oversight

FHFA's Oversight of the Enterprises' Compensation of Their Executives and Senior Professionals

Published by the Federal Housing Finance Agency, Office of Inspector General on 2012-12-10.

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 the Enterprises’ Compensation of
       Their Executives and Senior Professionals




EVALUATION REPORT: EVL-2013-001         Dated: December 10, 2012
                                       FEDERAL HOUSING FINANCE AGENCY
                                         OFFICE OF INSPECTOR GENERAL

                                                  AT A GLANCE
                                                                  title
     FHFA’s Oversight of the Enterprises’ Compensation of Their Executives and Senior Professionals


Why FHFA-OIG Did This Report                                                             Number of           Median Cash
                                                                      Title
The Housing and Economic Recovery Act of 2008 (HERA)                                     Employees           Compensation
established the Federal Housing Finance Agency (FHFA or               Executives
Agency) as the supervisor and regulator of the Federal                EVP                23                  $1,718,200
National Mortgage Association (Fannie Mae) and the Federal            SVP                62                  $723,500
Home Loan Mortgage Corporation (Freddie Mac)                          Senior
(collectively, the Enterprises). In September 2008, FHFA              Professionals
placed the Enterprises into conservatorships.                         VP                 333                 $388,000
                                                                      Director           1,650               $205,300
In its role as the Enterprises’ conservator, FHFA oversees the        Total              2,068
compensation of their executives, including their Chief              Since FHFA-OIG’s March 2011 report, FHFA has taken action
Executive Officers (CEOs), but it generally delegates to the         to strengthen its control of executive compensation. In March
Enterprises responsibility for determining the compensation          2012, FHFA implemented a revised compensation program that
levels of their approximately 11,900 non-executive                   reduces the annual compensation of the Enterprises’ CEOs
employees.                                                           nearly 90% from about $5 million to $600,000 each. The
There has been considerable Congressional interest in, and           Agency has also enhanced its oversight of executive
public debate about, the compensation paid by the                    compensation by implementing recommendations made by
Enterprises. In March 2011, the FHFA Office of Inspector             FHFA-OIG in the March 2011 report, such as conducting
General (FHFA-OIG) issued a report that evaluated the                examinations of the Enterprises’ executive compensation
Enterprises’ executive compensation programs and                     procedures.
specifically examined pay practices for the six most-senior          On the other hand, FHFA’s oversight of senior professional
executives at both Fannie Mae and Freddie Mac. This report           compensation is comparatively limited. For example, FHFA has
examines pay practices affecting the Enterprises’                    not reviewed, examined, or tested the structures, processes, or
approximately 2,100 highest paid employees, including nearly         controls by which the Enterprises compensate their senior
90 executives (CEOs, Executive Vice Presidents (EVPs), and           professionals to gain assurance of their effectiveness. FHFA-OIG
Senior Vice Presidents (SVPs)) and 2,000 senior professionals        recognizes that FHFA has delegated non-executive compensation
(Vice Presidents (VPs) and Directors).                               to the Enterprises, having determined that doing so is the best
What FHFA-OIG Found                                                  way to manage them in conservatorship. However, FHFA-OIG
                                                                     believes that the Agency’s lack of independent assessment limits
The Enterprises use market data from consulting firms as part        its capacity to ensure that the costs associated with senior
of the process to set executive and senior professional target       professional compensation are warranted.
compensation at levels that are competitive with
compensation offered by comparable financial firms to                What FHFA-OIG Recommends
facilitate recruitment and retention.                                FHFA-OIG recommends that FHFA develop a plan to strengthen
For 2011, the Enterprises’ combined median compensation              its oversight of the Enterprises’ compensation of their senior
levels for executives and senior professionals were as follows.      professionals through reviews or examinations. FHFA agreed
                                                                     with this recommendation.

