IT COULD BE A LONG WINTER FOR FANNIE Mae. In late September, the Office of Federal Housing Enterprise Oversight (OFHEO), Fannie's government regulator, issued a report of its findings to date in a special examination investigating the company's accounting practices.
The report contends that Fannie, a government-sponsored enterprise (GSE), has misapplied generally accepted accounting procedures (GAAP). OFHEO criticized the company for its management's desire to minimize earnings volatility and for consciously violating GAAP in 1998 to maximize executive bonuses.
Franklin Raines, Fannie Mae's chairman and CEO, disagreed with OFHEO's assertion that the company's fixed its accounting practices to inflate bonuses. Fannie's accountants, he also said, determined that the company's policies and practices are in accord with GAAP, adding, “We want to demonstrate that we intended to do the right thing and we took care to do the right thing.”
Though Fannie Mae's board of directors admitted no wrongdoing, it signed an agreement shortly after the report's release to make changes in areas called for by OFHEO. Fannie will begin keeping more cash on hand, building up to a 30 percent capital surplus by June 2006. In addition, it will separate some of the functions OFHEO found to be in conflict of interest by appointing a chief risk officer and splitting business planning and forecasting off from the controller's office; the company also agreed to adjust its criticized accounting procedures to follow OFHEO's guidelines.
But those moves won't make Fannie's problems disappear. In its agreement with OFHEO, the board announced plans to commission its own probe of the company's accounting practices, led by former Sen. Warren Rudman. Shortly after the report's release, the board also altered the contracts of top executives, making them easier to terminate.
There's more: The U.S. Department of Justice has launched its own criminal investigation, and OFHEO's examination of the company's practices continues. Ultimately, though, OFHEO and Fannie Mae agree that the Securities and Exchange Commission (SEC) will likely be the final arbiter. The SEC opened a formal investigation in October, which gives the agency power to subpoena witnesses and documents. “It will take some time to play out,” says Mike McMahon, an analyst with Sandler O'Neill & Partners investment bank, who reduced his rating of Fannie Mae from “buy” to “hold” based on the OFHEO report.