oversight

Compliance Review of FHFA's Oversight of Enterprise Executive Compensation Based on Corporate Scorecard Performance

Published by the Federal Housing Finance Agency, Office of Inspector General on 2016-03-17.

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

           Federal Housing Finance Agency
               Office of Inspector General




      Compliance Review of
  FHFA’s Oversight of Enterprise
 Executive Compensation Based on
 Corporate Scorecard Performance




Compliance Review  COM-2016-002  March 17, 2016
                 Executive Summary
                 The Federal Housing Finance Agency (FHFA or the Agency) Office of
                 Inspector General (OIG) stated in an evaluation report issued on March 31,
                 2011, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie
                 Mae’s and Freddie Mac’s Executive Compensation Programs (2011
                 Evaluation Report) that Fannie Mae and Freddie Mac (the Enterprises) paid
COM-2016-002     their top six executives more than $35 million in compensation in 2009 and
                 2010. Based on our review of the oversight process used by FHFA, the
XXX-2016-0XX
March 17, 2016   Enterprises’ conservator, to assess the appropriateness of this compensation,
Date XX, 2015    we found that FHFA’s process was insufficiently robust because it generally
                 accepted the Enterprises’ annual at-risk compensation proposals rather than
                 verifying and testing the accuracy of the reported information and conclusions.
                                                 DRAFT




                 We recommended that FHFA strengthen its oversight over compensation for
                 Enterprise executives by, among other things, testing and verifying the
                 Enterprises’ proposals for the at-risk element of executive compensation,
                 which has been estimated by FHFA to have constituted 70% of an executive’s
                 annual compensation.

                 In December 2011, FHFA advised us that it had adopted enhanced controls,
                 including testing and verification procedures, to strengthen its oversight of
                 Enterprise proposals for at-risk compensation for Enterprise executives. We
                 closed our recommendation on February 27, 2012, based on our determination
                 that the controls, as drafted, addressed the deficiencies we identified.

                 On September 16, 2015, we initiated this compliance review to test
                 FHFA’s implementation of the controls it adopted in response to our
                 2011 recommendation. We learned, however, that FHFA discontinued the
                 implementation of the controls as of March 9, 2012, upon adoption of a new
                 Enterprise executive compensation structure. Adoption of that structure
                 came less than two weeks after OIG closed the 2011 Evaluation Report
                 recommendation. According to FHFA, it determined that its March 2012
                 compensation structure rendered the 2011 controls obsolete and it did not use
                 them.

                 We recognize that FHFA acted within its discretion in establishing the
                 new executive compensation structure in March 2012. However, FHFA’s
                 abandonment of the testing and verification controls it adopted in 2011 has
                 limited its capacity to review and oversee the Enterprises’ annual proposals
                 for the at-risk compensation element for executives, based on the executives’
                 contributions in meeting corporate financial and performance goals (also
                 referred to as Corporate Scorecard goals).
                 For calendar year 2014, FHFA approved total compensation payments of
                 approximately $80 million to 85 Enterprise executives, $11.7 million of which
                 was comprised of at-risk incentive pay, based on their performance in meeting
                 the Enterprises’ Corporate Scorecard goals. In light of these considerable
                 expenditures and the importance of the executives’ responsibilities, OIG
                 recommends that FHFA develop controls to test and verify that Enterprise
                 proposals for the at-risk element of compensation based on Corporate
COM-2016-002     Scorecard performance are reasonable and justified. OIG also recommends
                 that FHFA notify OIG when it does not fully implement, substantially alters, or
XXX-2016-0XX
March 17, 2016
                 abandons controls or other corrective actions that served as OIG’s basis for
Date XX, 2015    closing a report recommendation. FHFA disagreed with these
                 recommendations.
                                                 DRAFT




                 This compliance review was led by Alisa Davis, Senior Policy Advisor, and
                 Wesley M. Phillips, Senior Policy Advisor, with assistance from Andrew
                 Gegor, Jr., Senior Auditor, and Patrice Wilson, Senior Investigative Evaluator.
                 We appreciate the cooperation of FHFA staff, as well as the assistance of all
                 those who contributed to the preparation of this report.

                 This compliance review report has been distributed to Congress, the Office
                 of Management and Budget, and others and will be posted on our website,
                 www.fhfaoig.gov.




