A week after the release of a scathing report by its federal regulator, mortgage giant Fannie Mae agreed to major changes in its accounting, internal controls and management practices.
The agreement between Fannie Mae and its overseer, the Office of Federal Housing Enterprise Oversight, comes on the heels a highly critical OFHEO report that cited accounting irregularities and earnings management by the company. Fannie Mae, which is publicly traded, is also the subject of an informal investigation by the Securities and Exchange Commission, and a preliminary criminal investigation by the Department of Justice.
Under a deal signed in late September, the mortgage company agreed to significantly boost its capital reserve within the next nine months and to implement accounting treatments that would bring it into compliance with Statement of Financial Accounting Standards 91 and SFAS 133, including recalculating its transactions for derivatives going back to 2001.
Fannie Mae also agreed to appoint an independent chief risk officer and to a review of organizational, structural, and staffing and control issues, focusing on the chief financial officer, controllers, accounting, audit, financial reporting, business planning and forecasting, modeling, and financial standards functions.
"We are in full support of today's agreement. Working with the board and the company's regulators, we will begin to take steps immediately to comply with and implement the terms of the agreement," said Fannie Mae chairman and chief executive Franklin D. Raines.
As part of the agreement, Fannie's board will appoint a compliance committee made up of at least three outside directors to monitor the implementation of the agreement. The board or its compliance committee will also hire an independent counsel and an independent accounting firm, subject to OFHEO's approval, to conduct reviews of the company's accounting policies and practices, and agreed to give those firms full access to its books, records, e-mails, staff and resources.
"The serious concerns raised in OFHEO's report require prompt action," OFHEO director Armando Falcon Jr. said. "This agreement is an important step toward resolving these concerns and helping to assure safe and sound operations at the enterprise."
Earlier, OFHEO had raised the possibility of removing Fannie Mae's top management, after it said in a report that Fannie Mae applied accounting methods and practices that don't comply with GAAP in accounting for derivatives transactions and hedging activities, employed an improper "cookie jar" reserve in accounting for amortization of deferred price adjustments under GAAP, tolerated related internal control deficiencies, and, in at least one instance, deferred expenses in an effort to achieve bonus compensation targets.
In a letter to Fannie Mae's board last week on the results of the OFHEO report, Falcon wrote, "These findings cannot be explained as mere differences in interpretation of accounting principles, but are clear instances in which management sought to misapply and ignore accounting principles for the purposes of meeting investment analyst expectations, reducing volatility in reported earnings, and enabling fragmented processes and systems, and an ineffective controls environment, to exist."
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