oversight

FHFA's Oversight of Fannie Mae's Default-Related Legal Services

Published by the Federal Housing Finance Agency, Office of Inspector General on 2011-09-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

           FEDERAL HOUSING FINANCE AGENCY
             OFFICE OF INSPECTOR GENERAL



                 FHFA’s Oversight of Fannie Mae’s
                  Default-Related Legal Services




Audit Report: AUD-2011-004                 Dated: September 30, 2011
                     FHFA’s Oversight of Fannie Mae’s Default-Related Legal Services

Why FHFA-OIG Did This Audit                                                 What FHFA-OIG Found
In 1997, the Federal National Mortgage Association (Fannie Mae or           FHFA can strengthen its oversight of default-related legal services.
Enterprise) established its Retained Attorney Network (RAN) to              FHFA recognized the importance of its oversight of the Enterprises'
acquire default-related legal services associated with foreclosure,         default-related legal services and gradually accumulated information on
bankruptcy, loss mitigation, eviction, and Real Estate Owned (REO)          the attorney network programs of Fannie Mae and Freddie Mac.
closings. In August 2010, news reports alleged that RAN attorneys           However, FHFA did not schedule comprehensive examination coverage
had engaged in inappropriate foreclosure practices such as routinely        of foreclosure issues, including allegations of abuse by RAN law firms
filing false documents in court proceedings and “robo-signing.”             until after news stories about alleged abuses surfaced in August 2010.
The Housing and Economic Recovery Act of 2008 (HERA) established            FHFA had not previously considered risks associated with foreclosure
the Federal Housing Finance Agency (FHFA or Agency) as supervisor           processing to be significant. Instead, FHFA focused its examination
and regulator of the Enterprises: Fannie Mae and the Federal Home           resources on assessing high risk areas such as the Enterprises’
Loan Mortgage Corporation (Freddie Mac). On September 6, 2008,              management of credit risk.
FHFA placed the Enterprises into conservatorships out of concern that
                                                                            Also, there were indicators prior to August 2010 that could have led
their deteriorating financial conditions threatened the stability of the
financial markets. As the conservator, FHFA is responsible for              FHFA to identify the heightened risk posed by foreclosure processing
preserving and conserving each Enterprise’s assets and restoring them       within Fannie Mae’s RAN. These indicators included significant
to a sound financial condition in order to support the nation’s housing     increases in foreclosures, which accompanied the deterioration of the
finance markets. FHFA commenced a special review of Fannie Mae’s            housing market; consumer complaints alleging improper foreclosures;
RAN in late 2010 to determine whether the program met safety and            contemporaneous media reports about foreclosure abuses by Fannie
soundness standards, to evaluate the design and implementation of the       Mae’s law firms; and public court filings in Florida and elsewhere
RAN, and to identify vulnerabilities in its control structure. To date,     highlighting such abuses. Although FHFA’s management has yet to
FHFA has not released the results of its review.                            publish the results of its special review of Fannie Mae’s RAN, the
                                                                            examiners’ preliminary findings confirm that at least one of these
On February 25, 2011, Representative Elijah E. Cummings requested
                                                                            indicators – deteriorating industry conditions – should have provided
that the FHFA Office of Inspector General (FHFA-OIG) examine
“widespread allegations of abuse by ... law firms hired to process
                                                                            adequate warning of the increased risk associated with default-related
foreclosures as part of” the RAN, and Fannie Mae’s and FHFA’s efforts       legal services. Importantly, FHFA has a number of corrective actions
“to investigate these allegations and implement corrective action.”         planned in response to the special review.
Pursuant to the request, FHFA-OIG performed an audit to assess              FHFA needs to develop procedures to identify and assess new or
FHFA’s oversight of Fannie Mae’s default-related legal services             heightened risks, as it simultaneously addresses historic risks with which
performed by law firms within the RAN.                                      it is familiar. FHFA had neither an ongoing risk-based supervisory plan
                                                                            detailing examination and continuous supervision of default-related legal
What FHFA-OIG Recommends                                                    services, nor finalized examination guidance and procedures for use in
FHFA-OIG recommends that FHFA: (1) review the circumstances                 performing targeted examinations and supervision of such services.
surrounding FHFA’s not identifying the RAN foreclosure abuses at an         Consequently, FHFA has limited assurance that foreclosure processing
earlier stage and develop potential enhancements to its capacity to         abuses will be prevented and detected through its supervisory activities.
identify new and emerging risks; (2) develop and implement
comprehensive examination guidance and procedures together with             Additionally, FHFA has not developed formal policies to address poor
supervisory plans for default-related legal services; and (3) develop and   performance by law firms that have relationships – either directly
implement policies and procedures to address poor performance by            through contract or through its loan servicers – with both of the
default-related legal services vendors that have contractual                Enterprises. FHFA-OIG identified instances where Freddie Mac
relationships with both of the Enterprises.                                 terminated for poor performance law firms that processed foreclosures
                                                                            on its behalf, but Fannie Mae continued to use the firms. FHFA did not
In response to FHFA-OIG’s recommendations, FHFA provided                    specifically review such terminations and, therefore, lacks assurance that
written comments dated September 29, 2011. The Agency agreed                law firms with histories of performance deficiencies do not jeopardize
with the recommendations. The complete text of the written                  the safety and soundness of the Enterprises.
comments can be found in Appendix A of this report.



    Audit Report: AUD-2011-004                                                                               Dated: September 30, 2011
TABLE OF CONTENTS
TABLE OF CONTENTS ...................................................................................................................... 3

ABBREVIATIONS .............................................................................................................................. 5

PREFACE .......................................................................................................................................... 6

BACKGROUND ................................................................................................................................. 8

   FHFA and Fannie Mae ...................................................................................................................... 8

   Retained Attorney Network            ............................................................................................................... 9
   Distressed Mortgage Environment ..................................................................................................... 10

   Allegations and Evidence of Foreclosure Abuses (2005-Present) ............................................................. 12
        The Enterprises Are Required to Disclose Operational Risk ............................................................... 12
        2006 Report to Fannie Mae of Foreclosure Abuses in Florida ............................................................. 13
        2008 News Reports .................................................................................................................... 14
        Consumer Complaints Received by FHFA in 2009 ........................................................................... 14
        FHFA Staff Informed of Foreclosure Problems in Florida in June 2010 ................................................ 15
        August 2010 Article Reporting on Enterprise Foreclosure Abuses ....................................................... 16

   Responses to Allegations of Foreclosure Abuse ................................................................................... 16
        FHFA’s Efforts to Address Allegations of Abuse ............................................................................. 16
        Fannie Mae’s Efforts to Address Allegations of Abuse ...................................................................... 18

   Current Status of RAN Oversight ...................................................................................................... 19
        FHFA’s Oversight ...................................................................................................................... 19
        Fannie Mae’s Oversight .............................................................................................................. 20

FINDINGS ....................................................................................................................................... 22

   1.      Various Indicators Could Have Led FHFA to Identify and Address the Heightened Risk Posed by
           Foreclosure Abuses Prior to Late 2010 ....................................................................................... 22

   2.      FHFA’s Supervisory Planning and Guidance Do Not Adequately Address Default-Related
           Legal Services ....................................................................................................................... 24

   3.      FHFA Does Not Have a Formal Process for the Enterprises to Share Information About Problem Law
           Firms ................................................................................................................................... 25

CONCLUSION ................................................................................................................................. 26

