of accounting problems and improper earnings management at Freddie Mac and other high-profile firms, the initiation of OFHEO’s special examination, and credible allegations of improper earnings management” made by an employee in Fannie Mae’s controller’s office, the report elaborated.

The OFHEO report also found that improper earnings management at Fannie Mae increased earnings-driven bonuses and other compensation for senior executives. As an example, the report continued, more than $52 million of Raines’s $90 million in bonuses during the period in question was directly tied to earnings-per-share targets.

“The message from Mr. Raines was clear,” concluded the report. “EPS results mattered, not how they were achieved.”

OFHEO also observed that management did not make investments in accounting systems, computer systems, other infrastructure, and staffing needed to support a sound internal control system, proper accounting, and GAAP-consistent financial reporting. “Those failures came at a time when Fannie Mae faced many operational challenges related to its rapid growth and changing accounting and legal requirements,” the regulator added.