Fannie Mae: “False signatures”
While Federal Reserve Chairman Alan Greenspan, as expected, was forcefully testifying to limit the GSEs’ ability to grow their balance sheets by playing maturity mismatch, outgoing OFHEO director Armando Falcon was continuing his implacable enumeration of deficiencies both structural (policies) and personal (their implementation) at Fannie Mae:
As with previous accounting problems we have uncovered, they reflect Fannie Mae’s tendency toward overly aggressive interpretation of GAAP, or in certain instances — when compliance with GAAP would negatively affect the company — a willful disregard of accounting rules.
They also reflect situations where Fannie Mae’s accounting policies actually do comply with GAAP, but
… topped off with what could possibly be the most troubling of all: falsifying records. As the Washington Post put it:
False Signatures Aided Fannie Mae Bonuses, Falcon Says
Fannie Mae employees falsified signatures on accounting transactions that helped the company meet earnings targets for 1998, a “manipulation” that triggered multimillion-dollar bonuses for top executives, a federal regulator said yesterday.
Portrait of two unhappy legislators
Rep. Richard H. Baker, right, who headed the House hearing on Fannie and Freddie, with Paul E. Kanjorski (D-Pa.). (Ken Cedeno — Bloomberg News)
The Post then quantifies how much was at stake:
Armando Falcon Jr., director of the Office of Federal Housing Enterprise Oversight, said the entries were related to the movement of $200 million in expenses from 1998 to later periods. The result of the changes was an increase in Fannie Mae’s 1998 earnings per share and the release of a $27.1 million bonus pool for senior executives.
Fannie Mae reported paying the following executive bonuses in 1998:
Chairman and chief executive James A. Johnson received $1.932 million
Franklin D. Raines, chairman-designate, received $1.11 million
Chief Operating Officer Lawrence M. Small received $1.108 million
Vice Chairman Jamie S. Gorelick received $779,625
Chief Financial Officer J. Timothy Howard received $493,750
Robert J. Levin, an executive vice president, received $493,750.
Raines and Howard were ousted by the Fannie Mae board in December …
Back to Falcon, and the specific charges, which are sure to be red meat for attorneys for plaintiff stockholders:
These issues include falsified signatures on journal entries …
In this context, a ‘journal entry’ is an ex post facto adjustment in bookkeeping, and thus a change from what was originally recorded, so there had best be a very good reason for doing so.
… ; failure to require that journal entry preparers understand the purpose for which the journal entry was made, or that journal entry reviewers and approvers determined that entries were valid and appropriate; failure to require that journal entries include supporting documentation; lack of independent review of journal entries; and an absence of written policy guidance concerning journal entry procedures.
OFHEO has a witness (whom we shall dub Deep Discount):
During our special examination, a Fannie Mae employee testified that from 1999 through 2002, journal entries related to amortization bearing the employee’s name and signature were, in fact, not prepared by the employee. Those entries were created after the closing process, a time when journal entries require heightened scrutiny.
In addition, OFHEO obtained testimony from an employee in the Controller’s division indicating that the employee did not have an understanding of the purpose behind certain journal entries the employee made. The employee further stated a willingness to have prepared any entry asked of the employee – and, in fact, did prepare such entries.
The “just following instructions” defense ….
Deep Discount (note, there could be more than one witness) is continuing to provide information:
During the course of the special examination,
And OFHEO is continuing to chase the matter:
OFHEO has also directed Fannie Mae to determine who falsified the signatures on journal entries, and why the falsified journal entries were not detected at the time of entry or afterward.
Beyond these easy-to-digest charges, Director Falcon’s testimony (read the whole thing here) also lists a significant number of more sophisticated (and riskier) maneuvers, each of which served to increase or stabilize Fannie Mae’s earnings during the interval when senior executives were incentivized to boost those earnings (and hence the stock price)even if they later had to be restated sharply downward.
