OFHEO Finds Accounting Irregularities With Fannie Mae, SEC to Investigate

WASHINGTON – In June 2003 it was Freddie Mac that was called on the carpet for accounting irregularities. Now it’s Fannie Mae’s turn. A little more than a year after housing Government Sponsored Enterprise Freddie Mac disclosed it had understated profits by about $4.5 billion for 2000-2002, federal regulators have uncovered serious accounting problems at Fannie Mae, prompting an inquiry by the Securities and Exchange Commission and calling into question the company’s financial soundness. On Sept. 20, the Office of Federal Housing Enterprise Oversight (OFHEO) which regulates the housing GSEs and has been conducting a special examination of Fannie Mae’s accounting policies and practices for over a year, sent a report to the GSE’s board that found earnings manipulation, lax internal controls and a corporate culture “that emphasized stable earnings at the expense of accurate financial disclosures,” a letter to Fannie Mae’s board read. Fannie Mae Board’s Audit Committee was charged with overseeing the company’s response to the OFHEO’s examination. The Office of Federal Housing Enterprise Oversight says its findings “are serious and raise doubts concerning the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision, and the overall safety and soundness of the Enterprise,” a statement from Fannie Mae presiding director Ann McLaughlin Korologos read. According to Korologos’ statement, OFHEO found that Fannie Mae: (1) “applied accounting methods and practices that do not compy with GAAP in accounting for the enterprises derivatives transactions and hedging activities”; (2) “employed an improper `cookie jar’ reserve in accounting for amortization of deferred price adjustments under GAAP; (3) “tolerated related internal control deficiencies”; (4) “in at least one instance deferred expenses apparently to achieve bonus compensation targets” and (5) “maintained a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures.” Korologos said Fannie Mae’s board “has pledged its full cooperation with the regulators” in their investigation of the OFHEO’s report. The board has designated a committee made up entirely of independent directors to take the lead on both the OFHEO report and the SEC inquiry, and the board has retained independent counsel, former Sen. Warren Rudman of Paul, Weiss, Rifkind, Wharton & Garrison LLP to serve as counsel to the committee. The law firm in turn will retain an independent accounting firm to assist in the review of the OFHEO’s report findings. In October 2003, Fannie Mae disclosed a $1.2 billion accounting error for the third quarter of that year. The GSE said the error was caused by a change in accounting rules and didn’t affect the company’s net income. In July 2004, Fannie Mae released its second quarter 2004 financial results which the company said showed “a return to positive portfolio growth, exceptional credit results.” Among the results of that report, Fannie Mae said its net income was up 0.9% from the second quarter 2003. The disclosed accounting problems by Freddie Mac in June 2003 led to hearings by the House Financial Services Committee and an initiative to create a new federal agency to regulate and supervise the housing GSE. Secretary of Treasury John Snow was among those who testified and suggested that Congress enact legislation creating the new federal agency as a bureau of the Treasury. In July 2003, the Senate Banking Committee held a hearing on the regulatory oversight of the GSEs. In August, Sen. Chuck Hagel (R-Neb.) introduced legislation to regulate GSEs – the Federal Enterprise Regulatory Reform Act of 2003. Back on the House side, House Financial Services Committee Chairman Michael Oxley (R-Ohio) held a hearing Sept. 11 on H.R. 2575 – the Secondary Mortgage Market Enterprises Regulatory Improvements Act – introduced by Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee Chairman Richard Baker (R-La.) to strengthen the regulation of Fannie Mae and Freddie Mac. The bill was referred to the subcommittee in July 2003. -