                 Richard Parker
                 Deputy Inspector General, Compliance & Special Projects
TABLE OF CONTENTS ................................................................
EXECUTIVE SUMMARY .............................................................................................................2

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

BACKGROUND .............................................................................................................................6
      FHFA’s March 2012 Enterprise Executive Compensation Structure.......................................8
      FHFA Determined that the March 2012 Revisions to the Enterprises’ Executive
      Compensation Structure Rendered Obsolete the Controls in the Procedure Guide ...............10
      FHFA Review of Enterprise Proposals for Executive At-Risk Compensation Based
      on Individual Corporate Scorecard Performance ...................................................................11
                                                                                   DRAFT




      ECB’s Review of the Enterprises’ Compensation Proposals for the 2014 Corporate
      Scorecard Performance Demonstrates the Limited Nature of its Review Process .................12

COMPLIANCE REVIEW RESULTS ...........................................................................................14
      ECB’s Limited Reviews are Substantially Similar to the Deficient FHFA Executive
      Compensation Oversight Process Identified by OIG in the 2011 Evaluation Report ............14

CONCLUSION ..............................................................................................................................15

RECOMMENDATIONS ...............................................................................................................15

FHFA’S COMMENTS AND OUR RESPONSE ..........................................................................16

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................17

APPENDIX A ................................................................................................................................18
      FHFA’s Comments on OIG’s Findings and Recommendation ..............................................18

APPENDIX B ................................................................................................................................20
      Summary of Management’s Comments on the Recommendations ........................................20

ADDITIONAL INFORMATION AND COPIES .........................................................................21




                                          OIG  COM-2016-002  March 17, 2016                                                              4
ABBREVIATIONS .......................................................................

CEO                   Chief Executive Officer

CFO                   Chief Financial Officer

DER                   Division of Enterprise Regulation

ECB                   Executive Compensation Branch

Enterprises           Fannie Mae and Freddie Mac

Fannie Mae            Federal National Mortgage Association
                                                    DRAFT




FHFA or Agency        Federal Housing Finance Agency

Freddie Mac           Federal Home Loan Mortgage Corporation

OIG                   Federal Housing Finance Agency Office of Inspector General

Procedure Guide       FHFA Procedural Guide for Enterprise Executive Compensation
                      Scorecards




                         OIG  COM-2016-002  March 17, 2016                        5
BACKGROUND ..........................................................................

In our 2011 Evaluation Report, we explained the process
used by the Enterprises to compensate their executives.    Total Compensation is the
                                                           maximum compensation an
We outlined that, at the beginning of each year, each
                                                           Enterprise executive may
Enterprise established its financial and performance       receive and is based on data for
goals, and at year-end, each Enterprise assessed corporate comparable positions at other
performance against the goals. At that time, each          financial institutions. Total
Enterprise also determined whether each executive’s        compensation is comprised
contributions to its overall performance warranted an      of base salary and deferred
award to that executive of all, or only a portion of, her  compensation, with the latter
                                                           having fixed and at-risk
or his “at risk” compensation, such as bonuses. During
                                                           components.
this compliance review, an FHFA official estimated                 DRAFT




that in 2011 70% of each executive’s annual total
compensation was “at-risk” while the remaining 30% was fixed, base salary.

Our 2011 Evaluation Report identified deficiencies in FHFA’s oversight of the Enterprises’
corporate performance and executive compensation processes. We found that individual
offices within FHFA that reviewed and approved the Enterprises’ financial and performance
goals and measured performance against those goals did not do so using established, written
criteria and did not document their findings, thereby preventing any assessment by the FHFA
Director or a third party (like OIG) of the consistency and effectiveness of their oversight.
Further, we found that FHFA generally accepted the Enterprises’ annual compensation
determinations, without testing and verifying the adequacy of those determinations. Based
on our review, we found that FHFA’s approach was inconsistent with commonly accepted
examination and auditing procedures and concluded that, absent testing and verification,
FHFA lacked an empirical basis for approving Enterprise executive compensation.1




1
  FHFA stated that it might question an Enterprise’s proposed compensation for an individual executive if it
seemed inconsistent with the Agency’s experience with a particular executive or if the proposed compensation
was inconsistent with compensation paid to executives in comparable positions with other financial
institutions.



                                  OIG  COM-2016-002  March 17, 2016                                          6
We recommended that FHFA strengthen its oversight of the Enterprises’ executive
compensation by:

    1. Establishing written criteria and procedures for reviewing the Enterprises’ annual
       performance measures and year-end performance assessment data, as well as their
       recommended executive compensation levels; and

    2. Conducting independent testing and verification, perhaps on a randomized basis, to
       gain assurance that the Enterprises’ bases for developing recommended individual
       executive compensation levels are reasonable and justified.