EVALUATION REPORT: EVL-2013-001                                                                  Dated: December 10, 2012
TABLE OF CONTENTS
TABLE OF CONTENTS ..................................................................................................................................... 3

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

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

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

    I.           About the Enterprises and FHFA ................................................................................................................8
          A.     The Enterprises ............................................................................................................................................8
          B.     FHFA and Treasury .....................................................................................................................................8

    II.          FHFA’s Control and Oversight of Enterprise Executive Compensation .....................................................9
          A.     FHFA Initially Established Compensation Packages for the Enterprises’ Executives in 2009 .................10
          B.     Enterprises’ Compensation of Their Executives in 2010 and 2011 ...........................................................12
          C.     FHFA Revised the Enterprises’ Compensation Packages to Reduce Executive Compensation ................13
          D.     FHFA Has Taken Other Steps to Strengthen Its Oversight of Enterprise Executive Compensation .........15

    III.         FHFA’s Oversight of Non-Executive Compensation .................................................................................16
        A.       The Enterprises’ Senior Professionals and Their Roles and Responsibilities ............................................17
        B.       Overview of the Enterprises’ Senior Professional Compensation Packages .............................................18
        C.       Enterprise Senior Professional Compensation in 2010 and 2011 ..............................................................19

FINDINGS .......................................................................................................................................................... 22
          1.     Several General Issues and Risks Associated with Enterprise Senior Professional Compensation
                 Structures Merit Review by FHFA ............................................................................................................22
          2.     A Limited Test by FHFA-OIG Indicates That FHFA Should Consider Assessing Enterprise
                 Compensation Offers to Newly Hired Senior Professionals ......................................................................24
          3.     FHFA Has Not Examined the Enterprises’ Implementation of the Pay Freeze for Senior Professionals ..26

CONCLUSIONS ................................................................................................................................................ 27

RECOMMENDATION ...................................................................................................................................... 27

OBJECTIVES, SCOPE, AND METHODOLOGY ........................................................................................... 28

    Objectives ...............................................................................................................................................................28

    General Methodology .............................................................................................................................................28

    Enterprise Compensation Analysis Methodology ...................................................................................................28

    Aggregation of the Enterprises’ Compensation Data .............................................................................................30

    Median Level of Compensation ..............................................................................................................................30

    Partial-Year Employee Compensation Adjustment .................................................................................................30


               Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                                                      3
APPENDIX A ..................................................................................................................................................... 32

    Enterprise Executive and Senior Professional Attrition Rates ...............................................................................32

APPENDIX B ..................................................................................................................................................... 34

    FHFA’s Comments on FHFA-OIG’s Findings and Recommendation ...................................................................34

APPENDIX C ..................................................................................................................................................... 37

    FHFA-OIG’s Response to FHFA’s Comments .......................................................................................................37

ADDITIONAL INFORMATION AND COPIES .............................................................................................. 38




            Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                                                4
ABBREVIATIONS
CEO............................................................................................................. Chief Executive Officer
CFO .............................................................................................................. Chief Financial Officer
COO ............................................................................................................ Chief Operating Officer
EVP ........................................................................................................... Executive Vice President
Fannie Mae......................................................................... Federal National Mortgage Association
FHFA ........................................................................................... Federal Housing Finance Agency
FHFA-OIG ...................................... Federal Housing Finance Agency Office of Inspector General
Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation
GAO .................................................................................. U.S. Government Accountability Office
HERA.......................................................................Housing and Economic Recovery Act of 2008
LTI ...................................................................................................... Long-Term Incentive Award
MBS ..................................................................................................... Mortgage-Backed Securities
PSPA ........................................................................... Senior Preferred Stock Purchase Agreement
SVP .................................................................................................................Senior Vice President
TARP .............................................................................................. Troubled Asset Relief Program
Treasury ........................................................................................ U.S. Department of the Treasury
VP .............................................................................................................................. Vice President




          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                                       5
                                    Federal Housing Finance Agency
                                      Office of Inspector General
                                            Washington, DC




