Panel III of a Hearing of the Capital Markets Subcommittee of the House Committee on Financial Services - The OFHEO Report
Federal News Service October 6, 2004 Wednesday
HEADLINE: PANEL III OF A HEARING OF THE CAPITAL MARKETS SUBCOMMITTEE OF THE HOUSE COMMITTEE ON FINANCIAL SERVICES SUBJECT: THE OFHEO REPORT: ALLEGATIONS OF ACCOUNTING AND MANAGEMENT FAILURE AT FANNIE MAE
CHAIRED BY: REPRESENTATIVE RICHARD H. BAKER (R-LA)
WITNESS: ANN MCLAUGHLIN KOROLOGOS, PRESIDING DIRECTOR, BOARD OF DIRECTORS, FANNIE MAE
BODY:
BREAK IN TRANSCRIPT
REP. SCOTT: Thank you very much, Mr. Chairman. I wanted to ask-go back to a line of questioning I started with Mr. Raines, which I think gets to the fundamental problem that has been brought before this committee, and that is that your board made the decision to tie the compensation bonuses to earnings per share.
Can you comment on that? And I think it's very important that I reaffirm Mr. Raines's comment that this preceded him, because I think there are several things that I am very concerned about. One is the credibility of Mr. Raines who runs the department, which means the credibility of Fannie Mae. This serves a very, very important constituent for all of us across the country who are concerned about making sure we have adequate housing and affordable housing for all income levels.
But I'd like to find out why you, why that board believed it was appropriate to link executive compensation to earnings per share, and whether or not this move or this compensation scheme resulted in inappropriate incentives for management. I think that unless we can clear that and try to find, get some common ground on that issue, especially as I mentioned with the chart that Mr. Baker has provided this committee-which I am sure we're not the only ones that are going to see that chart-it's going to see some stark comparisons between what the actual salary is and what those bonuses are. So there's certainly meat for incentives here. And I think this might be something we want to share. Could you give me your comments on why you felt this was appropriate?
MS. KOROLOGOS: I would be happy to. Again, I've only been on the board since 1994, but in both my experience at Fannie Mae and many other corporate boards, in some places where I'm also on comp committees, earnings per share was a very acceptable incentive, if you will, generally combined with others. Different companies did it different ways. So you're not talking about a company that was the only one. I wanted to make that clear.
Why was that? Well, in the '80s, late '80s early '90s, the acceptable philosophy for compensation, besides always in some way being performance based, was to tie management to the shareholder, and earnings per share is one way to do that-likewise options which we saw become out of favor and the like.
In a way I would think we would all take comfort. At Fannie Mae it's a much more even transparent process than at other companies, precisely because we are a GSE. Unlike other public companies, the amount our executives make is somewhat dictated by law, and the law states that OFHEO is required to ensure that Fannie Mae's compensation programs are reasonable and comparable with compensation for employment in similar industries. We use the comparability test of looking at peer companies and the like, and structuring not only the earnings-per-share measurement, but in other aspects as well, both tangible and intangible performance measures and the like. So you generally have salary, you have bonus, you have long-term, you have short-term kind of incentives. So you try and strike a balance between financial and non-financial measures.
Earnings per share for purposes of this report seems to have jumped out, and you have questions-quite a legitimate one. I would only say that it is becoming in recent years, because of incentives leading in some companies to behavior that wasn't intended to relook at compensation, and there's a lot of different mixes going on.
REP. SCOTT: You've seen the report that was presented before the committee --
MS. KOROLOGOS: I actually did not see the paper that was handed out. No, I haven't.
REP. SCOTT: But you are familiar with the bonus and the structure and a comparison --
MS. KOROLOGOS: Yes, sir, very much so.
REP. SCOTT: Do you feel that that-do you stand by that? Do you feel that that is --
MS. KOROLOGOS: I stand by what we did, yes. I certainly do. And I think that I have found again my experience on a number of other boards it's always a work in progress. We use outside consultants as well, is what I wanted to assure you. So this is not something we plucked out of the air and allowed to hang out there to be abused in any way, shape or form.
REP. SCOTT: I think this is very important to get on the record because, you know, as I said earlier, there have been some very strong accusations made against Fannie Mae, and I want to make sure you have a chance to respond to that. And if I may continue, in view of that what changes, if any in corporate governance and some of these compensation policies that the board is considering to address in relationship to the issues that have been raised by this report, as you have seen the report-and, again, I too question the timing of it, and I think there probably are some motivations there. People say politics isn't a part in it, but you really can't take politics out of politics. And I believe really as a result of today's hearings that politics is certainly manifested in what we have here.
