Two top executives and auditor KPMG are out this week at Fannie Mae, following the Securities and Exchange Commission's decision that the mortgage giant violated accounting rules, leaving it faced with a massive restatement.

One week after the SEC said that some of Fannie Mae's practices violated accounting rules and asked it to restate past earnings, the company announced the retirement of chairman and chief executive officer Franklin D. Raines and the resignation of vice chairman and chief financial officer J. Timothy Howard.

In addition, the company's audit committee dismissed accounting firm KPMG LLP and has started a search for a new independent auditor.

Through a spokesman, the firm said, "We believe that Fannie Mae's accounting was grounded in the principles of FAS 133; however, we respect the decision of the chief accountant of the SEC. While we understand the audit committee's decision to change auditors, it is certainly disappointing but not unexpected. We will continue to work with the regulators and the company's new management to assist in a smooth transition."

The SEC said that from 2001 to mid-2004, Fannie Mae's accounting practices didn't comply with the accounting requirements related to accounting for deferred purchase price adjustments and for derivatives and hedging activities, and advised the company that it should, among other things, restate its financial statements to eliminate the use of hedge accounting.

The Public Company Accounting Oversight Board reportedly opened an investigation into KPMG's audits of the mortgage finance company. The Big Four firm has served as Fannie's auditor since 1969. KPMG said last week that it would "cooperate fully and thoroughly" with any PCAOB investigation. Fannie Mae is already under investigation by the Justice Department and the SEC.

The commission's findings were a blow to Fannie Mae executives, who have contended that its accounting methods were proper. Raines defended the company's accounting practices before members of Congress back in October. Under Sarbanes-Oxley, CEOs and CFOs must certify the accuracy of the financial statements, and could face jail time if they knowingly misrepresent a company's condition.

Fannie Mae had warned in November that if its accounting for some derivatives was deemed incorrect, it could have to restate earnings and report an after-tax loss of $9 billion on those transactions, and that if its accounting under FAS 91 was deemed noncompliant, it could report an after-tax loss of $26 million.

The company said that, effective immediately, board member Stephen B. Ashley will become the non-executive chairman of the board, while vice chairman and chief operating officer Daniel H. Mudd will serve as interim CEO, and executive vice president Robert Levin will serve as interim CFO. The board has hired executive search firm Spencer Stuart.

"We appreciate the many contributions of Frank Raines and Tim Howard, their devotion to Fannie Mae and their commitment to its mission," Ann Korologos, director of the non-management members of the board, said in a statement. "Fannie Mae's board of directors takes these steps today to move the company forward to serve its critical mission in a safe and sound manner."

The board said that the company is working to comply with Fannie Mae's Sept. 27 agreement with its regulator, the Office of Federal Housing Enterprise Oversight. That agreement was the result of a scathing report by the OFHEO that alleged widespread accounting manipulations at the company, including an allegation that Fannie Mae willfully violated generally accepted accounting principles back in 1998 in order to maximize executive bonuses.

"We are mindful of our obligations under the agreement with OFHEO, we are working diligently in cooperation with OFHEO to comply with the agreement, and we are making progress on implementing its terms," said H. Patrick Swygert, the board member who leads the compliance committee established to oversee implementation of the OFHEO agreement.

To that end, measures taken so far include the hiring of independent organizational and compensation consultants; submission and approval of an implementation plan for the agreement; and the submission of work plans for the organizational and compensation reviews. Board member Donald B. Marron is leading the work on the company's capitalization plan.

The board also said that the independent investigation commissioned by its Special Review Committee is proceeding to look into the findings of the OFHEO's Sept. 21 report. The investigation, led by former Senator Warren Rudman of the law firm of Paul, Weiss, Rifkind, Wharton & Garrison, is focused on accounting issues, organization, structure and governance, and executive compensation.

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