FHFA agreed with the first part of our recommendation in March 2011, but it disagreed
with the second part regarding the establishment of testing and verification procedures for
individual executive compensation levels. When FHFA provided us with its Procedural
Guide for Enterprise Executive Compensation Scorecards (Procedure Guide) on December
                                                                    DRAFT




30, 2011, the Procedure Guide set forth criteria and procedures for review and approval of
Enterprise proposals for at-risk compensation, as well as requirements for annual testing of
a random sample of individual executive compensation decisions,2 by FHFA’s Division of
Enterprise Regulation (DER).3

We reviewed the written criteria and requirements in the Procedure Guide and determined
that it remediated the deficiencies identified in our 2011 Evaluation Report; we closed our
recommendation on February 27, 2012. At that time, we were generally aware that FHFA
was considering revisions to the Enterprises’ executive compensation structure, as discussed
below.4 However, we were not advised until we conducted the fieldwork for this compliance
review that FHFA determined, upon adopting its revised compensation structure on March 9,
2012, that this structure rendered obsolete the controls in the Procedure Guide.




2
 According to the Procedure Guide, the goals of this testing were to verify that individual executive
performance ratings were reasonable and appropriately documented, assess whether governing policies and
procedures were followed, and assure that Enterprise processes for determining individual compensation
payments were sound and accurate based on individual and corporate performance results.
3
 The Procedure Guide also included procedures for FHFA’s review and approval of the Enterprises’ proposed
Corporate Scorecards at the beginning of each calendar year and the Agency’s assessments of the Enterprises
collective performance against the Corporate Scorecards at year-end.
4
  In FHFA’s December 30, 2011, letter to OIG, to which the Procedure Guide was appended, FHFA advised
that it was, “also considering modifications to the executive compensation structure, possibly coupled with
some lowering of non-CEO compensation. This work is underway, with decisions anticipated before the
Enterprises file their 10-Ks for 2011.” Freddie Mac included the information in its 2011 10-K, and Fannie
Mae amended its 2011 10-K to include the information.




                                  OIG  COM-2016-002  March 17, 2016                                         7
FHFA’s March 2012 Enterprise Executive
                                                                           The Conservatorship Scorecard is
Compensation Structure
                                                                           a weighted scorecard with specific
                                                                           objectives for the Enterprises to
In February 2012, FHFA issued its Strategic Plan for
                                                                           achieve in support of FHFA’s
the conservatorship in which it identified three broad                     strategic plan, such as maintaining
goals for its conservation of the Enterprises. On                          credit availability and reducing
March 9, 2012, FHFA issued its first annual guidance                       taxpayer risk, among other items.
to the Enterprises containing specific actions they
were expected to take to achieve the goals set forth in the Strategic Plan. These actions are
referred to as the Conservatorship Scorecard goals. That day, FHFA also publicly announced
that it had adopted a new Enterprise executive compensation structure, the purpose of which was
to balance “prudent” executive pay with the need to retain “quality” executives.5 Among other
                                                                   DRAFT




things,6 the revised executive compensation structure established that fixed compensation
accounted for 70% of each executive’s total compensation and the at-risk portion accounted for
the remaining 30%. As shown in Figure 1, below, and stated earlier in this report, FHFA
estimates that the at-risk component of each executive’s total compensation was approximately
70% prior to 2012, with the fixed component representing the remaining 30%.

              FIGURE 1.                 Each of the fixed and at-risk elements of the revised
        TOTAL COMPENSATION              executive compensation structure is made up of two parts:
        PRE-2012 VS CURRENT
                                               Fixed Element, totaling 70% of total compensation,
                          At Risk               includes base salary, which is paid on a recurring
                           30%                  basis throughout the year and is capped at $500,000
         At Risk                                for every Enterprise executive, save for Chief
          70%
                                                Executive Officers (CEOs) and Chief Financial
                           Fixed                Officers (CFOs).7 The remainder of this fixed
                           70%                  element is referred to as deferred salary, which is
         Fixed
                                                payable in quarterly installments after a one-year
         30%
                                                deferral period.
       Pre-2012         Current
    Source: OIG analysis of information provided by FHFA.