RECOMMENDATIONS ..................................................................................................................... 27
         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                                          3
OBJECTIVE, SCOPE AND METHODOLOGY ...................................................................................... 28

Appendix A ...................................................................................................................................... 30

       FHFA’s Comments on Findings and Recommendations .................................................................... 30

Appendix B ...................................................................................................................................... 32

       FHFA-OIG’s Response to FHFA’s Comments                      ................................................................................ 32

Appendix C ...................................................................................................................................... 33

       Summary of Management’s Comments on the Recommendations ....................................................... 33

ADDITIONAL INFORMATION AND COPIES ..................................................................................... 35




         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                                         4
ABBREVIATIONS
DCP .....................................................................................................Designated Counsel Program
Fannie Mae......................................................................... Federal National Mortgage Association
FHFA ........................................................................................... Federal Housing Finance Agency
FHFA-OIG ...................................... Federal Housing Finance Agency Office of Inspector General
FHLBanks ...............................................................................................Federal Home Loan Banks
Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation
GSE ............................................................................................ Government-Sponsored Enterprise
HERA.......................................................................Housing and Economic Recovery Act of 2008
MBS ..................................................................................................... Mortgage-Backed Securities
NSO................................................................................................National Servicing Organization
RAN ...................................................................................................... Retained Attorney Network
REO..................................................................................................................... Real Estate Owned




        Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                                    5
                                    Federal Housing Finance Agency

                                       Office of Inspector General

                                              Washington, DC




                                             PREFACE
FHFA-OIG was established by HERA,1 which amended the Inspector General Act of 1978.2
FHFA-OIG is authorized to conduct audits, investigations, and other activities of the programs
and operations of FHFA; to recommend policies that promote economy and efficiency in the
administration of such programs and operations; and to prevent and detect fraud and abuse in
them. This is one in a series of audits, evaluations, and special reports published as part of
FHFA-OIG’s oversight responsibilities to promote economy, effectiveness, and efficiency in the
administration of FHFA’s programs.

The objective of this performance audit was to assess FHFA’s oversight of Fannie Mae’s default-
related legal services performed by law firms within the RAN. Specifically, FHFA-OIG
reviewed FHFA’s: (1) written policies and procedures for its oversight of Fannie Mae’s RAN;
(2) oversight of Fannie Mae’s internal controls over its RAN; and (3) supervisory actions taken
concerning the RAN.

The audit found that FHFA recognizes the importance of its oversight of Fannie Mae’s default-
related legal services performed by law firms within the RAN, but it needs to improve its
capacity to identify new and emerging areas of risk. Additionally, FHFA does not have a
continuous supervision plan or detailed examination guidance to govern its oversight of the
RAN, and it had not accomplished any targeted examinations of the RAN until it initiated a
special review in late 2010. FHFA also has not established a formal process and the requisite
policies to address concerns associated with law firms that have relationships with both Fannie
Mae and Freddie Mac to ensure that information is shared across both Enterprises.

FHFA-OIG believes that the recommendations contained in this report will help the Agency
achieve more economical, effective, and efficient operations. FHFA-OIG appreciates the
assistance of all those who contributed to the audit.

1
    Public Law No. 110-289.
2
    Public Law No. 95-452.

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                       6
This audit was led by Jennifer Fain, Audit Director, who was assisted by Jacob Kennedy,
Auditor-in-Charge.

This report will be distributed to Congress, the Office of Management and Budget, and others
and will be posted on FHFA-OIG’s website, www.fhfaoig.gov.




Russell A. Rau
Deputy Inspector General for Audits




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                    7
BACKGROUND
FHFA and Fannie Mae

HERA established FHFA as supervisor and regulator of the housing government-sponsored
enterprises (GSEs): Fannie Mae, Freddie Mac, and the 12 Federal Home Loan Banks. FHFA’s
mission is to provide effective supervision and regulation over the GSEs to support their housing
finance and affordable housing goals and to provide for a stable and liquid mortgage market.
Targeted examinations and continuous supervision of GSE operations are means to accomplish
FHFA’s mission.

As a GSE chartered by Congress, Fannie Mae’s mission is to
provide liquidity, stability, and affordability to the U.S. housing Targeted Examinations
and mortgage markets. Fannie Mae accomplishes this mission                 are in-depth focused
by supporting the secondary mortgage market. It purchases           assessments   of a specific risk or
                                                                        risk management system.
from loan sellers residential mortgages that meet its
underwriting criteria, and loan sellers can use the sales proceeds  Continuous Supervision
to originate additional mortgages. Fannie Mae may hold these           is a wide range of ongoing
mortgages in its portfolio or may package them into mortgage-        activities designed to monitor
backed securities (MBS) that are, in turn, sold to investors. In      and analyze an Enterprise’s
                                                                         overall business profile,
exchange for a fee, Fannie Mae guarantees that investors will            including any trends or
receive timely payment of principal and interest on the MBS.           associated emerging risks.
With respect to the loans that it holds in its portfolio, Fannie
Mae contracts with loan servicers to collect mortgage payments,
segregate tax and insurance escrows, forward to Fannie Mae principal and interest payments, pay
obligations from escrows, and handle foreclosure actions.

On September 6, 2008, FHFA placed the Enterprises into conservatorships after finding that their
deteriorating financial conditions threatened the stability of the financial markets.3 The FHFA
Director stated that the conservatorships were designed to stabilize the Enterprises by preserving
and conserving their assets with the objective of returning them to normal business operations.
As conservator, FHFA is responsible for the overall management of the Enterprises.




3
  Among FHFA’s statutory authorities is the ability of the Director to appoint the Agency as “…conservator or
receiver for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated entity.” 12 U.S.C. §
4617(a)(1) and (2).

       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                           8
Retained Attorney Network

In 1997, Fannie Mae established the RAN to perform default-related legal services associated
with foreclosure, bankruptcy, loss mitigation, eviction, and REO closings and entered into
engagement letters with the RAN firms.4

Fannie Mae does not manage individual law firms as they litigate foreclosure proceedings;
instead, the servicers of Fannie Mae mortgages are responsible for managing the RAN law firms.
In all cases where a servicer refers Fannie Mae foreclosures to a law firm, the servicer is
responsible for monitoring all aspects of the performance of the attorney to whom it makes a
referral.5

According to Fannie Mae, the RAN permits it to control costs through negotiated rates with the
law firms and gives it the ability to direct law firms to take consistent actions while monitoring
and controlling timelines and efficiency.

