Fannie Mae Accounting Scandal Essay

An accounting scandal is described as a business scandals that stems from intentional manipulation of financial statements with the disclosure of financial misdeeds by trusted executives of corporations or governments. Inappropriate accounting practices more often than not amount to fraud. These fraudulent acts are investigated by government agencies and often change the reputation, structure, and prosperity of a company.
Fannie Mae (Federal National Mortgage Association, or FNMA) was established in 1938 during the Great Depression as part of the New Deal. FNMA is a government sponsored enterprise (GSE) - a publicly traded company which operates under a Congressional charter. Fannie Mae was created to stimulate homeownership and expand the

liquidity of mortgage money by creating a secondary market. The corporation buys mortgages on the secondary market, pools them and sells them as mortgages-backed securities to investors on the open market. Fannie Mae channels its efforts into increasing the availability and affordability of homeownership for low-, moderate- and middle-income Americans. (Investopedia)
On September 22, 2004 The Office of Federal Housing Enterprise Oversight (OFHEO) released a report stating that Fannie Mae had ‘funny accounting practices’.

The corporation had widespread accounting errors, including shifting of losses. This report opened up the examination of FNMA.
The senior managers at Fannie Mae repeatedly engaged in questionable acts. FNMA completed two transactions through investment banking firm Goldman Sachs Group Inc., where $107 million of Fannie Mae’s earnings were improperly pushed into future years. This technique shaped the company's books to appear as if the company had reached earnings targets. The appearance of higher earnings prompted its executives, including Franklin Raines (former CEO), Timothy Howard (former CFO) and others, to receive the maximum payout possible. (Day)
The Office of Federal Housing Enterprise Oversight (OFHEO) report found significant problems with the way Fannie Mae’s accounting results were generated and reviewed. Individuals involved in the process were burdened by “heavy workloads, weak technical skills, and a weak review environment.”(Cristie, 17) Under the reported conditions, OFHEO found that accounting operations relied on a few individuals with widespread discretion. In this type of environment, the process for developing new accounting policies is ineffective, and internal controls are weak or non-existent. The company was governed by a weak board of directors, who failed to install basic internal controls and

were left uninformed by Franklin Raines and Timothy Howard. (Cristie, 17)
From 1998 to 2004, the company's financial results were smoothed as a result of the misapplication of certain Generally Accepted Accounting Principles (GAAP); specifically rules relating to the amortization of loan fees, premiums and discounts, and rules involving hedge accounting, known as SFAS 133.

In both cases, Fannie Mae recognized that the company was departing from GAAP, but it failed to consider whether the departures were quantifiable. Senior management defended the company’s accounting practices by saying there was simply a disagreement over FASB (Financial Accounting Standards Board) accounting standards.

(Day)
The Securities and Exchange Commission (SEC) did not agree with senior executives, and ruled that Fannie Mae would have to restate its earnings for the past 3½ years (2001-mid 2004). The SEC required that Fannie Mae: 1. Correct its accounting practices related to SFAS 91 and 133, 2. Supplement its capital surplus by an amount equal to 30% of the required minimum capital, 3. Review staff structure, responsibilities, independence, compensation, and incentives, 4. Appoint an independent chief risk officer and separate key business functions now performed jointly by certain individuals or departments, and 5. Put in place new controls and policies to assure adherence to accounting rules. The agreement also bared the company from buying and holding home loans for its own investment portfolio, one of its most profitable but risky business lines. Another requirement was to review the conduct of former and current executives. (Day)
Fannie Mae agreed, without admitting or denying the allegations, to an injunction for violations of Section 17(a) (2) and (3) of the Securities Act of 1933. The terms of the settlement required Fannie Mae to pay a $400 million penalty that was jointly negotiated by The Office of Federal Housing Enterprise Oversight and the Securities and Exchange Commission. The 340 page report declares "The conduct of Mr. Raines, CFO Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity. Those individuals engaged in improper earnings management in order to generate unjustified levels of compensation for themselves and other executives." During the six years of connection to improper accounting practices Raines received $52.8 million in bonuses. (Day)
The company was required to fire Raines and Howard, thus the board pressured CEO Franklin Raines and CFO Timothy Howard to leave the company. In 2004 CEO Raines was allowed to retire and CFO Howard resigned, both executives received severance packages. CEO Raines's attorney Robert Barnett said in a prepared statement that Raines "has repeatedly stated that he never authorized, encouraged, or was aware of violations" of accounting rules but, "strongly believes that, as the leader of Fannie Mae, he should be accountable for what happened within the organization, regardless of personal involvement or fault." (Day) CFO Howard made no comment.
Ultimately, Fannie Mae fell victim to fraudulent accounting practices orchestrated by those with excessive much power. Companies must beware of weak internal controls and fraudulent employees, these issues can easily lead to unfortunate events. Fannie Mae has since recovered but this accounting scandal will live in infamy.