5
 Press Release, FHFA Announces New Conservatorship Scorecard for Fannie Mae and Freddie Mac; Reduces
Executive Compensation (Mar. 9, 2012) (online at www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-
Announces-New-Conservatorship-Scorecard-for-Fannie-Mae-and-Freddie-Mac.aspx).
6
  The new structure included an average reduction of 10% in executives’ total compensation and the
elimination of bonuses and long-term incentive payments.
7
    CEO compensation is capped at $600,000 annually. CFO base salary can exceed $500,000.



                                    OIG  COM-2016-002  March 17, 2016                                          8
        At-risk Element, totaling 30% of total compensation, all of which is deferred and is
         subject to performance-based reduction:

             o Half of this at-risk deferred compensation (or 15% of total compensation) is
               subject to a reduction based on FHFA’s determination of how each Enterprise
               performed against FHFA’s annual Conservatorship Scorecard measures, so
               that all executives at an Enterprise receive the same percentage.

             o The remaining half of this at-risk
               deferred compensation (or 15% of total                         The Corporate Scorecards, also
               compensation) is subject to a reduction                        referred to as financial and
               based on the Enterprise CEO’s and Board                        performance targets, contain
                                                                              goals set by the Enterprises for
               of Directors’ evaluation of an individual
                                                                              their financial, operations, and
               executive’s performance against annual                 DRAFT
                                                                              mission-related activities,
               Enterprise Corporate Scorecard                                 among other items.
               performance measures.8, 9




8
 FHFA reported to us that Enterprise executives’ compensation may be tied to specific Corporate Scorecard
goals or other financial and performance objectives that are not specifically in the goals. For presentational
purposes, in this report we use the term “Corporate Scorecard goals” to refer to all such standards against
which the Enterprises measured the performance of their executives.
9
 One of the Enterprises uses a separate Internal Audit Scorecard to determine the at-risk portion of total
compensation for the executive in charge of its Internal Audit function.



                                   OIG  COM-2016-002  March 17, 2016                                           9
Figure 2 provides an illustration            FIGURE 2. CALCULATION OF A HYPOTHETICAL ENTERPRISE
of the compensation of a                               EXECUTIVE’S TOTAL COMPENSATION
hypothetical Enterprise
executive with a $1 million total                   Total Compensation
compensation, under the March                           $1,000,000
2012 executive compensation
                                                      Maximum of $150,000
structure.                                        Based on Enterprise assessment
                                                     of individual performance             At-risk compensation,
FHFA Determined that the                           against Corporate Scorecard                   all deferred
March 2012 Revisions to                                                                         (30% of total
                                                       Maximum of $150,000                    compensation)
the Enterprises’ Executive                          Based on FHFA assessment of                 $0–$300,000
                                                   Enterprise performance against
Compensation Structure
                                                     Conservatorship Scorecard
Rendered Obsolete the
                                                                    DRAFT




Controls in the Procedure
Guide                                                         $200,000                      Fixed compensation,
                                                        Fixed, deferred salary               both deferred and
During this compliance review,                                                                  non-deferred
FHFA advised us that it                                                                         (70% of total
determined that the March 2012                                                                 compensation)
                                                                                                   $200,000
revisions to the Enterprise
                                                                                                 + 500,000
executive compensation structure                                                                   $700,000
rendered the Procedure Guide’s
requirements obsolete;                          Maximum of $500,000
                                           Fixed, non-deferred base salary
accordingly, it did not use them
subsequently.10 FHFA explained
that its revised executive
compensation structure
reduced the percentage of at-
risk compensation determined        Source: OIG analysis of information provided by FHFA.
by the Enterprises from an
estimated 70% of each executive’s total compensation in 2011 to 30%, of which 15% would
be based on an executive’s Corporate Scorecard performance. FHFA determined that it was
“reasonable” to delegate to the Enterprises responsibility for developing annual Corporate


10
  The only evidence we found of application of any of the requirements in the Procedure Guide was in a
January 2012 DER special examination of the controls over the Enterprises’ processes for developing their
2011 executive compensation proposals based on 2011 performance. FHFA reported to us that DER has not
examined the effectiveness of the Enterprises’ controls in subsequent years. Further, although the Procedure
Guide required FHFA to review and approve the Enterprises’ Corporate Scorecards at the start of each year
and their performance against them at year-end, FHFA has not done so since the establishment of the 2011
Procedure Guide.



                                   OIG  COM-2016-002  March 17, 2016                                         10
Scorecards, measuring their individual executive performance against the scorecards, and
determining the 15% at-risk compensation for each individual executive based on that
assessment. As discussed below, FHFA requires the Enterprises to submit their annual
determinations of individual executive compensation to the Agency for its review and
approval.