In August 2008, Fannie Mae announced that it was enhancing its network and was expanding the
RAN model to 140 law firms covering 31 jurisdictions. The intent of the enhanced network was
to “…foster a more disciplined, end-to-end approach to default management; facilitate more
effective management of fees, costs, quality, and reporting to Fannie Mae; and facilitate
enhanced loss mitigation efforts by network attorneys.” To achieve these objectives, Fannie Mae
required that loan servicers refer foreclosures and bankruptcy cases only to attorneys included in
the RAN. Prior to this enhancement, servicers selected and managed foreclosure law firms of
their choice, which Fannie Mae asserted limited its ability to oversee the process and manage its
costs. Fannie Mae has expanded the RAN model to 191 firms within 45 states.6

Historically FHFA did not consider the RAN to be a high-risk area and did not focus its
examination and monitoring efforts on it. FHFA’s practice was and is to focus on high-risk areas
4
  An engagement letter is a contract between Fannie Mae and a RAN law firm requiring the “…firm’s non-exclusive
representation of Fannie Mae and provision of services in foreclosure, bankruptcy, loss mitigation, eviction, related
litigation, and REO closing proceedings in the firm’s [respective] state(s)….” Law firms in the RAN may also have
other clients.
5
    Fannie Mae’s Servicing Guide, Section 104.01 (p. 281).
6
    According to Fannie Mae’s Servicing Guide, Section 104.03:
           For jurisdictions that are not included on the Retained Attorney List, Fannie Mae will continue to rely upon
           servicers to select and retain qualified attorneys (or trustees) of their choice to handle Fannie Mae
           foreclosure and bankruptcy matters in accordance with Fannie Mae’s standard guidelines. When the
           servicer retains its own attorney (or trustee) to handle foreclosure proceedings, Fannie Mae requires the
           servicer to retain competent, diligent, local legal counsel (or trustees) who are highly experienced in
           conducting foreclosures. Foreclosure services must be performed by qualified and experienced attorneys
           (or trustees) in accordance with applicable law and professional standards of conduct.

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                             9
such as credit risk,7 which has caused billions of dollars of losses for the Enterprises in recent
years. High-risk areas were a critical concern for FHFA after its establishment and the creation
of the conservatorships. Further, FHFA officials explained that during the relevant time frame,
the Office of Credit Risk (OCR)8 focused its limited resources on evaluating loan modification
and loss mitigation proposals from the Enterprises and scaled back scheduled examinations.
FHFA officials viewed foreclosures, including addressing foreclosure abuse,9 as primarily the
responsibility of servicers.10

Distressed Mortgage Environment

When FHFA placed Fannie Mae into conservatorship in September 2008, Fannie Mae’s credit
book of business was $3.1 trillion, or approximately 26% of the total U.S. residential mortgage
debt outstanding.11 According to Fannie Mae’s loan price index, home prices declined
approximately 9% by the end of 2008, the greatest decline since the home price index’s inception
in 1975. Home prices continued to fall through 2010.

As home prices declined, serious delinquencies rose, as illustrated in Figure 1 below, rising from
400,000 homes at the end of 2008 to nearly 1,000,000 at the end of 2009.12




7
  Credit Risk arises from an obligor’s failure to meet a term of any financial contract with the Enterprise or other
failure to fulfill a financial commitment.
8
  Although unrelated to the impending foreclosure and documentation issues that were publicized in August 2010,
the Agency’s OCR was tasked with the responsibility of analyzing the attorney networks as early as May 2010.
According to FHFA officials, other than responding to Congressional inquiries, the credit risk team did not conduct
any special reviews of the attorney networks at that time.
9
 For purposes of this report, “foreclosure abuse” relates to allegations against certain law firms who performed
default-related services on behalf of or for Fannie Mae, either directly or through contract with servicers who service
Fannie Mae loans. Examples of abusive practices include: (1) creating and filing incomplete and improper
documents; (2) fraudulent affidavits; (3) improper notarizations; and (4) use of “robo-signing” to process foreclosure
documents. “Robo-signing” refers to habitually signing documents without the requisite knowledge of the
underlying facts.
10
  Although foreclosures are the responsibilities of the servicers and law firms, the Agency has statutory
responsibility for the safety and soundness of the Enterprises, and this includes compliance with the legal
requirements and liability risks associated with foreclosures.
11
  This figure includes mortgage assets held in Fannie Mae’s investment portfolio, Fannie Mae MBS held by third
parties, and credit enhancements provided on mortgage assets.
12
  Fannie Mae classifies single-family loans that are three months or more past due or in the foreclosure process as
seriously delinquent.

       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                          10
Figure 1: Seriously Delinquent Single-Family Loans

                              1,000,000                                                     6.00%

                               800,000                                                      5.00%




                                                                                                    Delinquency %
                                                                                            4.00%
                 # of Loans

                               600,000
                                                                                            3.00%
                               400,000
                                                                                            2.00%
                               200,000                                                      1.00%
                                     0                                                      0.00%
                                          4Q-08   1Q-09   2Q-09    3Q-09   4Q-09   1Q-10

                                                          loans        rate


              Source: FHFA “1Q10 SF Risk Assessment” Analysis Memorandum, May 7, 2010


As of the first quarter of 2011, approximately 400,000 additional loans were seriously
delinquent.13

Rising delinquencies led to substantial increases in foreclosures. Between 2007 and 2010, the
volume of Fannie Mae foreclosures increased to historic levels. Fannie Mae foreclosures more
than doubled from 2007 to 2008, and increased by more than 50% the following year.14 Fannie
Mae foreclosed on 262,078 properties in 2010, an 80% increase from 2009 and a 433% increase
from 2007. The unpaid principal balance on the 2010 foreclosures totaled over $47 billion.

Additionally, Fannie Mae’s sale of foreclosed properties did not keep pace with the rapid
foreclosure increases, and its inventory of REO grew. In 2007, Fannie Mae’s REO portfolio
consisted of 33,729 properties, which then rapidly increased in succeeding years through 2010 to
162,489 properties. That 381% increase over three years is illustrated in Figure 2 showing
foreclosures and REO inventory.




13
     According to an FHFA official, Fannie Mae had referred 700,000 loans to foreclosure in 2010.
14
     Total properties acquired through foreclosure between 2007 and 2009: 49,121; 94,652; and 145,617, respectively.

          Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                              11
Figure 2: Single-Family Foreclosure and REO Properties



                             300,000                                                            180,000
                                                                                                160,000
                             250,000




                                                                                                          Real Estate Owned
                                                                                                140,000
              Foreclosures



                             200,000                                                            120,000
                                                                                                100,000
                             150,000
                                                                                                80,000
                             100,000                                                            60,000
                                                                                                40,000
                              50,000
                                                                                                20,000
                                  0                                                             0
                                       2007      2008            2009             2010
                                                 Foreclosures            REOs


          Source: Fannie Mae Securities and Exchange Commission 10K Filings for 2008 and 2010


Allegations and Evidence of Foreclosure Abuses (2005 - Present)

As the volume of home foreclosures rose, Fannie Mae, Freddie Mac, FHFA, and FHFA’s
predecessor agency, the Office of Federal Housing Enterprise Oversight (OFHEO), were in a
position to learn of foreclosure abuses through direct reports and the news media15 and to
understand their impact on the law firms’ relationships with the Enterprises.

         The Enterprises Are Required to Disclose Operational Risk

Prior to FHFA’s establishment, OFHEO required the Enterprises to develop operational risk
management programs.16 As envisioned by OFHEO, the Enterprises’ operational risk
management programs would feed data to its examiners who, in turn, would use the data to
identify the level of – and trends in – operational risk at the Enterprises. FHFA’s definition of

15
   The media reports referenced herein are not offered for the accuracy or truth of their content. Rather, they
illustrate that information about foreclosure abuses was publicly available at times relevant to this audit.
16
  “These requirements [to collect operational event data and report it to OFHEO] are consistent with the safety and
soundness responsibilities of OFHEO under the Federal Housing Enterprises Financial Safety and Soundness Act of
1992.” Letter to Richard F. Syron from Director, OFHEO, dated August 10, 2007.
On September 23, 2008, OFHEO/FHFA reiterated the Enterprises’ requirements to develop operation risk programs
and report information to OHFEO/FHFA and issued its Enterprise Guidance on Operational Risk Management
(Guidance). The Guidance notes that “the effective management of operational risk is required to support Enterprise
safety and soundness.” Enterprise Guidance on Operational Risk Management (PG-08-002) at pp. 1-4. The
Guidance formally requires the Enterprises to develop and implement operational risk programs.