                                             PREFACE
As the Enterprises’ conservator, FHFA is responsible for preserving and protecting their assets
and mitigating their costs to limit further taxpayer exposure. A significant cost is the
compensation the Enterprises provide to their approximately 11,900 employees. Specifically,
FHFA-OIG estimates that in 2011 the two Enterprises collectively paid approximately
90 executives a total of $92 million, and 2,000 senior professionals a total of approximately
$455 million.1 Since 2009, FHFA has directly overseen the Enterprises’ compensation of their
two CEOs and approximately 90 other executives. On the other hand, FHFA has delegated to
the Enterprises the responsibility for setting the compensation levels for all other employees.
FHFA views the delegation of this and other day-to-day business decisions to be the most
effective and efficient means by which to manage the conservatorships.

Although FHFA directly oversees the Enterprises’ compensation of their executives, there
remains considerable Congressional interest in, and public debate about, the compensation paid
to Enterprise employees and FHFA’s oversight of this area. FHFA and the Enterprises have
stated that the Enterprises’ current levels of compensation are necessary to recruit and retain
talented executives and other employees. In 2011, Congress held oversight hearings on the
appropriateness of Enterprise executive compensation, and legislative measures limiting
Enterprise executive compensation were introduced.2 In March 2011, FHFA-OIG issued a report




1
  The Congressional Budget Office estimates that the Enterprises’ total compensation costs—including salary and
benefits—for all employees is $2 billion annually. See Congressional Budget Office, Cost Estimate for H.R. 1221
Equity in Government Compensation Act of 2011 (January 4, 2012) (online at
http://www.cbo.gov/publication/42821).
2
  See, e.g., U.S. Senate Committee on Banking, Housing, and Urban Affairs, Oversight of the Federal Housing
Finance Agency, 112th Cong. (November 15, 2011); House Committee on Oversight and Government Reform, Pay
for Performance: Should Fannie and Freddie Executives Be Receiving Millions in Bonuses?, 112th Cong.
(November 16, 2011) (H. Rept. 112-94); Stop the Outrageous Pay at Fannie and Freddie Act, S.2054, 112th
Congress; Equity in Government Compensation Act of 2011, H.R.1221, 112th Congress; and Stop Trading on
Congressional Knowledge Act of 2012, Pub. L. No. 112-105, § 16, 126 Stat. 303.


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                        6
that evaluated FHFA’s oversight of the Enterprises’ executive compensation programs and
specifically examined pay practices for their six most-senior executives.3

This report examines FHFA’s oversight of pay practices affecting the Enterprises’ approximately
2,100 most highly compensated employees and it covers three areas. First, it updates FHFA-
OIG’s March 2011 report on executive compensation by detailing FHFA’s late-2011 and 2012
initiatives in this area, and provides current data on executive compensation levels.4 Second, the
report assesses FHFA’s oversight of Enterprise non-executive employee compensation
structures, controls, and processes, with a focus on senior professional compensation.5 Finally,
the report provides comprehensive data on the Enterprises’ compensation of their senior
professionals in 2010 and 2011.

This report was prepared by Wesley M. Phillips, Senior Policy Advisor; Simon Z. Wu, Chief
Economist; and Jon A. Anders, Program Analyst. FHFA-OIG appreciates the assistance of all
those who contributed to the completion of the evaluation or who cooperated with FHFA-OIG
personnel during the process.

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




Richard Parker
Director, Office of Policy, Oversight, and Review




3
  See FHFA-OIG, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie Mac’s
Executive Compensation Programs (EVL-2011-002) (March 31, 2011) (online at
http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final%2C%20signed.pdf).
4
  In the March 2011 report, FHFA-OIG assessed FHFA’s oversight of the Enterprises’ compensation of their top six
executives. In this report, FHFA-OIG provides an update on the prior findings, including actions taken by the
Agency to implement the recommendations contained in the March 2011 report. This report also contains an
analysis of FHFA’s oversight of the Enterprises’ compensation of all of their nearly 90 executives in 2010 and 2011,
including the top six executives whose compensation was the subject of the March 2011 report.
5
  FHFA-OIG has focused on senior professionals because they are the most highly compensated group of non-
executive employees. FHFA-OIG estimates that in 2011 the Enterprises paid their 2,000 senior professionals about
$455 million in cash compensation.