But having said all of that, OFHEO has given a report. Are you going to make any changes in the way you operate if so, in governance and in compensation as a result of this report in some of the issues that it has pointed out that you know it runs the gamut of misapplied accounting rules, the guarantee to kind of stabilize the earnings, the inadequacy of the regulatory capital, the deferred expenses so the bonus could be-I mean, it just seems to me, do you take this report, to say, you know, I'm wrong here-or do you take it and say, Here's what we're going to do to try to fix this situation? Do you give this report that amount of credibility?
REP. BAKER: And, Mr. Scott, that will have to be your last question, because you are well over time.
REP. SCOTT: All right.
MS. KOROLOGOS: Let me assure you I think two significant things perhaps. One, the agreement we signed itself permits us-I think there's 32 or 33 issues there-working with Senator Warren Rudman and the accounting people that they will bring in to do a very deep dive, if you will, and look very carefully at all of those issues, some of which may result in change, some may not. I can't prejudge that. So that's the root for the report itself in terms of taking it seriously, following all of the issues, both through the agreement and the report itself.
Secondly, you ask if there will be changes in governance. In terms of the company's governance and its organization, that is a part of the agreement, and that will be addressed accordingly. In terms of corporate board governance, I said in my statement, and I really do believe-but I'm open always to best practices, and we follow these issues religiously-that we are at a point, because of good governance, that we are able to, one, get us this far to keep some stability and calm to a process that I think is very important, to exercise our fiduciary responsibilities in a thoughtful and informed way, and organized ourselves previously to be able to participate in the various teams that are going to be created to fulfill our obligations under the agreement. One board member has particular expertise in capital markets and the like, Don Marron from-formerly of Paine Webber. He's a-he'll be a very good team person. Another woman, Leslie Rahl, on the board, on the board is a derivatives expert-let her work on those issues. So we are organizing ourselves with our expertise. So I think that's the corporate board governance piece. Whether changes come for board governance from the report, I don't see that right now, but I'm open to it, but I don't see that.
I think the third issue, on compensation, however-obviously we'd welcome any findings from the independent investigation that address some of the allegations in that area. But as a member of the comp committee, we have been addressing, as we look again at comparables, at best practices, at the structure of compensation at those in our industry, how to base the bonus plan on more than just earnings per share, such as risk and mission factors. And that's going to be forthcoming. So that is a piece of work that's already been going on, but it's been going on because of the marketplace, if you will, and executive compensation.
REP. BAKER: The gentleman's time is expired. Ms. Waters.
BREAK IN TRANSCRIPT
REP. SCOTT: So, Mr. Chairman, just to make sure we're clear, there will be no movement whatsoever on any regulatory reform until we have this rebuttal process in both OFHEO and Fannie Mae to today's hearings?
REP. BAKER: Not exactly. What I said was there will be no further action by this committee on this subject matter until conditions warrant action by the subcommittee. Assume for a moment, if you wish to pursue this discussion, that OFHEO comes back with another troubling report in the next two days or the next two months. Certainly the committee would want to receive that report and discuss the findings. I'm not suggesting, however, we would move on a legislative proposal in the next five days. There's certainly not time to do so. It would likely be early next year a reform proposal introduced; it would go through due process, all members would be heard; and certainly the enterprises and all those who have a stake in this matter would be given ample opportunity to voice their opinion. And I don't know exactly the sensitivity that you and the gentle lady are addressing-there's not going to be anything introduced tomorrow that takes page 46 of this report and makes it a new regulation, if that's what you're after.
REP. SCOTT: The-you mentioned in the event that there may be another report. Is there any indication or evidence on your part that OFHEO is contemplating or putting forward another report?
REP. BAKER: Oh, no. Let me make it clear one more time I have no information that any other member does not have. I have had no phone calls from anybody. I asked the director in the public view today, Mr. Director, what's your next step? -- hoping that that would send the signal that whatever he told me he was going to tell you.
REP. SCOTT: Right.
REP. BAKER: That's all I know.
REP. SCOTT: All right.
REP. BAKER: And when I know more, I'll be happy to share it. And in the meantime, I hope I don't see you all till January. (Laughter.)
If there is no further business for this committee, we stand adjourned.