       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                          12
operational risk is broad and applies to the full range of the Enterprises’ business activities.
Operational risk is defined as, “…exposure to loss resulting from inadequate or failed internal
processes, people, and systems, or from external events (including legal events).”17

Fannie Mae recognizes that foreclosure abuse is an operational risk. As it noted in its 2010
Securities and Exchange Commission 10-K filing, “the failure of our servicers or a law firm to
apply prudent and effective process controls and to comply with legal and other requirements in
the foreclosure process poses operational, reputational and legal risks for us.”18 Yet, there is
little evidence that Fannie Mae disclosed allegations of foreclosure abuse to its regulator.

           2006 Report to Fannie Mae of Foreclosure Abuses in Florida

In December of 2003, a Fannie Mae shareholder began alerting Fannie Mae to foreclosure abuse
allegations, and in 2005 Fannie Mae hired an outside law firm to investigate a variety of
allegations regarding purported foreclosure processing abuses. In May 2006, the law firm issued
a report of investigation in which it found that:

           [F]oreclosure attorneys in Florida are routinely filing false pleadings and affidavits….
           The practice could be occurring elsewhere. It is axiomatic that the practice is improper
           and should be stopped. Fannie Mae has not authorized this unlawful conduct.

Further, the report observed that Fannie Mae did not take steps to ensure the quality of its
foreclosure attorneys’ conduct, the legal positions taken in the attorneys’ pleadings, or the
manner in which the attorneys processed foreclosures on the Enterprise’s behalf.

FHFA-OIG could not establish whether Fannie Mae complied with its obligation to notify
OFHEO of the 2006 report of foreclosure abuses. Fannie Mae officials claim that they informed
an OFHEO senior official of the report during a telephone conversation in 2006, but they have
no record of the communication. The OFHEO official, who now works for FHFA, has no
records or recollection of the conversation.




17
     Enterprise Guidance on Operational Risk Management (PG-008-002), September 23, 2008.
18
   Fannie Mae’s 10-K Report as of December 31, 2010, www.fanniemae.com/ir/pdf/earn-ings/2010/10k_2010.pdf,
p. 62.

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                       13
        2008 News Reports

In 2008, allegations began to circulate about “foreclosure mills” managing defaulted loans for
the Enterprises. For example, a March 30, 2008, New York Times article, Foreclosure Machine
Thrives on Woes, reported on complaints involving law firms filing improper or duplicative
foreclosure and bankruptcy pleadings and levying inappropriate fees upon borrowers. Further,
the article revealed that several courts had imposed significant financial sanctions against the
abusive firms and – in some cases – their clients, which included Fannie Mae. In particular, the
article stated that:

        In 2006 ... [a] federal bankruptcy judge overseeing a matter involving ... a
        borrower in Lodi, N.J., issued a $125,000 sanction against the Shapiro & Diaz
        firm, which is a part of the Shapiro Attorneys Network. The judge found that
        Shapiro & Diaz had filed 250 motions seeking permission to seize homes using
        pre-signed certifications of default executed by an employee who had not worked
        at the firm for more than a year.
        Butler & Hosch, a law firm in Orlando, Fla., that is employed by Fannie Mae, has
        also been the subject of penalties. Last year, a judge sanctioned the firm $33,500
        for filing 67 faulty motions to remove borrowers from their homes.
        Barrett Burke in Texas has come under intense scrutiny by bankruptcy judges.
        Overseeing a case last year[, a bankruptcy judge] examined the firm’s conduct in
        eight other foreclosure cases and found problems in all of them. In five of the
        matters, documents show, the firm used inaccurate information about defaults or
        failed to attach proper documentation when it moved to seize borrowers’ homes.
        [The Judge] imposed $75,000 in sanctions against Barrett Burke for a pattern of
        errors in the [one] case.

        Consumer Complaints Received by FHFA in 2009

At least as early as August 2009, FHFA received consumer complaints concerning purportedly
inappropriate foreclosure practices involving Fannie Mae loans. FHFA-OIG identified 35 such
complaints that FHFA received and referred to Fannie Mae between August 2009 and October
2010. FHFA-OIG previously found that FHFA did not assess overall trends related to consumer
complaints.19


19
  See FHFA-OIG, Report on the Audit of the Federal Housing Finance Agency’s Consumer Complaints Process
(AUD-2011-001, dated June 21, 2011), available for inspection at www.fhfaoig.gov/Content/Files/AUD-2011-
001.pdf, which found that FHFA did not adequately record, evaluate or follow up on consumer complaints.
Additionally, FHFA did not have a consolidated system for receiving complaints, maintaining them, processing
       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                      14
        FHFA Staff Informed of Foreclosure Problems in Florida in June 2010

In June 2010, FHFA’s Office of Conservatorship Operations performed a two-day field visit to
Florida to gain a better understanding of foreclosure processing, among other things. FHFA staff
met with 17 representatives from the mortgage industry, legal community, and federal and state
government, including a local circuit court judge whom the FHFA General Counsel had
repeatedly suggested should be contacted. The resulting report to FHFA’s Acting Director,
dated June 9, 2011, noted that servicers, attorneys, and other supporting personnel were
overloaded with the volume of foreclosures, the average timeline for foreclosures had increased
from 150 to 400 days, documentation problems were evident, and law firms (referred to as
“foreclosure mills”) were not devoting the time necessary to their cases due to Fannie Mae’s flat
fee structure and volume-based processing model. As a result of the visit, FHFA staff developed
a listing of actionable items for FHFA, including:

            Incorporating foreclosure checklists into the Enterprises’ attorney network processes
             to ensure that attorneys are prepared in legal proceedings;

            Revising the Enterprises’ compensation model for attorneys to incentivize speed and
             effectiveness and penalize poor performance; and

            Engaging the Enterprises on servicer (and law firm) problems such as:

             o lost/mishandled documents;

             o inadequate responsiveness to borrowers; and

             o delays in the foreclosure process, including foreclosure sale cancellations and
               poor preparation for foreclosure hearings.

FHFA-OIG has found no evidence that action was taken on any of these items except as noted
below.

Shortly after the Florida visit, FHFA notified senior Fannie Mae officials about the results of the
visit, including that: “attorneys are increasingly unprepared when they enter the courtroom (e.g.,
they don’t have the note, don’t know if the borrower has been offered HAMP [a loan
modification], service has been cancelled, etc.) which cause foreclosure sale cancellations and
ultimately lengthens timelines.” FHFA did not ask Fannie Mae for a response to the information
provided concerning the results of the Florida visit.

them, or tracking their resolution by the Enterprises. Therefore, additional complaints beyond the 35 could have
been received by FHFA.

       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                         15
           August 2010 Article Reporting on Enterprise Foreclosure Abuses

In August 2010, a widely circulated news article reported that Fannie Mae and Freddie Mac had
failed to oversee their networks of law firms that process foreclosures on their behalf.
Specifically, the article alleged that some of those firms – including RAN firms – had filed
forged documents (e.g., affidavits and mortgage assignments) in judicial foreclosure
proceedings.20 Thereafter, many other print and electronic media reports described similar
behavior by law firms representing Fannie Mae and Freddie Mac.