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                         7
BACKGROUND
I. About the Enterprises and FHFA

            A. The Enterprises

The Enterprises support the secondary mortgage market by purchasing residential mortgages
from loan originators such as banks and credit unions. The loan originators may then use the
proceeds of these transactions to originate more mortgages. The Enterprises may hold mortgages
in their investment portfolios or package them into mortgage-backed securities (MBS) that they
sell to investors. In exchange for a fee, the Enterprises guarantee that MBS investors will receive
timely payment of principal and interest on their MBS investments.

            B. FHFA and Treasury

On July 30, 2008, HERA established FHFA as the regulator of Fannie Mae, Freddie Mac, and
the Federal Home Loan Bank System.6 Generally, FHFA is responsible for overseeing the safety
and soundness of the regulated entities (i.e., Fannie Mae, Freddie Mac, and the Federal Home
Loan Bank System), supervising their efforts to support housing finance and affordable housing
goals, and facilitating a stable and liquid mortgage market.

With respect to compensation, HERA requires FHFA to prohibit the regulated entities from
paying any compensation to their executives that is not “reasonable and comparable with
compensation for employment in other similar businesses (including other publicly held financial
institutions or major financial services companies) involving similar duties and responsibilities.”7

Further, HERA authorizes FHFA’s Director to “appoint the Agency as conservator or receiver
for a regulated entity” for a variety of reasons, including insolvency or inadequate
capitalization.8 On September 6, 2008, FHFA became Fannie Mae’s and Freddie Mac’s
conservator and, as such, the Agency has the authority to conserve and preserve their assets.

HERA also expanded Treasury’s authority to provide financial support to the Enterprises.9
Pursuant to its authority under HERA, Treasury entered into senior preferred stock purchase
agreements (PSPAs) with the Enterprises in which it agreed to provide financial support to them

6
    Pub. L. No. 110-289, § 1101, 122 Stat. 2661.
7
    12 U.S.C. §§ 4502(12), 4518(a).
8
    12 U.S.C. § 4617.
9
    See 12 U.S.C. § 1719(g).


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                       8
during their conservatorships.10 As of September 30, 2012, Treasury has invested $187.5 billion
in the Enterprises, thereby enabling them to remain solvent and continue their operations.

As the Enterprises’ conservator, FHFA has broad powers to control and direct their business
activities. Thus, in 2009 FHFA established compensation programs to govern their executives’
annual compensation levels; the Agency oversees the Enterprises’ implementation of these
programs.11 However, FHFA has delegated to the Enterprises responsibility for setting the
compensation paid to all of their non-executive employees and other day-to-day business
decisions. The Agency believes that its delegation of the authority to make decisions in areas
such as non-executive compensation is the most efficient and cost-effective means of managing
the conservatorships.12

On December 16, 2010, however, FHFA exercised its conservatorship authority and imposed a
pay freeze on general merit pay increases and cost of living adjustments to be paid to all
Enterprise employees during 2011. The pay freeze was subsequently extended to cover 2012.
FHFA stated that the pay freeze is intended to limit Enterprise expenditures in a manner
consistent with the pay freeze imposed upon the executive agencies of the federal government.
While the pay freeze is in effect, and as a general matter, an employee may not receive an
increase in compensation unless the employee is promoted or there is a significant change in the
employee’s duties and responsibilities.