We are not suggesting that FHFA intended to mislead OIG when it submitted the Procedure
Guide on December 30, 2011. Based on our review of documents and information garnered
during interviews, we understand there were considerable deliberations in the Agency about
the elements of the revised executive compensation structure during the first two months of
2012, and the Agency did not finalize the details of the revised structure until shortly before it
was announced on March 9, 2012.11 We closed our recommendation on February 27, 2012,
based upon the Procedure Guide as it was submitted to us by the Agency in December 2011.
The Agency subsequently determined, less than 2 weeks later, that this 2011 Procedure Guide
                                                                     DRAFT




was obsolete, but it did not advise us of its determination until we commenced this
compliance review in September 2015.

FHFA Review of Enterprise Proposals for Executive At-Risk Compensation Based on
Individual Corporate Scorecard Performance

Although FHFA has delegated most of the responsibilities delineated in the 2011 Procedure
Guide to the Enterprises, the Agency reported to us that it continues to review and approve
the Enterprises’ annual determinations of executive at-risk compensation based on individual
Corporate Scorecard performance. The Agency’s stated purposes for its reviews are to
(1) meet a statutory and regulatory requirement to approve executive compensation payments
and ensure those payments are “reasonable” and “comparable,”12 and (2) to ensure the
proposed compensation is consistent with the Agency’s experiences with particular
executives. To achieve these purposes, FHFA conducts limited reviews of information
provided by the Enterprise and engages in internal consultations.

According to FHFA, each January the Enterprises submit their proposals for providing each
executive with up to 15% of her or his total compensation. The proposals are based upon
Enterprise assessments of an individual executive’s performance as measured against the
Enterprises’ Corporate Scorecards for the prior calendar year. FHFA has charged its



11
  For example, an FHFA official said that it was not until the first quarter of 2012 that FHFA began to
consider using a Conservatorship Scorecard as a means to assess the Enterprises’ performance and to
determine a portion of their executives’ at-risk compensation.
12
     See 12 U.S.C. § 4518(a); 12 C.F.R. § 1230.3(a).




                                    OIG  COM-2016-002  March 17, 2016                                   11
Executive Compensation Branch (ECB)13 with responsibility for reviewing the materials
submitted by the Enterprises and preparing a memorandum to the FHFA Director with
recommendations to approve, reject, or revise the Enterprises’ proposals for each executive.14
The Director typically informs the Enterprises of his decision in February each year.

ECB has not established written procedures for its annual reviews of the Enterprises’
compensation proposals. An ECB official characterized the ECB’s reviews as an informal
“sanity check,” which we found to be quite limited in scope. According to the ECB official,
the office reviews the materials provided by the Enterprises and does not challenge an
Enterprise’s compensation proposal for an individual executive unless: (a) it would award
an executive an amount in excess of 15% of the executive’s total compensation, or (b) it
conflicts with information (good or bad) that came to ECB’s attention during the year. For
example, ECB explained to us that it might question an Enterprise proposal to award an
executive the full 15% of her or his total compensation if its own experience with that
                                                                     DRAFT




executive was negative, or if it received negative information about that executive’s
performance from other Agency officials, or from the Enterprises’ compensation committees,
internal audit groups, or risk managers.

ECB’s Review of the Enterprises’ Compensation Proposals for the 2014 Corporate
Scorecard Performance Demonstrates the Limited Nature of its Review Process

We analyzed the process by which ECB reviewed in early 2015 the Enterprises’ executive
compensation proposals based on Corporate Scorecard performance in calendar year 2014. We
sought, and were provided with, the Enterprises’ proposals to compensate all executives covered
by the revised compensation structure, except their CEOs, for the 15% at-risk element based on
achievement of the 2014 Corporate Scorecard goals, all documentation the Enterprises provided
in support of their proposals, and ECB’s material evidencing its review of the Enterprises’
proposals. Our review identified significant limitations in the materials provided to ECB by the
Enterprises in support of their executive compensation proposals, as well as in ECB’s review of
those materials:15



13
   ECB consists of its Manager and three staff members. The Manager oversees one staff member who
focuses on Enterprise oversight and two staff members who focus on Federal Home Loan Bank compensation
oversight.
14
  ECB also attends meetings of the Enterprises’ boards of directors during which annual executive
compensation proposals are made by their compensation committees.
15
   FHFA has not updated and standardized the content requirements for the Enterprises’ executive
compensation proposals since 2012. The 2012 requirements for executive compensation state that the
Enterprises must “provide sufficient, relevant information to support a meaningful evaluation by the
Conservator of requests for approval.” If, after reviewing a proposal, ECB believes that it has not received
information sufficient to support it, then ECB can request additional information from the Enterprise.



