Investigation of Fannie Mae points to former finance chief, controller

Thursday, February 23rd 2006, 12:07 pm

By: News On 6

WASHINGTON (AP) _ An extensive investigation of embattled Fannie Mae 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 New Hampshire, 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.

The highly critical September 2004 report by the regulators also singled out Howard, saying that he ``failed to provide adequate oversight'' _ a charge he has denied.

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 Bush administration, which has been critical of Fannie Mae and Freddie Mac, its smaller rival in the $8 trillion home-mortgage market, quickly cited the report's findings as buttressing its view that Congress should reduce their huge mortgage portfolios.

``The Rudman report lays bare the earnings-at-any-cost culture that had developed over many years at Fannie Mae and the substantial abuses that resulted,'' Treasury Undersecretary Randy Quarles said in a statement. ``A principal vehicle for generating these earnings was the enormous growth in the portfolio of retained mortgages, and that remains the principal legacy of this decade of abuse.''

Fannie Mae shares jumped $1.91 to $57.82 in morning trading on the New York Stock Exchange, reflecting investors' relief that the Rudman investigation had found no major new problems and had noted a ``dramatic'' improvement in Fannie Mae's corporate culture and internal organization under the current management.

Howard, Raines and Spencer couldn't immediately be reached for comment. Howard and Raines defended the company's accounting in sworn testimony at a congressional hearing in October 2004, rejecting the regulators' allegations of accounting improprieties and management misdeeds going back to the late 1990s.

Howard and Raines have certified in sworn written statements the accuracy of Fannie Mae's financial results during the period in question, 2001-2004. They would have violated a law _ enacted in response to the 2002 corporate scandals and calling for possible prison terms _ had they been aware of the accounting improprieties when they signed off. Certifying the financial statements makes it harder for executives to make the case that they relied on the advice of the company's auditors.

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. The company has been unable to file a financial report since mid-2004. The Office of Federal Housing Enterprise Oversight, which initially discovered the problems, continues its review and the Justice Department is pursuing a criminal investigation.

The findings of the Rudman report may provide additional fuel for Congress members who want to bring a tighter government hand over Fannie Mae and Freddie Mac, both created by Congress to inject money into the home-loan market.