Bad Culture at the Top Equals Accounting Fraud at Fannie Mae

Fannie Mae reached a settlement in its $11billion accounting scandal with the Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight (“OFHEO”).  Under the terms of the settlements the company agreed to pay a total civil penalty of $400 million.  

The SEC complaint, based on alleged violations of the antifraud and reporting provisions of the securities laws, stated that from 1998 to 2004 Fannie Mae failed to comply with FAS 91, which requires companies to recognize loan fees, premiums and discounts as an adjustment over the life of the applicable loans.  In the fourth quarter of 1998 by not recording the full FAS 91 adjustment, the company overstated income to meet certain targets and understated expenses.  In the following periods, according to the complaint, Fannie Mae used a “precision threshold” to determine the amount of the FAS 91 adjustment despite the fact that there is no support in the literature for such an adjustment.  The company also misapplied FAS 133, which concerns accounting for derivate instruments and failed to comply with the requirements of that statement.   The complaint alleged other accounting irregularities including improper practices involving the estimation and eminence of the loan loss reserve, the amortization of debt issuance costs and the consolidation of certain securitization transactions. These acts and practices were directed and/or implemented with the knowledge or approval of Fannie Mae’s senior management according to the complaint.  The company’s historical financial statements will be restated.
The report by OFHEO stated that Fannie Mae’s financial results were “illusions deliberately and systematically” created by its top executives.  During the period approximately half of the CEO’s compensation was tied to earnings targets.  According to the OFHEO report the company had an “unethical and arrogant culture” at the top during the period of the accounting irregularities.  OFHEO, which suggested in its report that Fannie Mae tried to interfere with its investigation, gave the company 60 days to determine whether those involved in the irregularities should remain with the firm.  

The SEC stated that “the Commission considered the cooperation that Fannie Mae provided the Commission staff during its investigation” in determining to accept the offer of settlement which resulted in the entry of a statutory injunction and payment of the fine. SEC v. Federal Nation Mortgage Association, Case No. 06-00959 (RBW) D.D.C. (May 23, 2006).  LR-19710.