                                   OIG  COM-2016-002  March 17, 2016                                         12
        One Enterprise submitted compensation proposals to FHFA for 50 of the 85 total
         executive proposals submitted by both Enterprises. For 41 of the 50 executives, the
         only information that the Enterprise submitted was the proposed percentage and
         compensation amount (e.g., 15% of an executive’s total compensation). The
         Enterprise did not provide any other supporting documentation or materials, such
         as the Corporate Scorecard goal(s) for which each executive was responsible or
         the basis for the proposed compensation amounts. ECB did not request additional
         documentation and, in February 2015, FHFA’s Director approved the Enterprise’s
         proposals for these 41 executives without exception or comment. As proposed by the
         Enterprise, 37 of the 41 executives received the full targeted amount (15% of her or
         his total compensation), and 4 received 95% of the targeted amount.

        The other Enterprise submitted compensation proposals for the remaining 35 of the 85
         total executives. For 26 of these 35 executives, the Enterprise submitted to FHFA the
                                                                  DRAFT




         proposed compensation amount (e.g., 15% of total compensation) and a qualitative
         rating of each executive’s performance, i.e., “Exceeds,” “Achieves,” or “Needs
         Improvement.” The Enterprise, however, did not provide information on the specific
         Corporate Scorecard goal(s) for which each executive was responsible, or how it
         arrived at its ratings. ECB did not request additional documentation and, in February
         2015, FHFA’s Director approved the Enterprise’s proposals for these 26 executives:
         14 of them received the full targeted amount (15% of their total compensation) and 8
         of them received 95% of the targeted amount.16

The discussion above relates to 67 of the 85 executive compensation proposals submitted by
the Enterprises to FHFA for calendar year 2014 (41 at the first Enterprise and 26 at the second
Enterprise). The compensation proposals submitted by the Enterprises for the remaining 18
executives (9 at one Enterprise and 9 at the other) were distinguished by the fact that they
identified the Corporate Scorecard goal(s) for which each executive was responsible, as well
as the Enterprises’ assessment of whether or not they were on track to meet these goals. In
February 2015, FHFA’s Director approved the Enterprises’ proposals for these 18 executives:
14 received the full targeted amount (15% of total compensation), and 4 received 95% of the
targeted amount.

We analyzed the Enterprises’ proposals for these 18 executives. For 4 of the 18 individuals,
the Enterprises proposed that the individual executives receive the full 15% even though the
Enterprises were not on track to meet some of the Corporate Scorecard goals for which the



16
  For various reasons, FHFA approved payments of less than 95% of the targeted amounts for the other four
executives as requested by the Enterprise.




                                 OIG  COM-2016-002  March 17, 2016                                        13
executives were accountable.17 We discussed with ECB two of these four proposals—one
from each Enterprise. ECB did not follow up with the Enterprises in these particular cases
before the FHFA Director approved the Enterprises’ proposals , underscoring the fact that
ECB does not have written procedures that specify when it should question the Enterprises’
executive compensation recommendations. Although ECB did not follow up in either of
these cases, it observed that the Enterprises were on track to meet other Corporate Scorecard
goals for which the two executives were responsible, and the executives had substantial
responsibilities and were well regarded.


COMPLIANCE REVIEW RESULTS ................................................

As discussed earlier, in our 2011 Evaluation Report we identified significant limitations in
                                                                  DRAFT




FHFA’s process for reviewing and approving the Enterprises’ annual executive compensation
proposals for at-risk compensation based on corporate performance. Specifically, FHFA
generally accepted the Enterprises’ proposals rather than testing and verifying them to
ensure their appropriateness. We recommended that FHFA establish testing and verification
procedures. In response, FHFA advised us on December 30, 2011, that it adopted the
Procedure Guide, which included such procedures. On March 9, 2012, FHFA introduced
a new executive compensation structure which, it determined, rendered obsolete the testing
and verification requirements contained in the Procedure Guide. Since that time, ECB has
conducted only limited reviews of the Enterprises’ compensation payment proposals for
individual executives for at-risk deferred compensation based on Corporate Scorecard
performance.

