Affordable Housing Institute : US

O God, “give me chastity, but not yet,” Saint Augustine is reputed to have prayed, and in the latest (albeit anticipated) development in the ongoing Fannie Mae saga, the company has sued its former auditors for, in effect, not stopping its own misbehavior. 

 

“Please stop me from smoothing earnings … but not yet!”

 

As the Washington Post reports:

 

Fannie Mae yesterday sued its former auditor, KPMG, alleging malpractice by the big accounting firm when it approved years of financial statements that were riddled with errors.

 

The moving finger files a complaint, and having filed, moves on

 

Fannie Mae alleged that KPMG’s failures led to one of the biggest accounting restatements in history, involving “virtually every key accounting policy” affecting its business. The problems were so extensive that the mortgage-finance giant has spent more than $1 billion to redo its books, Fannie Mae said.

 

Reading Fannie Mae’s complaint, one might not realize that it was Fannie Mae, not KPMG, who prepared those books.

 

“KPMG often did nothing more than rubber-stamp Fannie’s internal accounting decisions, in defiance of KPMG’s professional obligations and the very purpose for which it was hired,” Fannie Mae says in the lawsuit.

 

Why is a company now suing its auditors for going along with what the company wanted to do?  Isn’t that selective amnesia?

 

 

Any company is not an individual; instead it is, in terms of its governance anyhow, a collection of constituencies, which in Fannie Mae’s case includes at least four distinct groups:

 

1. Shareholders, who own the company.
2. Taxpayers (via Congress), who have granted it valuable proprietary resources that also put taxpayers at substantial systemic risk.
3. Management, responsible to the shareholders and seeking to grow shareholder value — and not coincidentally, to enrich themselves with huge bonus packages.
4. The Audit Committee on behalf of the Board of Directors, who not only have duties to the shareholders, but especially new obligations ever since Sarbanes-Oxley.

 

It’s the difference between Group 3 and Group 4 that the lawsuit (copy here in .pdf) is at such great pains to emphasize.

 

It was his fault.

 

While the lawsuit blames KPMG for the accounting troubles, regulators have alleged that Fannie Mae deliberately and fraudulently violated accounting requirements.

 

Under the Sarbanes-Oxley statute independent directors — and especially their Audit Committee — have an increased duty not simply to be careful observers of management, but even more to be active watchdogs with a devil’s-advocacy skepticism about anything management is telling them.  

 

Now, you should be on the Audit Committee, son.

 

Here, from one of my earlier posts, is how OFHEO saw the board’s (in)activity:

 

To hear OFHEO tell it, the board was at best somnolent:

 

The Board of Directors and its committees failed to meet the safety and soundness obligations set forth in OFHEO corporate governance regulations and other applicable standards for corporate governance.  The members of the Board were all knowledgeable and qualified individuals, fully capable of understanding the business and corporate governance duties with which they were charged. The sophisticated and prestigious members of the Board failed:

 

·         To stay appropriately informed of corporate strategy

·         To assure appropriate delegations of authority

·         To ensure that Board committees functioned effectively

·         To provide an appropriate check on Chairman and CEO Raines

·         To hire and retain a qualified senior executive officer to manage the internal audit function

·         To initiate independent investigations of Fannie Mae, and

·         To ensure timely and accurate reports to federal regulators. 

Page 10.

 

“Take Sarban-Ox tonight, and sleep, safe and restful, sleep, sleep, sleep“

 

Under Sarbanes-Oxley, failure of the Audit Committee to uncover management wrongdoing is a highly risky proposition, exposing the affected directors to personal as well as professional liability.  What defenses have the audit committee members?  Faced with actual lawsuits from shareholders and threatened lawsuits from OFHEO (subsequently filed on Monday, December 19), the new Fannie Mae all but had to sue KPMG.

 

Fannie Mae’s lawsuit covers audits for 2001 through 2003, including work performed after the accounting debacle at Enron heightened awareness of audit risks and led to the downfall of KPMG’s rival, Arthur Andersen.

 

Fannie Mae, which is seeking more than $2 billion, employed KPMG for more than 30 years, and it paid KPMG more than $28 million from 2001 through 2003, the suit says. The accounting firm wore two hats in the relationship — for example, advising Fannie on how to comply with a new accounting rule and then auditing Fannie’s compliance, the lawsuit said.

 

Problems?  What problems?

 

Now, that is a Sarbanes-Oxley extreme no-no, although as a former FHA Commissioner once said indignantly to me in an elevator, “Hey!  It’s wasn’t illegal when I did it!” 

 

 

Just as Arthur Andersen’s split of what became Accenture, in October, 2002 (while all this was going on!) KPMG put its consulting group into their very own dinghy, labeled BearingPoint.

 

You fellows enjoy the auditing business, you hear?

 

The chief accountant at the Securities and Exchange Commission reviewed Fannie Mae’s compliance with that rule in December 2004 and concluded that it was “not even on the page,” the lawsuit said.

 

Note that the SEC’s broadside occurred some time after the questionable reporting methods.

 

In a 2004 report, the Office of Federal Housing Oversight quoted a senior vice president of the company as saying Fannie Mae had “several known departures” from generally accepted accounting principles and that the company had cleared them with its auditors.

 

In a May report, OFHEO accused the audit committee of the company’s board of directors of exercising “little, if any, meaningful or active oversight.”

 

Given statements like these, it should be little wonder that OFHEO too was pondering (and promptly filed) its own litigation against Fannie Mae.

 

OFHEO director James B. Lockhart III issued a statement yesterday saying Fannie’s complaint against KPMG was appropriate and consistent with the agency’s findings.

 

Therefore, for Fannie Mae’s current management and current and past Audit Committees, might not the best defense be a good offense?

 

Off-ense!

 

Fannie Mae’s lawsuit defends the audit committee, which was headed by Thomas P. Gerrity, a former dean of the Wharton business school at the University of Pennsylvania.  “The Audit Committee was diligent in performing its duties and properly relied on KPMG’s continuing assurances,” the suit says.

 

Sure am glad that’s cleared up.

 

 

Actually, the once-and-present KPMG will almost certainly have to sue Fannie Mae in return:

 

KPMG spokesman Tom Fitzgerald declined to address the allegations in the lawsuit.  However, he said that the firm intends “to pursue our own claims against Fannie Mae.”

 

I should think we can count on it — and it’s more than likely that KPMG will also sue BearingPoint, its former self.  (Enron bankrupted Arthur Anderson, and $2 billion claim plus a government complaint is enough to motivate any large public accounting firm.)

 

KPMG will probably allege fraud, citing such things as false signatures, while Fannie Mae will swing its own mud at now-departed KPMG partners:

 

One of the senior KPMG accountants involved in auditing Fannie Mae, Joseph Boyle, was also involved in disputed KPMG audits of Xerox, the lawsuit says. Without admitting or denying wrongdoing, Boyle last year agreed to an SEC order in the Xerox case suspending him from auditing public companies.

 

Boyle, who retired from KPMG in 2003, did not return a call seeking comment, and neither did a lawyer who represented him.

 

Retired, but far from forgotten.

 

Think that’ll cover the attorneys’ fees?

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