II. FHFA’s Control and Oversight of Enterprise Executive Compensation

Since FHFA-OIG issued its March 2011 report, FHFA has taken several steps to strengthen its
control and oversight of Enterprise executive compensation.13 For example, in March 2012,
FHFA revised the Enterprises’ executive compensation packages. The revisions will result in
significant reductions in the compensation of the Enterprises’ CEOs as well as much smaller
reductions in the compensation of other executives. Further, FHFA has issued a written policy
10
   Specifically, pursuant to the PSPAs, the Enterprises request and obtain funds from Treasury, which owns
preferred stock in them. Under the agreements, the liquidation value of Treasury’s stock increases as the Enterprises
obtain additional Treasury funds. In exchange for Treasury’s investment in them the Enterprises must consult with
Treasury on a variety of significant business activities, including awards of executive compensation.
11
  With respect to executive compensation, the PSPAs state that the Enterprises may not enter into any new
compensation arrangements with, or increase the benefits payable under, existing compensation arrangements of any
executive officer without obtaining the consent of the Director of FHFA, in consultation with Treasury.
12
   For a detailed discussion and analysis of FHFA’s delegations under the conservatorships, see FHFA-OIG, FHFA-
OIG’s Current Assessment of FHFA’s Conservatorships of Fannie Mae and Freddie Mac (WPR-2012-001) (March
28, 2012) (online at http://www.fhfaoig.gov/Content/Files/WPR-2012-001.pdf).
13
   See FHFA-OIG, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie
Mac’s Executive Compensation Programs (EVL-2011-002) (March 31, 2011) (online at
http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final%2C%20signed.pdf).


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                         9
governing its oversight of executive compensation and conducted examinations to assess
Enterprise compensation procedures.

           A. FHFA Initially Established Compensation Packages for the Enterprises’
              Executives in 200914

As described in FHFA-OIG’s 2011 evaluation report, in late 2008 and early 2009, FHFA, in
coordination with Treasury, developed compensation packages for the Enterprises’ executives.15
FHFA’s Acting Director said that, among others things, the goals of the packages were to align
executive decision-making with the long-term financial prospects of the Enterprises and to
minimize costs to taxpayers. FHFA also sought to ensure that the Enterprises could recruit and
retain talented executives and professionals.

The key elements of the Enterprises’ executives’ 2009 compensation packages were: Base
Salary, Deferred Base Salary, and Long-Term Incentive Awards (LTI).16 Each of these elements
is summarized below.17

        Base Salary: Base salary was tied to the individual executive’s level of responsibility
         and was intended to provide the executive with a fixed level of annual compensation.
         Under the 2009 program, base salary could not exceed $500,000 per year, except for each
         Enterprise’s CEO, COO, and CFO, whose base salaries ranged from $600,000 to
         $900,000.

        Deferred Base Salary: Deferred base salary was a separate salary component. It
         consisted of two elements: a fixed portion and a performance-based portion. Payments
         of such salary were to be made during the calendar year following the year for which the
         executive’s performance was being rated. The deferred base salary earned during each

14
  Enterprise executives were paid in accordance with the 2009 packages until the packages were revised in 2012.
The major elements of the 2009 packages, with the exception of long-term incentive awards, form the basis of the
2012 packages under which the executives are now compensated.
15
   For a full description of this process, see FHFA-OIG, Evaluation of Federal Housing Finance Agency’s
Oversight of Fannie Mae’s and Freddie Mac’s Executive Compensation Programs (EVL-2011-002) (March 31,
2011) (online at
http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final%2C%20signed.pdf).
16
   FHFA-OIG also observes that the 2009 compensation packages included provisions intended to address some of
the problematic issues associated with corporate executive compensation programs. For example, the packages
required FHFA approval for “golden parachute” executive severance packages, thereby mitigating the possibility
that Enterprise executives could leave with large payouts even as the financial conditions of their companies
deteriorated.
17
   The 2009 executive compensation packages also included certain compensation earned prior to the Enterprises’
entry into conservatorship.


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                        10
         quarter was paid on the last business day of the calendar quarter in the year following the
         performance year.

        LTIs:18 LTIs were designed to provide executives with incentives to meet specific
         corporate and individual performance measures over the long-term, as well as to remain
         with the Enterprises for extended periods. LTI payments were approved by each
         Enterprise’s compensation committee and by FHFA. They were paid in two parts; the
         first LTI payment was made by March 15th of the year immediately following the
         performance year, and the second was made one year later.

