Days after Fannie Mae's federal regulator released a highly critical report on the mortgage giant's accounting practices, observers say top management may not survive the fallout.
Fannie Mae's regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), conducted an eight-month investigation and found such pervasive problems that OFHEO suggested a management change.
“These findings cannot be explained as mere differences in interpretation of accounting principles, but clear instances in which management sought to misapply and ignore accounting principles," OFHEO Director Armando Falcon said in the letter to Fannie Mae's board, Reuters reported.
The report said that Fannie Mae failed to apply generally accepted accounting principles, manipulated earnings to lessen the appearance of volatility and aimed to meet Wall Street's profit expectations and hand out generous bonuses to executives.
The letter outlined steps the company should take, including having non-management directors correct accounting irregularities, strengthening the company's capital position and tightening internal controls. Falcon said in the letter, "We must consider the accountability of management and whether we have sufficient confidence in management to fully implement these corrective measures.”
Reuters reported that most of the blame in the report is laid on Chief Financial Officer Timothy Howard, although the responsibility may fall on the shoulders of Chief Executive Franklin Raines.
"If you look at what major corporations are doing, where there are widespread failures relating to accounting practices, both the CEO's and the CFO's heads roll," said Jacob Frenkel, a former Securities and Exchange Commission enforcement lawyer and federal prosecutor.
CBS News reported that the company on Thursday made amendments to work agreements with Raines, Howard, and Chief Operating Office Daniel Mudd that tightened the definition of the circumstances by which an executive can be fired for "cause." The new terms say "cause" constitutes being convicted of, or pleading no contest to a felony, or if the executive "materially harms" Fannie Mae through fraud, dishonesty, willful misconduct or doing their job in a grossly negligent manner.
The amendments to the work agreements must be approved by the director of OFHEO.
Meanwhile, a law firm claims Fannie Mae's false statements pumped up its stock price. The suit says the company deferred expenses to meet targets that would trigger pay bonuses and improperly accounted for its enterprise's derivatives transactions and hedging activities.
The law firm of Cohen Milstein Hausfeld & Toll PLLC said the class period runs from Oct. 11, 2000, to Sept. 22, 2004.
Fannie Mae officials have retained outside counsel and will hire an independent auditor to respond to regulators.