Federal and state regulators and law enforcement officials subsequently initiated probes into
whether banks and foreclosure law firms improperly seized homes using fraudulent or
incomplete paperwork. For example, in August 2010, the Florida Attorney General announced
that his office had launched investigations into allegations of unfair and deceptive foreclosure
practices involving three Florida law firms. The three law firms were part of Fannie Mae’s RAN
and included the Law Offices of David J. Stern, P.A. (the Stern Law Firm).

Responses to Allegations of Foreclosure Abuse

           FHFA’s Efforts to Address Allegations of Abuse

In November 2010, FHFA initiated concurrent special reviews of Fannie Mae’s RAN and
Freddie Mac’s Designated Counsel Program (DCP) risk management practices. The primary
objective of these reviews was to determine whether the attorney network programs met safety
and soundness standards. The reviews evaluated the design and execution of the existing
frameworks, identified vulnerabilities in the control structure, and assessed the recent
enhancements to the frameworks adopted in 2010.

The Agency concluded its review in January 2011, and Agency examiners documented their
findings in a memorandum and verbally briefed Fannie Mae about the findings. Among other
things, the examiners concluded that Fannie Mae could have reacted to foreclosure deficiencies
sooner because, “deteriorating industry conditions over the past several years should have
provided adequate warning to the GSEs to review policies, processes, and controls of other
vendors and counterparties including law firms.”21




20
     Fannie and Freddie’s Foreclosure Barons, Mother Jones, August 4, 2010.
21
  The Agency communicates its special review findings to the Enterprises through a “conclusion letter.” This letter
includes the findings from the review, a “supervisory rating” based on the remediation effort necessary to address
the identified weaknesses, and recommendations – called “Matters Requiring Attention.”

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                        16
FHFA examiners also found that Fannie Mae’s existing control structure for RAN did not meet
safety and soundness standards in a number of areas:

            Fannie Mae had not performed a formal cost-benefit analysis to determine if the RAN
             is cost effective (i.e., if the documented benefits of the program outweighed its
             inherent risks, such as the legal risk that Fannie Mae could be held liable for the
             actions of the RAN participants).

            Prior to the media reports that followed the magazine article in August 2010, Fannie
             Mae had inadequate controls in place to prevent or detect foreclosure abuses such as
             false assignment affidavits. Since then, it has developed controls to prevent or detect
             foreclosure documentation issues among the RAN law firms, but these controls are
             yet to be fully implemented.

            Fannie Mae had not developed adequate procedures for the RAN, such as procedures
             for (1) determining whether a law firm should be added to or removed from the RAN,
             (2) conducting oversight of RAN participants by its National Servicing Organization
             (NSO), (3) performing onsite visits to law firms by Fannie Mae’s internal legal
             department, and (4) defining steps that oversight employees must take if they uncover
             an issue such as improper preparation and/or notarization of documents used in
             foreclosure proceedings.

            Fannie Mae had not developed comprehensive training manuals for the law firms
             participating in RAN.

            Fannie Mae’s ongoing monitoring of law firms was inadequate. After law firms
             completed their applications and were accepted into the RAN, their reporting and
             Fannie Mae’s monitoring of them was less than satisfactory. If a law firm self-
             reported no issues as it processed cases, then Fannie Mae presumed the firm was
             doing a good job.

Although the Agency briefed Fannie Mae management and FHFA-OIG on the results of its
special review, a final report has not been published or released to the Enterprise. FHFA is still
deliberating on the best course of action concerning Fannie Mae’s RAN.22


22
  During the same time frame as FHFA’s special review, the Federal Reserve System, the Office of the Comptroller
of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation conducted a review
of foreclosure practices, which focused on 14 federally-regulated mortgage servicers. The resulting report,
Interagency Review of Foreclosure Policies and Practices, issued in April 2011, identified inadequate monitoring
and controls to oversee foreclosure activities conducted on behalf of servicers by external law firms or other third-
party vendors and disclosed enforcement actions taken. See www.occ.treas.gov/news-issuances/news-
       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                         17
           Fannie Mae’s Efforts to Address Allegations of Abuse

Fannie Mae has also initiated multiple efforts to address foreclosure abuse issues. These efforts
include: (1) audits and reviews of RAN law firms; (2) questionnaires to the RAN law firms; and
(3) RAN compliance oversight enhancements.

        1.       Audits and Reviews of RAN Law Firms: Beginning in early 2010, Fannie Mae
initiated certain loss mitigation activities associated with its default-related legal services.
According to the Enterprise, it hired a third-party vendor to perform audits of law firms in the
RAN, and the audits focused on compliance with engagement letters. The audits included
review of fees and costs charged; the accuracy of the language used in foreclosure pleadings to
describe the standing of the servicer; and compliance with state foreclosure processes.

Fannie Mae also retained a law firm to develop a legal compliance checklist and work with
Fannie Mae’s attorneys to conduct litigation reviews at the largest RAN firms in Florida.23 The
law firm’s objective was to perform foreclosure and litigation loan file reviews at several RAN
law firms. Another law firm was retained to conduct a review of the foreclosure and consumer
bankruptcy processes in the United States. The objective of this review was to identify legal
risks in the foreclosure and consumer bankruptcy processes and to identify which of those risks
were the most serious for Fannie Mae.

Through June 30, 2011, contractors retained by Fannie Mae have conducted 49 onsite reviews of
law firms. FHFA-OIG selected and reviewed the contractor’s reports for four RAN law firms.24
The contractors documented their work in various reports and memorandums to Fannie Mae.
FHFA-OIG assessed whether the audits and reviews provided Fannie Mae with information
about the deficiencies or operational weaknesses that may have contributed to improper
preparation and notarization of documents used in foreclosure proceedings. FHFA-OIG
determined that the reports reviewed missed the opportunity to confirm and provide a better
understanding of the allegations of foreclosure abuses. Instead, the audits and reviews were
narrowly focused on areas such as attorney fees and engagement letter issues (e.g., data
protection controls), rather than on more substantive qualitative issues regarding foreclosure
processing in compliance with applicable laws and regulations. As a result, FHFA-OIG


releases/2011/nr-occ-2011-47a.pdf. The interagency review identified safety and soundness weaknesses in the
oversight of vendors of default-related legal services. Although the federal banking regulators proceeded with
enforcement actions against servicers months ago, FHFA has not yet finalized its special review and related actions.
23
 The litigation reviews were subsequently expanded to encompass law firms located in New York, New Jersey,
Michigan, Pennsylvania, and Ohio.
24
     The selection was based on the law firm’s caseload size, alleged issues, and auditor’s judgment.

          Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                            18
concluded the audits and reviews did not lend themselves to identifying critical operational
issues including risks associated with improper foreclosures.

        2.     Questionnaires to RAN Law Firms: In late 2010, after assessing the allegations
of foreclosure abuse by the Stern Law Firm in Florida, as discussed above, Fannie Mae emailed
questionnaires to all RAN law firms asking them to report if they had issues similar to the Stern
Law Firm. Specifically, the questionnaire asked the law firms to determine whether: (1) their
policies, procedures, and processes are adequate to ensure that the documents prepared and
executed in connection with foreclosure proceedings are in compliance with applicable law; and
(2) their employees and/or third parties responsible for preparing and executing such documents
followed and continue to follow its policies, procedures, and processes. Most of the RAN firms
acknowledged receipt of the questionnaire and/or provided confirmation that their policies and
procedures are in compliance. Several law firms, however, disclosed foreclosure process issues,
and Fannie Mae stated that it worked with these law firms to understand their issues and to
develop plans of remediation. Additionally, Fannie Mae has dedicated staff to monitor the
progress in remediating these issues.