ECB’s Limited Reviews are Substantially Similar to the Deficient FHFA Executive
Compensation Oversight Process Identified by OIG in the 2011 Evaluation Report

ECB’s limited reviews, characterized by an ECB official as a “sanity check,” are substantially
similar to the ad hoc review that FHFA conducted at the time of our 2011 Evaluation Report.
Per the current review process, ECB accepts each of the Enterprises’ proposals, unless a
proposal for an individual executive is inconsistent with information that ECB may have
obtained from its own experience or another source. ECB does not have a systematic process
in place by which to evaluate the appropriateness of the Enterprises’ proposals, nor does it test
and verify them. Moreover, it does not necessarily follow up on indications that a particular
compensation recommendation might be questionable. As we found, FHFA approved one
Enterprise’s proposals to provide all or nearly all the entire targeted amount (15% of total

17
  FHFA approved the recommended amounts in these four cases—as it did in the other 14 cases (total of 18
executive compensation proposals).



                                 OIG  COM-2016-002  March 17, 2016                                       14
compensation) to 41 executives, even though the Enterprise provided no documentation or
information to support its proposed compensation of those executives.

FHFA justifies ECB’s limited reviews on the grounds that the percentage of executive
compensation determined by the Enterprises through the Corporate Scorecard process is
sufficiently small (i.e., 15% of an individual’s total compensation) so additional review is
unnecessary. The Enterprises, however, remain in conservatorship, and compensation of
Enterprise executives is considerable. Something more than a limited review is needed to
ensure that Enterprise proposals for executive compensation are based on demonstrated
individual performance.


CONCLUSION ............................................................................
                                                           DRAFT




Although FHFA finalized criteria and procedures for review and approval of Enterprise
proposals for at-risk compensation and for annual testing of a random sample of individual
executive compensation decisions to implement the recommendation in our 2011 Evaluation
Report, it discontinued those requirements in March 2012 without informing OIG. All at-risk
individual executive compensation decisions made by FHFA since March 2012 have been
subject to an ad hoc limited review, which amounts to the same process used by FHFA that
gave rise to our 2011 evaluation. Absent clear documentation from the Enterprises, the FHFA
Director approves the Enterprises’ annual compensation proposals without adequate assurance
that they are reasonable and justified.


RECOMMENDATIONS ...............................................................

OIG recommends that FHFA develop a strategy to enhance ECB’s capacity to review the
reasonableness and justification of the Enterprises’ annual proposals to compensate their
executives based on Corporate Scorecard performance. To this end, FHFA should ensure that:
the Enterprises submit proposals containing information sufficient to facilitate a comprehensive
review by ECB; ECB tests and verifies the information in the Enterprises’ proposals, perhaps on
a randomized basis; and ECB follows up with the Enterprises to resolve any proposals that do
not appear to be reasonable and justified.

OIG recommends that FHFA develop a policy under which it is required to notify OIG within 10
days of its decision not to fully implement, substantially alter, or abandon a corrective action that
served as the basis for OIG’s decision to close a recommendation.




                              OIG  COM-2016-002  March 17, 2016                                 15
FHFA’S COMMENTS AND OUR RESPONSE .................................

We provided a draft of this evaluation to FHFA for its review and comment. On March 10,
2016, FHFA’s Acting Deputy Director, Division of Conservatorship, and its Chief Financial
Officer provided the Agency’s written comments, including its rejection of both of our
recommendations. The Agency’s comments are published verbatim in Appendix A.

In response to our first recommendation, FHFA declined to develop a strategy to enhance its
reviews of the Enterprises’ annual executive compensation proposals based on Corporate
Scorecard performance. Instead, the Agency will continue to perform “high level review[s]” of
the Enterprises’ proposals, which it deems sufficient. As demonstrated in this report, however,
FHFA’s current “high level review” does not provide it with assurance that the Enterprises’
executive compensation recommendations are reasonable or justified.
                                                          DRAFT




In February 2015, the Agency approved all of the Enterprises’ compensation proposals, even
though it lacked basic information necessary to evaluate properly many of those proposals. The
Agency also approved the payment of full at-risk compensation for some executives despite the
fact that the Enterprises were not on track to meet some of the Corporate Scorecard goals for
which the executives were responsible. In these cases, the Agency did not follow-up with the
Enterprises to gather basic information about their compensation proposals, much less challenge
any of them. These facts demonstrate that the Agency’s high level review process is flawed, and
does not permit it to ensure that Enterprise executive compensation based on Corporate
Scorecard performance is reasonable or justified. Our recommendation provides FHFA with
significant flexibility in developing a strategy to address the shortcomings in its review process;
we urge FHFA to reconsider its decision to reject it.