The three elements described above were combined to form each executive’s target “total direct
compensation” (see Figure 1 below).19 Although the target total direct compensation for each
executive was determined annually, deferred base salary and LTI payments were paid in
subsequent years (e.g., for calendar year 2009, deferred base salary was paid in 2010 and LTI
payments were to be made by March 15, 2011). Thus, actual or cash compensation paid in any
given year could vary from the target total direct compensation approved by FHFA for an
executive. Compensation payments for executives also required the approval of the
Compensation Committees of the Enterprises’ Boards of Directors and FHFA prior to payment.




18
  Compensation terminology used in this report may vary from that used by the Enterprises. For example, Freddie
Mac uses the term “Target Incentive Opportunity” rather than LTI. This report uses the term “LTI” for consistency
and presentational purposes.
19
   In 2009, FHFA approved total direct compensation targets for each “named executive officer,” as well as all
EVPs, based upon the position’s requirements, the executive officer’s expertise, and benchmarks based on the
market median of direct compensation offered at comparable financial firms. Each year thereafter the Enterprises
established corporate goals that were approved by FHFA and formed the basis by which the executives’
performance was evaluated for the performance-based elements of their compensation. The evaluation of corporate
and individual performance occurs at the end of the year when the Enterprises establish the funding levels for LTI
and deferred base salary payments. The “actual” total direct compensation levels are approved by FHFA and are
typically less than the “target” levels. For example, in 2011 FHFA approved funding levels at Fannie Mae for LTI
and deferred base salary at 85% of target.
“Named executive officers” are all individuals serving as a company’s CEO, CFO, and the three most highly
compensated executive officers other than the CEO and CFO, as well as up to two additional individuals who would
have qualified as one of the registrant’s three most highly compensated executive officers but for the fact that the
individual was not serving as an executive officer at the end of the last completed fiscal year. See 17 C.F.R. §
229.402(a)(3).


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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Figure 1: Calculation of Enterprise Executives’ Total Direct Compensation20



                                                   Performance-
                 Fixed                                                                Total Direct
                                                       Based
              Compensation                                                           Compensation
                                                   Compensation

                                                    •   Long Term Incentives
                •   Base Salary
                                                    •   Performance-Based
                •   Fixed Portion of
                                                        Element of Deferred
                    Deferred Base Salary
                                                        Base Salary




            B. Enterprises’ Compensation of Their Executives in 2010 and 2011

In 2011, FHFA reviewed and approved compensation packages for a total of 87 executives at
Fannie Mae and Freddie Mac (see Figure 2 below).

Figure 2: Combined Enterprise Executive Compensation Subject to FHFA Oversight in
          201121
                                           Title    Number of Employees
                                           CEO               2
                                           EVP              23
                                           SVP              62
                                           Total            87

Fannie Mae’s and Freddie Mac’s former CEOs received a total of $10.7 million in cash
compensation or “take home pay” pursuant to the FHFA-approved compensation packages.22
Figure 3 below shows the median cash compensation paid in 2010 and 2011 to the 85 other




20
     Source: FHFA Testimony and Fannie Mae and Freddie Mac 10-K annual reports.
21
   Source: Enterprise data provided to FHFA-OIG. The number of employees includes all executives who were on
the Enterprises’ payrolls during any portion of the calendar year.
22
   This evaluation report uses a different methodology than total direct compensation to describe executive and
senior professional compensation levels. This methodology, which FHFA-OIG refers to as “cash compensation
paid,” shows cash income received from all sources in a particular calendar year. This includes current-year base
salary and deferred base salary and LTI payments earned in previous years. FHFA-OIG believes that the cash
compensation paid methodology—or “take home pay” analysis—offers advantages in terms of comparing
compensation trend data over time. See Objectives, Scope, and Methodology section of this evaluation report for
further information.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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Enterprise executives.23 The median cash compensation level for the Enterprises’ EVPs declined
by 8.8%, from $1.9 million in 2010 to $1.7 million in 2011. Similarly, the median cash
compensation level for their SVPs declined 5.2% from $763,000 to $724,000 from 2010 to 2011.
According to Enterprise officials, this decline is likely due to a variety of factors, such as the
ongoing pay freeze, the departures of relatively high-paid executives, and their replacement with
lower-paid executives.

