Report Is Kind to Fannie Mae

Raines didn't know the accounting was bad, Rudman concludes.
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Updated from 8:24 a.m. EST

Ousted

Fannie Mae

(FNM)

CEO Franklin Raines was unaware that the mortgage company's accounting practices departed from generally accepted principles, an investigation led by former Sen. Warren Rudman concluded Thursday.

The investigation, conducted over a year at the request of Fannie Mae's board, did find that Raines "contributed to a culture that improperly stressed stable earnings growth and that, as the chairman and CEO of the company from 1999 through 2004, he was ultimately responsible for the failures that occurred on his watch."

Raines left the company in December 2004 as the accounting scandal exploded. The company, which was set up by Congress to create a secondary market in home loans, is in the process of a massive financial restatement that could lop $11 billion off its previously reported earnings.

No major recommendations for reforming Fannie's management structure were offered, with the authors noting that that the company already has put into place many "significant corrective measures.''

The report from Rudman, now a partner with the New York law firm Paul Weiss Rifkind Wharton & Garrison, will be a disappointment to short-sellers anticipating a new round of damaging revelations.

In fact, shares of Fannie were rallying Thursday, even as the broader market indices were trading in the red. In early trading, shares of the government-sponsored mortgage finance firm were up $1.49, or 2.6%, to $57.40.

"Fannie Mae is a different company than a year ago,'' said Fannie CEO Daniel Mudd in a statement. "We have been humbled, even embarrassed. But we have begun to make significant changes.''

Rudman's inquiry laid most of the blame for Fannie's accounting malfeasance on the company's former chief financial officer, Timothy Howard, and its former controller, Leanne Spencer. The two "were primarily responsible for adopting or implementing accounting practices that departed from GAAP and that they put undue emphasis on avoiding earnings volatility and meeting EPS expectations and growth targets," the report found.

Howard did not cooperate with Rudman's legal team during its investigation. The report notes that the former CFO declined "repeated requests for interviews.'' Spencer, meanwhile, initially cooperated, but then stopped after lawyers discovered she had withheld a "critical document'' from them.

Overall, the report is kind to Fannie Mae's current management, concluding there has been "a dramatic shift in the 'tone at the top' and the company's internal organization." The report says "no member of management who we found knowingly participated in improper conduct continues to be an employee of the company," and said appropriate changes in corporate governance "either have been implemented or are underway."

The inquiry also concluded that, with only one exception in 1998, there's no evidence that Fannie Mae's accounting shenanigans "were motivated by a desire to maximize bonuses" triggered by financial milestones. Rather, "management's adoption of certain accounting policies and financial reporting procedures was motivated by a desire to show stable earnings growth, achieve forecasted earnings, and avoid income statement volatility."

Rudman's team reached another conclusion that is consistent with previous findings: that Fannie Mae's accounting department was rank with unqualified people who either didn't understand their roles or failed to carry them out properly.

The Rudman report, however, doesn't mean an end to the scandal at Fannie.

The company must still complete restatement and file its updated financial reports. The firm's main regulator, the Office of Federal Housing Enterprise Oversight, is continuing to investigate the accounting irregularities, along with the

Securities and Exchange Commission

.

Legislators in Congress also continue to push for a bill that would stiffen the regulatory oversight of Fannie and its sister company,

Freddie Mac

(FRE)

. Some in Congress also want to limit the powers of both government-sponsored firms to buy mortgages and repackage them as mortgage-backed securities.

Fannie hasn't provided an estimate for the cost of the Rudman report. But is has estimated that it would spend more than $560 million last year to cover the costs associated with the restatement and related investigations.