COSO and The Office

COSO and the American version of "The Office" meet.

This is the result.

Fannie Mae's Corrupt Corporate Culture

An arrogant and unethical corporate culture

The Federal National Mortgage Association – commonly known as Fannie Mae – is a corporation sponsored by the United States Government. It was created in 1938 as a secondary market for mortgages insured by the US Federal Housing Administration.

It is the second largest borrower in the world, only behind the United States government.

In the late 1980s and the 1990s, Fannie Mae grew rapidly into the largest firm in the US housing finance system and a major global financial institution. It achieved double-digit growth in earnings per share for 15 straight years and leveraged its extraordinary financial success into enormous political influence.

Fannie Mae’s corporate culture was intensively focused on attaining earning per share goals.

Decisions by the CEO set an inappropriate tone at the top that permeated throughout his chairmanship.

The message from the CEO was clear: EPS results mattered, not how they were achieved.

The United States Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight (“OFHEO”) recently announced a settlement with Fannie Mae that includes $A531 million in penalties for what it called an “extensive financial fraud” undertaken over six years by doctoring earnings so executives could collect hundreds of millions of dollars in bonuses.

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The regulatory examination found an environment where the ends justified the means.

Senior management manipulated accounting; reaped maximum, undeserved bonuses; and lied to investors.

OFHEO recently released a 300 page report after a two year review involving examining nearly 8 million pages of documents.

The key findings included:

• Fannie Mae’s senior management promoted an image of the company as one of the lowest risk financial institutions in the world and as “best in class” in terms of risk management, financial reporting, internal control and corporate governance. The findings showed that this was a façade.
  
• A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (“GAAP”). The company also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by an estimated $US10.6 billion.
  
• During the period covered by the report – 1998 to mid 2004 – Fannie Mae reported extremely smooth profit growth and hit announced targets for earnings per share precisely each quarter. Those achievements were illusions deliberately and systematically created by senior management with the aid of inappropriate accounting and improper earnings management.
  
• By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximised the bonuses and other executive compensation they received, at the expense of shareholders.
  
• Fannie Mae’s Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its Executive Chairman; failing to exercise the requisite oversight over the operations and failing to discover or ensure the correction of a wide variety of unsafe and unsound practices, even after similar industry problems became apparent.
  
• Senior management did not make investments in accounting systems, computer systems, other infrastructure, and staffing needed to support a sound internal control system, proper accounting and GAAP consistent financial reporting.

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The failings of Fannie Mae were also a failing of their Office of Internal Auditing.

Most inappropriately Mr Rajappa, Senior Vice President for Operations Risk and head of Fannie Mae’s Office of Auditing gave a speech to his internal auditors which encapsulated the tone at the top and corporate culture under the CEO’s – Mr Frank Raines – stewardship:

“By now every one of you must have 6.46 (reference to EPS target) branded into your brains. You must be able to say it in your sleep, you must be able to recite it forwards and backwards, you must have a raging fire in your belly that burns away all doubts, you must live, breath and dream 6.46, you must be obsessed by it … Remember, Frank has given us an opportunity to earn not just our salaries, benefits, raises, ESPP, but substantially over and above if we make 6.46"

The failures of the Office of Auditing manifested themselves in a variety of ways:

• The Office’s audit program failed to properly confirm compliance with GAAP as specified in its audit objectives or to consistently audit critical accounting policies, practices, and estimates in a timely way.
  
• Internal Audit reports prepared by the Office consistently understated problems and overstated work accomplished.
  
• Rather than undertaking independent work to confirm compliance with policies and procedures, the Office relied on the managers of the units under audit to confirm compliance.
  
• In addition, the Office had insufficient staff and insufficient expertise at a time when demands on it were increasing due to the increased size and complexity of Fannie Mae’s business, major information technology transformation projects and new assignments.
  
• The Office of Auditing failed to exercise due professional care in investigating allegations of accounting improprieties raised by an employee of the Office of the Financial Controller.
  
• The Office’s communications to the Audit Committee of the Board of Directors were frequently incomplete and inadequate, thereby violating its own Board-approved Charter and best practices.