Figure 3: Median Cash Compensation Paid to Enterprise EVPs and SVPs in 2010 and
          201124

                $2,000,000

                $1,750,000

                $1,500,000

                $1,250,000

                $1,000,000

                  $750,000

                  $500,000

                  $250,000

                        $0
                               EVP 2010      EVP 2011                     SVP 2010      SVP 2011


            C. FHFA Revised the Enterprises’ Compensation Packages to Reduce Executive
               Compensation

On March 9, 2012, FHFA revised the Enterprises’ 2009 executive compensation packages,
reducing the amount of compensation paid to Enterprise executives for 2012 and future years.25
Specifically, FHFA stated that there were plans to hire new CEOs at compensation levels that
would be sharply lower than had been the case in the past (e.g., the targeted total direct
compensation for the CEOs was set at $500,000 each by FHFA in consultation with the

23
   The median is described as the numerical value separating the higher from the lower half of data observations.
Statistically, a median is less likely than an average to be a skewed number, as an average can be dramatically
affected by a few exceptionally high or low paid individuals in the group.
24
     Source: Enterprise data provided to FHFA-OIG.
25
  See FHFA, FHFA Announces New Conservatorship Scorecard for Fannie Mae and Freddie Mac; Reduces
Executive Compensation (March 9, 2012) (online at http://www.fhfa.gov/webfiles/23438/ExecComp3912F.pdf).


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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Enterprises). Further, FHFA stated that the revised packages would, among other things,
(1) eliminate bonuses (e.g., LTI) as a component of executive compensation, and (2) reduce
executives’ annual compensation, other than that of the CEOs, by 10%.26

In May and June 2012, respectively, Freddie Mac and Fannie Mae appointed, with FHFA’s
review and consent, new CEOs, each of whom is subject to the 2012 changes in executive
compensation. Although FHFA initially targeted CEO total direct compensation at $500,000,
Freddie Mac’s new CEO will earn $600,000 in total direct compensation in 2012 and subsequent
years. As shown in Figure 4 below, this represents a reduction of cash compensation of 88%
from the $5.1 million that the former CEO received in 2011.27 An FHFA official explained that
the Agency agreed to the $600,000 figure to incorporate all factors necessary to attract the
candidate, including his commuting and living expenses.28 The new CEO will not receive any
deferred compensation or bonuses.

Fannie Mae’s new CEO was already an employee of the Enterprise, and FHFA agreed that he
would be compensated in accordance with the terms of his previous position as Chief
Administrative Officer, General Counsel, and Corporate Secretary for 2012.29 However, his total
direct compensation will be reduced to $600,000 starting on January 1, 2013, which is 89%
lower than the $5.6 million that Fannie Mae’s former CEO received in 2011.

Figure 4: 2011 CEO Cash Compensation Compared with Total Compensation Under the
          New Compensation Packages30

      Enterprise                    2011 Total Cash             Total Compensation            Percent Decline
                                     Compensation               Under New Packages
      Fannie Mae                      $5,609,117                      $600,000                        89.3%
      Freddie Mac                     $5,134,700                      $600,000                        88.3%

Although the 2012 revisions to the pay packages and the ongoing pay freeze will reduce
executive compensation costs, Agency and Enterprise officials have expressed concern that such
reductions in compensation could make it more difficult for the Enterprises to recruit and retain
executives and other employees. For example, an Enterprise official said that the FHFA pay