        3.       RAN Compliance Oversight Enhancements: In early 2011, Fannie Mae’s
internal auditors initiated their own review of the RAN. The internal audit was primarily focused
on the effectiveness of Fannie Mae’s oversight of its servicers. According to Fannie Mae
officials, the internal audit findings were similar to the findings of FHFA’s special review
examiners. The internal audit team communicated its findings to Fannie Mae’s NSO, which is
tasked with all oversight of the RAN. Officials from NSO stated that they began addressing the
internal audit’s findings and recommendations, including: assigning ownership of the RAN and
designing a staffing plan; creating a risk-based process for on-site reviews; developing a firm
performance and compliance monitoring plan; and assessing policies and procedures governing
default-related legal services.

Current Status of RAN Oversight

       FHFA’s Oversight

FHFA recently underwent an organizational restructuring. According to FHFA’s Acting
Director, “…the new structure will enhance our capability to meet our critical mission, provide
greater career opportunities for our staff, and make us more efficient and consistent in our
regulatory activities.” Specifically, the core examination teams on-site at each Enterprise will be
responsible for all Enterprise issues, including RAN oversight. Other Agency groups, like the
credit risk and operational risk teams, will support the core examination teams. Additionally, the


      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                   19
Agency is drafting new examination policies and procedures, which are expected to be
completed by the end of 2012, and these policies will address default-related service vendors.

The Agency also has directed Fannie Mae to recoup some of the costs and fees on its foreclosed
loan portfolio as well as address foreclosure-related deficiencies. For example, in 2010, the
Agency directed Fannie Mae to impose compensatory fees against the servicers for violating
foreclosure timeline limits.

          Fannie Mae’s Oversight

Fannie Mae stated that it enhanced its oversight activities in 2010 by expanding its legal
department and NSO.25 The legal department added 6 staffers (3 full-time attorneys, a contract
attorney, a paralegal, and a business analyst) to oversee the network, and NSO increased its staff
size from 6 to 28.

In June 2011, NSO also developed a staffing analysis in response to Fannie Mae’s internal audit
report. A critical element of the staffing plan is an analysis of how NSO will incorporate key
drivers when assessing the need to adjust staffing levels for RAN governance purposes. These
key drivers include, but are not limited to, anticipated volumes (i.e., foreclosures, serious
delinquencies), trending of non-routine litigation issues, additional RAN governance program
requirements, and new internal audit or FHFA requirements.

At the direction of FHFA, Fannie Mae began imposing compensatory fees against certain
servicers in 2010.26 Compensatory fees are a remedy used by Fannie Mae against the servicers
for “breach of servicing obligations.”27 Although Fannie Mae does not impose compensatory
fees directly against law firms, the firms have compensated Fannie Mae for errors, such as
failing to bid the proper amount at a foreclosure sale and failing to provide notice to subordinate
lien holders in connection with the foreclosure process. Moreover, the law firms indemnify
Fannie Mae against losses or damages incurred as a result of their negligence or failure to
perform their obligations in accordance with the terms of the engagement letters. Finally,


25
  Fannie Mae’s NSO manages the Enterprise’s loss mitigation activities through its relationship with mortgage
servicers who are tasked with servicing Fannie Mae’s single-family guarantee book of business.
26
     According to Fannie Mae, compensatory fees were not imposed on the servicers prior to 2010.
27
     According to Fannie Mae’s Lender Letter LL-2010-11 dated October 1, 2010:
          If Fannie Mae believes that the servicer is failing to comply with Fannie Mae’s servicing requirements,
          Fannie Mae may pursue a variety of remedies, either to correct a specific problem or to improve the
          servicer's overall performance. One possible remedy is the imposition of a compensatory fee to
          compensate Fannie Mae for damages and to emphasize the importance Fannie Mae places on a particular
          aspect of the servicer's performance.

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                         20
concerning law firms terminated from the RAN, Fannie Mae is currently pursuing recovery for
losses caused by the errors and omissions of those firms handling Fannie Mae’s foreclosures.




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                   21
FINDINGS
FHFA-OIG finds that:

     1. Various Indicators Could Have Led FHFA to Identify and Address the
        Heightened Risk Posed by Foreclosure Abuses Prior to Late 2010

FHFA did not begin to act on foreclosure abuse issues involving Fannie Mae’s RAN until mid-
2010. Prior to that time, FHFA had not considered risks associated with foreclosure processing
to be significant, and, instead, had focused its limited examination resources on assessing high
risk areas such as the Enterprises’ management of credit risk.

FHFA-OIG believes that there were multiple indicators of foreclosure abuse risk prior to 2010
that could have led FHFA to identify and act earlier on the issue. Moreover, FHFA Supervisory
Handbook 2.1 requires “Managers [to] develop work plans that are dynamic documents,
reviewed and updated as necessary based on Enterprise business profiles, risk assessments, and
external factors such as industry, economic, legislative, and regulatory developments.” These
foreclosure abuse indicators included, among other things, the deteriorating financial conditions
that led to the conservatorship (i.e., the increasing number and dollar value of mortgage defaults
and REO in the Enterprises’ portfolios), consumer complaints alleging improper foreclosures,
contemporaneous media reports about foreclosure abuses by Fannie Mae’s law firms, and public
court filings in Florida and elsewhere alleging such abuses.

Notwithstanding these indicators, FHFA did not begin to implement a risk-based supervisory
plan of targeted examinations and monitoring activities associated with the Enterprises’ default-
related legal services until media reports began to circulate widely in August 2010, at which time
FHFA concluded that reports of improper foreclosure activities reached a critical level that
supported further action. Prior to August 2010, FHFA stated it was gradually accumulating
information on the attorney network programs of Fannie Mae and Freddie Mac but did not
formally assess the risks the networks may have posed to their safety and soundness.

Among the indicators was the deteriorating condition of the housing market. Although
dramatically increasing mortgage delinquencies and resulting foreclosures prompted FHFA to
take the extraordinary measure of placing the Enterprises into conservatorships,28 it did not cause

28
  The purpose of appointing the conservator is to preserve and conserve Fannie Mae’s assets and property and to
put it in a sound and solvent condition. The goals of the conservatorship are to help restore confidence in the
Enterprise, enhance its capacity to fulfill its mission, and mitigate the systemic risk that has contributed directly to
the instability in the current market. As conservator, FHFA may take any necessary action to restore the firms to a
sound and solvent condition. The conservator controls and directs the operations of the Enterprises. The
       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                           22
the Agency to focus supervisory strategies on the foreclosure process. Yet, as part of its special
review of the Enterprises’ default-related legal services, FHFA examiners concluded that
deteriorating industry conditions over the past several years should have prompted the
Enterprises to review their policies, processes, and controls over their default-related legal
services vendors. Moreover, the foreclosure spikes that contributed to the conservatorships in
September 2008 continued to rise, further heightening the risk of loss. As discussed earlier (see
Figures 1 and 2), from 2008 through 2010, the number of Fannie Mae properties in foreclosure
and in its REO portfolio increased substantially.