FHFA also disagreed with the second recommendation, stating that it would be “impracticable”
for FHFA to notify OIG of material changes to corrective actions in light of the regularity with
which it revises its processes. In the absence of such notification, OIG may be left with the
erroneous impression that the Agency is implementing a corrective action that has, in fact, been
abandoned. Moreover, failure to inform us when a corrective action is not fully implemented, or
is substantially altered, may impede our oversight; it would render us unable to assess whether
any alternative action taken by the Agency remedied the deficiency noted in our underlying
report. Given the benefits of providing OIG with notification, and the likely consequences of
failing to undertake such a simple action, OIG submits that the Agency should reconsider its
decision in this regard.

FHFA also provided technical comments on a draft of this report which we incorporated as
appropriate.




                              OIG  COM-2016-002  March 17, 2016                               16
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The original objective of this compliance review was to test FHFA’s implementation of
the requirements in the 2011 Procedure Guide. However, as outlined in the report, FHFA
discontinued these requirements as of March 2012. Accordingly, our revised objective for
this compliance review was to assess ECB’s processes for identifying and following up on
proposed Enterprise compensation payments based on Corporate Scorecard results.

To address the objective, we evaluated the effectiveness of ECB’s review process for the
Enterprises’ proposed payments for 2014 Corporate Scorecard performance. In the absence
of a written procedure about ECB’s review of Corporate Scorecard executive payments,
we identified criteria from the Government Accountability Office’s Standards for Internal
Control in the Federal Government (September 2014) concerning information principles
                                                        DRAFT




against which to assess ECB’s oversight. We analyzed key documents provided by the
Agency and questioned ECB regarding its oversight and follow-up on information contained
in those documents. We also verified the mathematical accuracy of the proposed payments.

In addition, we interviewed Agency and Enterprise personnel and reviewed other public
and internal Agency documents relating to Enterprise executive compensation. Further, we
reviewed materials related to ECB’s administration of Conservatorship Scorecard processes.

We conducted our compliance review during the period September 2015 to January 2016
under the authority of the Inspector General Act of 1978, as amended and in accordance with
the Quality Standards for Inspection and Evaluation (January 2012), which were promulgated
by the Council for the Inspectors General on Integrity and Efficiency.




                            OIG  COM-2016-002  March 17, 2016                               17
APPENDIX A .............................................................................

FHFA’s Comments on OIG’s Findings and Recommendation




                                                    DRAFT




                          OIG  COM-2016-002  March 17, 2016                        18
                         DRAFT




OIG  COM-2016-002  March 17, 2016   19
APPENDIX B..............................................................................

Summary of Management’s Comments on the Recommendations

This table presents management’s response to the recommendations in the OIG report and the
status of the recommendations as of when the report was issued.


                                                               Expected                     Resolved
    Rec.                                                      Completion      Monetary       Yes or       Open or
    No.         Corrective Action: Taken or Planned              Date         Benefits        Noa         Closedb
           FHFA disagreed with our recommendation to
           develop a strategy to enhance its review of            Not
    1.                                                                            $0            No            Closed
           the Enterprises’ annual proposals based on          applicable
           Corporate Scorecard performance.
                                                                   DRAFT




           FHFA disagreed with our recommendation to
           notify us of material changes in the                   Not
    2                                                                             $0            No            Closed
           corrective action that served as a basis for        applicable
           our recommendation closure.

a
  Resolved means: (1) management concurs with the recommendation, and the planned, ongoing, or
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 OIG monetary benefits, a different amount, or no amount ($0). Monetary benefits are considered resolved
as long as management provides an amount.
b
  Once OIG determines that agreed-upon corrective actions have been completed and are responsive, the
recommendation can be closed.




                                  OIG  COM-2016-002  March 17, 2016                                           20
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

      Call: 202-730-0880

      Fax: 202-318-0239

      Visit: www.fhfaoig.gov


                                                           DRAFT




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

      Call: 1-800-793-7724

      Fax: 202-318-0358

      Visit: www.fhfaoig.gov/ReportFraud

      Write:

                FHFA Office of Inspector General
                Attn: Office of Investigations – Hotline
                400 Seventh Street SW
                Washington, DC 20219




                              OIG  COM-2016-002  March 17, 2016                          21