December 26, 2004
At Fannie, The Ties That Blind
GRETCHEN MORGENSON, NY TIMES

http://query.nytimes.com/mem/tnt.html?tntget=2004/12/26/business/26watc.html&tntemail0=&pagewanted=print&position=

AFTER hemming and hawing and bobbing and weaving, the board of directors of Fannie Mae finally jettisoned Franklin D. Raines, the mortgage finance giant's former chief executive, and Timothy Howard, its former chief financial officer, last week. They appear to have done so only under duress from Fannie's chief regulator, the Office of Federal Housing Enterprise Oversight, which in September put the company on notice that its improper accounting had vastly overstated profits and misrepresented its financial position.

The board's reluctance to defenestrate Mr. Raines and Mr. Howard, who appear to have misstated their company's financial statements to the tune of around $9 billion, fed suspicions that Fannie Mae's directors were loyal to management first, and shareholders second.

Questions of allegiance were also raised when it became clear that Fannie's directors allowed Mr. Raines to retire rather than to be fired outright. That distinction meant that he will reap millions of dollars in benefits and stock awards that he might otherwise have lost. Regulators are now investigating the compensation awarded to Fannie's executives; Mr. Raines will receive an annual pension of more than $1 million under the terms of his exit.

With a new year approaching, it seems a perfect time for the Fannie board to look hard and long at their own roles in the mess. But because nobody ever takes responsibility for wrongdoing today - especially not high-powered directors of public companies - a rigorous self-analysis from Fannie's board is unlikely.

Maybe we should do it for them.

Here's the question: Just how independent are Fannie Mae's independent directors? Under its charter, it has 18 directors. Thirteen are elected annually by shareholders and five are appointed by the president. Two presidential appointees were on the audit committee at the end of 2003, but they are no longer associated with company. President Bush has declined to appoint new directors to the board, leaving those seats vacant.

In any enormous accounting debacle, all eyes turn first to a company's audit committee. The company considers all of them to be independent.

As of last year, they included Thomas P. Gerrity, the chairman and a former dean of the Wharton School at the University of Pennsylvania; Frederic V. Malek, the chairman of Thayer Capital Partners, a private equity firm; Anne M. Mulcahy, the chief executive of Xerox; and Joe K. Pickett, the retired chief executive of HomeSide International, parent of a mortgage lending company. The two presidential appointees on the committee at the time were Taylor C. Segue III, a lawyer in Michigan at Howard & Howard; and William R. Harvey, president of Hampton University in Hampton, Va.

Fannie's audit committee is charged with overseeing the accounting, reporting and financial practices of Fannie, including the integrity of its financial statements and its compliance with regulatory requirements.

Hmmm. Sound like they sort of fell down on the job? Yes, indeed, said Greg Taxin, chief executive of Glass Lewis, an institutional advisory firm that advised Fannie shareholders to vote against all audit committee members up for re-election at Fannie Mae last year. "The point of that committee is to protect shareholders from precisely what happened here," he said. "This audit committee needs to be replaced."

A Fannie Mae spokesman said that none of the company's directors were available to comment for this article. Mr. Segue did not return a phone call seeking comment and Mr. Harvey could not be reached.

Ms. Mulcahy left Fannie's board last September, a few days before Ofheo's devastating report was made public. She joined the board of Citigroup and said that she could not be a director at two financial services concerns simultaneously. She can run, but because she became a director at Fannie in 2000 she will not be able to hide from scrutiny of the board's actions during the years it was found to have cooked its books. A spokesman for Xerox did not return a request for comment from Ms. Mulcahy.

WHILE the audit committee members had an obligation to monitor Fannie's accounting, they are not the only directors bearing responsibility for the debacle at the company. The entire board should don a hair shirt.

Take Ann Korologos. She is Fannie Mae's presiding director and the person heading the special review committee of the board. Her tenure at Fannie Mae has been long, since 1994. The vice chairwoman of the RAND Corporation board of trustees and former Secretary of Labor under President Ronald Reagan, Ms. Korologos must now oversee the investigation of Fannie Mae's accounting practices, governance and structure and executive compensation.

But Ms. Korologos's other affiliations show links to Fannie Mae. She is chairwoman emeritus of the Aspen Institute, a nonprofit group in Washington that has received $280,000 in grants from the Fannie Mae Foundation, a nonprofit arm that works for affordable housing, between 1996 and 2002. She was the institute's chairwoman for the first four of those years.

Mr. Malek, another Fannie audit committee member, joins Ms. Korologos at Aspen; he is an "active trustee" there.

(The Aspen Institute's original goal, according to its Web site, was "for American business leaders to lift their sights above the possessions which possess them, to confront their own nature as human beings, to regain control over their own humanity by becoming more self-aware, more self-correcting and hence more self-fulfilling.")

Ms. Korologos has also been a visiting fellow at the Urban Institute, which has received $2.65 million in grants from the Fannie Mae Foundation since 1990, and she sits on the corporate council of the Conservation Fund, a nonprofit group that works to protect the nation's land and water resources. The Conservation Fund has received $54,000 from the Fannie Mae Foundation since 1995.

Another recipient of Fannie Mae Foundation grants - $125,000 since 1993 - is the Federal City Council, a nonprofit organization based in Washington that works to improve the city. Ms. Korologos was the council's president from 1990 to 1995. And H. Patrick Swygert, the president of Howard University and a Fannie director since 2000, also has ties to the Federal City Council.

Fannie also considers Mr. Swygert to be independent. But Fannie employed his son in its technology unit until late last spring. And since 1989, the Fannie Mae Foundation has dispensed 35 grants to Howard University, totaling $555,186. Almost $400,000 of those grants went to the university during the years that Mr. Swygert was sitting on Fannie's board.

Then there is Mr. Malek, the private investor with close ties to Fannie managers. He is a partner with Mr. Raines in the Washington Baseball Club, which is bringing the Montreal Expos to the nation's capital.

A Fannie spokesman said the company's criteria for independence were far stricter than those of the New York Stock Exchange. Since the company changed its guidelines in 2003, donations to charities with which directors are affiliated do not exceed $100,000 a year. He said the directors acted quickly and appropriately when its regulator, Ofheo, made the findings of its investigation public. After the Securities and Exchange Commission said it had agreed with Ofheo that Fannie had misrepresented its financial position, the board chose to act more deliberately to make sure the decisions it made were the right ones, the spokesman said.

It is altogether possible that Fannie Mae's board has acted entirely properly and in the shareholders' interests at all times. But the appearance of conflicts still resonates, especially in its lumbering approach to ousting Mr. Raines and Mr. Howard.

"This board has all the classic hallmarks of a cozy, friendly board," Mr. Taxin, the institutional investors' adviser, said. "Everything from the personal and professional relationships that go back many years between all these people, to the charity and business relationships that exist.

"After being accused of billion-dollar misstatements and having received warnings from the regulator, this board really had to think quite hard whether the C.E.O. and C.F.O. had to be fired. In this era, that should have been a fairly easy decision to make."