As the foreclosures increased and REO accumulated, news reports began to circulate about
“foreclosure mills.”29 News coverage of law firm deficiencies in filing foreclosures (including
firms working on behalf of Fannie Mae and Freddie Mac) became especially prominent
beginning in August 2010. Numerous news articles were written about “robo-signing,” which
involves employees signing mortgage related documents at record speeds without verifying their
accuracy; foreclosure mills that file incomplete and inaccurate documents, fraudulent affidavits,
and improper notarizations; and the concealment of known mistakes from courts, attorneys, and
clients. Additionally, in late 2010, several of the largest servicers imposed a foreclosure filing
moratorium.

FHFA-OIG finds that these indicators could have led FHFA to identify the emerging risk before
the rise in media attention in August 2010. Based on the foregoing, FHFA needs to develop
procedures to identify and assess new or heightened risks, as it simultaneously addresses historic
risks with which it is familiar. In the absence of such action, FHFA has limited assurance that
foreclosure processing abuses will be prevented and detected through its supervisory activities.




conservator may take over the assets of, operate the Enterprises with all the powers of the shareholders, the
directors, and the officers of them, and conduct all of their business.
29
  A widely circulated Mother Jones article from August 2010, Fannie and Freddie’s Foreclosure Barons, was just
one of many newspaper articles that highlighted foreclosure abuses such as “robo-signing.” Earlier stories on the
topic also circulated. For example, and as discussed above, a March 30, 2008, New York Times report, Foreclosure
Machine Thrives on Woes, noted complaints of law firms filing improper or duplicative foreclosure and bankruptcy
pleadings and levying inappropriate fees upon borrowers.

       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                          23
       2. FHFA’s Supervisory Planning and Guidance Do Not Adequately
          Address Default-Related Legal Services

To date, FHFA has neither an ongoing risk-based supervisory plan detailing examination and
continuous supervision of default related legal services, nor finalized examination guidance and
procedures for use in performing targeted examinations and monitoring of such services.

As a Federal agency, FHFA is subject to internal control standards that help it meet its
responsibilities and minimize risk associated with its programs and operations. For example, the
Government Accountability Office’s Standards for Internal Control in the Federal Government
defines control activities as the policies, procedures, techniques, and mechanisms that help
ensure an agency’s objectives are met.30 Further, as specified in the Office of Management and
Budget’s Circular A-123, it is management’s responsibility to develop and maintain effective
internal controls.31 Thus, as agencies develop and execute strategies for implementing or
reengineering agency programs and operations, they should design management structures that
help ensure accountability for results, such as approved guidance and procedures specific to
performing targeted examinations and continuous monitoring of default-related legal services.

FHFA’s examination guidance and procedures – Supervisory Guide and Supervision Handbook –
are general in nature and not specific to operational risk areas, such as default-related legal
services. Although the Agency’s Supervision Reference and Procedures Manual includes more
detail concerning review procedures related to operational risk, these procedures do not address
specific third-party vendor risks, such as risks associated with default-related legal services
performed by law firms.

Additionally, the Agency has not finalized the manual for use by its examiners. Rather, the
manual has been in “beta testing”32 for over two years. FHFA has stated that the manual is
authorized for use by examiners, and during the “beta testing” the examiners have been using the
manual to conduct examinations, including the special review of the RAN. Nonetheless, FHFA
would benefit from completion of supervisory plans and finalization of examination guidance for
default-related legal services that collectively provide management’s direction governing the
supervisory process.




30
     GAO/AIMD-00-21.3.1 (11/99), p. 11.
31
     OMB Circular A-123 (June 21, 1995), § 2.
32
  Beta testing is the last stage of product testing and normally involves using the product in real-world
circumstances.

         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                          24
       3. FHFA Does Not Have a Formal Process for the Enterprises to Share
          Information About Problem Law Firms

FHFA does not have a formal process to address performance problems associated with law
firms that have relationships – either directly through contract or through its loan servicers – with
both of the Enterprises. Specifically, FHFA does not have a policy requiring the Enterprises to
notify the Agency when they terminate a third-party vendor, such as a law firm, for poor or
inappropriate performance. The Agency also does not have a process to apprise an Enterprise
when it learns that a particular law firm has been terminated by the other Enterprise. Although
the Enterprises appear to have notified each other of vendor terminations in the past, such
notifications appear to have been done on an ad hoc basis. FHFA also has not developed and
implemented a policy that requires Enterprises to evaluate the performance of a vendor when
they learn that the other Enterprise terminated the firm.

Fannie Mae has terminated six law firms from its RAN since 2008, but FHFA does not have a
formal policy or practice to apprise either Enterprise of the other Enterprise’s termination
actions. Moreover, Freddie Mac has terminated law firms for poor performance, and Fannie
Mae has retained the firms. Indeed, Freddie Mac terminated one law firm that processed over
43% of Fannie Mae’s loan foreclosures in Florida. Freddie Mac voluntarily notified Fannie Mae
of its reasons for terminating the firm, which included foreclosure processing abuses, but Fannie
Mae decided to retain the law firm’s services. Fannie Mae determined that the cost of
transferring its files from the firm to a replacement vendor would be substantial. Additionally,
Fannie Mae claimed it would work closely with the firm to mitigate its deficiencies.33 In another
example, Freddie Mac terminated a law firm in Maryland,34 and, again, Fannie Mae decided to
retain its services. Fannie Mae asserted that it reviewed the allegations and did not find the same
type of deficiencies in its review of the firm.

FHFA needs to address concerns (e.g., poor and inappropriate performance) associated with
third-party vendors, such as law firms, that do business with both Enterprises. Failure to do so
leaves the Enterprises vulnerable to problems or abuses identified by the other Enterprise.
Further, FHFA’s prompt action will help mitigate the reputational risks associated with the
allegations of improper foreclosure practices.

33
  Fannie Mae estimates it will incur significant costs when it terminates law firms in its RAN for breach of contract.
These costs include costs incurred to investigate the actions of the firm, external third-party fees, internal operating
costs, and file transfer fees (i.e., fees paid to the replacement RAN firm to physically acquire the foreclosure files).
For example, when Fannie Mae terminated the Stern Law Firm, it estimated it would incur approximately $5.5
million in total costs. The costs include $4.6 million in file transfer fees (this estimate represents $200 per transfer
for approximately 23,000 loan files). Fannie Mae estimated all other associated costs at approximately $900,000.
34
     Again, its reasons included foreclosure processing abuses.

          Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                           25
CONCLUSION
FHFA can strengthen its oversight of default-related legal services. FHFA recognized the
importance of its oversight of the Enterprises’ default-related legal services and gradually
accumulated information on the attorney network programs of Fannie Mae and Freddie Mac.
However, FHFA did not schedule comprehensive examination coverage of foreclosure issues,
including allegations of abuse by specific law firms that performed default-related legal services
for Fannie Mae until after news accounts of abuses surfaced in August 2010. FHFA historically
considered the RAN to be an area of comparatively low risk, but several key indicators could
have led the Agency to recognize its increasing risk. For example, rising default and foreclosure
rate trends reflect increased operational risks, and the consequential allegations of foreclosure
abuses represent reputational risks for the Enterprises. Had the Agency more fully explored and
considered these indicators, it could have elevated default-related legal services as an area of
concern worthy of increased supervisory attention. Indeed, FHFA might have been able to take
earlier action to strengthen controls over Fannie Mae’s law firms involved in the foreclosure
process. Even if these indicators had not precipitated a program of examinations of Fannie
Mae’s default-related legal services, at the very least they should have prompted the Agency to
enhance its risk assessment and monitoring activities.

