If anyone wonders why stocks are so volatile and housing is still rising, one reason is the culture of greed that infects many of the most prominent company executives, who skim earnings, lie about their revenues and collect bonuses for performances they haven't earned. A textbook case is Fannie Mae, its upper management and ousted CEO, Franklin Raines.

"Arrogant and unethical" is how the Office of Federal Housing Enterprise Oversight (OFHEO) described Fannie Mae's corporate culture in its Special Examination. Employees, says the report, manipulated numbers to trigger bonuses for senior executives from 1998 until 2004, a period for which Fannie Mae has restated nearly 10.6 billion in income.

The exhaustive 348-page report is an indictment of cultural greed and what makes this case even more shocking, if one can be shocked after the criminal conduct of senior management at Enron, Homestore and a parade of others, is that Fannie Mae is a government-sponsored entity, even if it is a publicly-held company.

Under the leadership of CEO Franklin Raines, beginning in 1999, the company was encouraged and incentified to double earnings per share (EPS) in five years. This mandate led to a sense of entitlement that "senior management could write the rules that applied to Fannie Mae, financial rewards tied to a measure of profits that management could easily manipulate, and the relative disinterest of senior executives in adhering to standards of prudent business operations."

Among the findings outlined in the report:

• "Fannie Mae's Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its chairman Franklin Raines, and senior management, and by failing to exercise the requisite oversight over the Enterprise's operations.

• "That misconduct ultimately led to the SEC directing Fannie Mae to restate its financial results for 2002 through mid-2004, the departure of Mr. Raines and the Enterprise's Chief Financial Officer, Timothy Howard, losses of tens of billions of dollars in market capitalization for Fannie Mae shareholders, and expenses for the restatement process, regulatory examinations, and litigation the Enterprise has recently estimated will exceed $1.3 billion in 2005 and 2006 alone.

• "Improper earnings management at Fannie Mae increased the annual bonuses and other compensation linked to EPS that senior management received" (dwarfing basic salaries.) For CEO Raines, "two compensation components directly tied to meeting EPS goals accounted for more than $20 million for the six years from 1998 through 2003. Three-year EPS goals also played a crucial role in determining the size of the approximately $32 million awarded to Mr. Raines during that six-year period under a long-term executive compensation program. In total, over $52 million of Mr. Raines $90 million during the period was directly tied to achieving EPS targets."

Fannie Mae senior management basically "promoted an image of the Enterprise as a private firm whose corporate objectives were essentially identical to the federal government's public policy objectives. The message was: what is good for Fannie Mae is good for housing and the nation. Senior executives used that image and their political influence to try to ensure that Fannie Mae operated under rules that differed from those that applied to other corporations."

Folks, that's reprehensible.

The report ends with recommendations from OFHEO's staff to the Acting Director that are little more than a slap on the wrist:

• Fannie Mae must meet all of its commitments for remediation

• Fannie Mae must review OFHEO's report to take steps to improve its controls, accounting systems, risk management practices and systems, external relations program, data quality, and corporate culture.

• Fannie Mae's Board of Directors must enhance its oversight of Fannie Mae's management.

• Fannie Mae must undertake a review of individuals currently with the Enterprise that are mentioned in OFHEO's report.

• The Enterprise's growth should be limited.

As if this weren't bad enough, Raines is getting $1.4 million annually as a pension as part of his "exit." He may get to keep his ill-gotten bonuses, based on performance he didn't earn because of shortcomings in the new toothless Sarbanes-Oxley rules. According to an article by Matthew Boyle for Fortune, "They Didn't Earn It - They Should Return It," two U.S. district courts have ruled" that Sarbanes-Oxley's "Section 304 does not provide a 'private right of action,' a legal term than means shareholders cannot sue under 304."

The SEC can always seek disgorgement, requiring Raines to give back the bonuses.

Meanwhile, Fannie Mae is being fined $400 million.

Contrast investing in a company like Fannie Mae that had every advantage possible including a government sponsorship, lies to investors and loses their money, with buying a house, selling it after two years and keeping the capital gains.

So there's a leak in the pipes. At least it can be fixed.

Published: May 24, 2006

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