The Agency’s special review of the RAN framework is a positive step and the Agency should
continue with undertaking such reviews. FHFA-OIG contends, however, that the Agency should
have paid closer attention to the highly dynamic housing foreclosure environment between 2008
and 2010 and, in the future, should become more proactive in its oversight of the RAN in
particular and the foreclosure process in general. The Agency needs to apply a proactive
approach going forward to identify and assess new and emerging risks and to develop detailed
guidance on conducting targeted examinations of the Enterprises’ operational risks associated
with their vendors. This guidance should incorporate continuous supervision, special reviews,
and targeted examinations and address crossover issues that affect both of the Enterprises and
their relationships with third-party vendors.

FHFA would have greater assurance that foreclosure processing abuses will be prevented and
detected by strengthening controls in its supervisory processes.




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                   26
RECOMMENDATIONS
FHFA-OIG recommends that FHFA:

1.    Review the circumstances surrounding FHFA not identifying the foreclosure abuses at an
      earlier stage and develop potential enhancements to its capacity to identify new and
      emerging risks.

2.    Develop and implement comprehensive examination guidance and procedures together
      with supervisory plans for default-related legal services.

3.    Develop and implement policies and procedures to address poor performance by default-
      related legal services vendors that have contractual relationships with both of the
      Enterprises.




     Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                  27
OBJECTIVE, SCOPE AND METHODOLOGY
The objective of this performance audit was to assess the extent of FHFA’s oversight of Fannie
Mae’s default-related services performed by law firms within the RAN. Specifically, FHFA-
OIG sought to review FHFA’s: (1) written policies and procedures for its oversight of Fannie
Mae’s RAN; (2) oversight of Fannie Mae’s internal controls over its RAN; and (3) supervisory
actions taken concerning the RAN.35

FHFA-OIG performed its fieldwork for this audit from April 2011 through July 2011. FHFA-
OIG conducted this audit at FHFA’s three offices located in Washington, D.C., and Fannie
Mae’s office in Washington, D.C. FHFA-OIG interviewed FHFA and Fannie Mae personnel.
To achieve its objective, FHFA-OIG relied on computer-processed and hard copy data from
FHFA and Fannie Mae. This included data contained in the xWorks document repository and
the Agency’s MS Outlook email account. FHFA-OIG assessed the validity of the computerized
and hard copy data and found it to be generally accurate, but could not conclude on its
completeness.

FHFA-OIG assessed the internal controls related to its audit objectives. Internal controls are an
integral component of an organization’s management that provides reasonable assurance that the
following objectives are achieved:

           Effectiveness and efficiency of operations;

           Reliability of financial reporting; and

           Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives, and include the processes and procedures for planning,
organizing, directing, and controlling program operations as well as the systems for measuring,
reporting, and monitoring program performance. Based on the work completed on this
performance audit, FHFA-OIG considers deficiencies related to FHFA’s oversight of Fannie
Mae’s default-related legal services performed by law firms within the RAN to be significant
within the context of the audit objective.

FHFA-OIG conducted this performance audit in accordance with Generally Accepted
Government Auditing Standards. Those standards require that audits be planned and performed

35
     The audit was not intended or designed to assess the effectiveness of Fannie Mae’s oversight of the RAN.

           Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                           28
to obtain sufficient, appropriate evidence to provide a reasonable basis for FHFA-OIG’s findings
and conclusions based on the audit objective. FHFA-OIG believes that the evidence obtained
provides a reasonable basis for the finding and conclusions included herein, based on the audit
objectives.




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                   29
APPENDIX A
FHFA’s Comments on Findings and Recommendations




     Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                  30
Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                             31
APPENDIX B
FHFA-OIG’s Response to FHFA’s Comments

On September 29, 2011, FHFA provided comments to a draft of this report agreeing with all
three recommendations and identifying FHFA actions to address each recommendation. FHFA-
OIG considers the actions sufficient to resolve the recommendations, which will remain open
until FHFA-OIG determines that agreed upon corrective actions are completed and responsive to
the recommendations. See Appendix C of this report for a summary of management’s comments
on the recommendations.

With regard to FHFA’s response to Recommendation 3, FHFA stated that it is concluding its
examination activity and will ensure that appropriate steps are taken by September 29, 2012, to
remediate Enterprise deficiencies in the management of risks associated with default-related
legal services vendors. While this action is positive, FHFA should address poor performance by
these counterparties that have relationships with both of the Enterprises as part of its remedial
efforts in accordance with the agreed-to recommendation.

FHFA noted that it does not have direct supervisory authority over providers of default-related
legal services and that the matters at issue concern FHFA’s oversight of Fannie Mae and how
Fannie Mae manages counterparty risk in its contractual relationships with legal service
providers. FHFA-OIG agrees with these points and further notes that FHFA, as conservator for
Fannie Mae, has the powers of the management, Board of Directors and shareholders of the
Enterprise.

FHFA’s response referred to prior comments provided to FHFA-OIG that were considered in
finalizing this report.




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                   32
APPENDIX C
Summary of Management’s Comments on the Recommendations

This table presents the management response to the recommendations in FHFA-OIG’s report and
the status of the recommendations as of the date of report issuance.

 Rec. No.       Corrective Action: Taken      Expected Completion       Monetary      Resolved:a    Open or
                      or Planned                     Date               Benefits      Yes or No     Closedb


    1.         FHFA will review its                09/29/2012               $0           Yes          Open
               existing supervisory
               practices, including off-
               site monitoring
               activities, and determine
               whether there are useful
               enhancements to
               consider and implement
               concerning assessments
               of emerging risks.

    2.         FHFA will review its                09/29/2012               $0           Yes          Open
               supervision reference
               and procedures manual
               and add detailed
               provisions to it that
               pertain to default-related
               legal services. Further,
               FHFA’s supervisory
               plans will be revised to
               reflect the final actions
               taken to address
               weaknesses in the RAN.
    3.         FHFA will ensure that               09/29/2012               $0           Yes          Open
               appropriate steps are
               taken to remediate
               Enterprise deficiencies
               in the management of
               risks associated with
               default-related legal
               services vendors.


         Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                      33
a Resolved means – (1) Management concurs with the recommendation, and the planned, ongoing, and completed
corrective action is consistent with the recommendation; (2) Management does not concur with the recommendation,
but alternative action meets the intent of the recommendation; or (3) Management agrees to the FHFA-OIG
monetary benefits, a different amount, or no ($0) amount. Monetary benefits are considered resolved as long as
management provides an amount.
b Once the FHFA-OIG determines that the agreed-upon corrective actions have been completed and are responsive
to the recommendations, the recommendations can be closed.




       Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
                                                      34
ADDITIONAL INFORMATION AND COPIES


For additional copies of this report:

          Call the Office of Inspector General (OIG) at: 202-408-2544

          Fax your request to: 202-445-2075

          Visit the OIG website at: www.fhfaoig.gov



To report alleged fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

          Call our Hotline at: 1-800-793-7724

          Fax us the complaint directly to: 202-445-2075

          E-mail us at: oighotline@fhfa.gov

          Write to us at: FHFA Office of Inspector General
                           Attn: Office of Investigation – Hotline
                           1625 Eye Street, NW
                           Washington, DC 20006-4001




      Federal Housing Finance Agency Office of Inspector General • AUD-2011-004 • September 30, 2011
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