26
     The policy is designed to reduce each executive’s total direct compensation by 10% with a few exceptions.
27
     In effect, he will receive a base salary of $600,000 and nothing more.
28
     The new CEO plans to commute between New York and Freddie Mac’s headquarters in McLean, Virginia.
29
     The official’s target total direct compensation is $2.655 million for 2012, according to FHFA.
30
  Source: Enterprise data provided to FHFA-OIG and testimony from FHFA officials. As noted above, Freddie
Mac’s CEO will receive $600,000 in total direct compensation for 2012, and the total direct compensation for
Fannie Mae’s CEO will be reduced to $600,000 starting on January 1, 2013.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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freeze could have detrimental effects on recruitment and retention if it remains in effect
indefinitely. FHFA officials said that they will continue to monitor the effects of the 2012
revision to the executive compensation packages and the pay freeze on Enterprise recruitment
and retention efforts.31 Appendix A contains data on attrition rates for Enterprise executives and
senior professionals for the period 2004 through 2012. The data reveal significant fluctuations
over time: substantial increases in voluntary attrition rates at both Enterprises in 2009 (the year
after they entered conservatorship), decreases in 2010, increases in 2011, and decreases to date in
2012.

           D. FHFA Has Taken Other Steps to Strengthen Its Oversight of Enterprise
              Executive Compensation

FHFA has taken several other steps to strengthen its oversight of executive compensation:

        FHFA has completed its implementation of the recommendations contained in FHFA-
         OIG’s March 2011 report on its oversight of executive compensation.32 Specifically,
         FHFA: (1) developed written guidelines governing its oversight and reviews of executive
         compensation; and (2) completed examinations to assess the Enterprises’ processes for
         setting individual executive compensation levels.

        FHFA has also established procedures to review the Enterprises’ implementation of the
         Agency’s December 2010 pay freeze directive.33 As discussed previously, FHFA stated
         in its pay freeze directive that increases in compensation for employees would only be
         permitted in connection with promotions and changes in duty. According to an FHFA




31
   FHFA officials said that they receive periodic attrition rate data by business line from the Enterprises, and that the
data include the Enterprises’ assessment of the impact of various Agency initiatives on their rates of attrition. An
FHFA official also told FHFA-OIG that discussions were recently held among the Agency and the Enterprises
concerning the impact of the 2011-2012 pay freezes upon the Enterprises. The Agency official also provided
supporting documentation to FHFA-OIG.
32
   See FHFA-OIG, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie
Mac’s Executive Compensation Programs (EVL-2011-002) (March 31, 2011) (online at
http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final%2C%20signed.pdf).
33
   In his December 16, 2010, letter to the Enterprises, Acting Director DeMarco wrote, “[a]s Conservator I am
directing each of you to maintain individual salaries and wage rates at 2010 levels for 2011. Pay bands or pay scales
should remain at 2010 levels. Appropriately modest pay increases associated with promotions or significant
changes in an employee’s duties are permitted, consistent with your current pay programs. The Federal Housing
Finance Agency (FHFA) will work with you and your respective Human Resource teams on implementation
questions. We will be examining implementation of this directive.” Letter from Edward DeMarco, Acting Director
of FHFA, to the CEOs of Freddie Mac and Fannie Mae (December 16, 2010).


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                           15
         compensation official and documents received by FHFA-OIG, the Agency routinely
         reviews Enterprise requests to promote their executives.34

III. FHFA’s Oversight of Non-Executive Compensation

As compared to its oversight of executive compensation, FHFA’s oversight of the Enterprises’
compensation of their approximately 11,900 non-executive employees, including about 2,000
senior professionals, has been limited. Specifically, FHFA imposed an Enterprise-wide pay
freeze, commented on proposed changes to Freddie Mac’s compensation structure for non-
executives in 2012, and approved several employee retention payments.35 However, FHFA has
not reviewed, examined, or tested the Enterprises’ compensation programs to ensure that they are
effective in mitigating costs. Neither has the Agency assessed the Enterprises’ use of promotions
and changes in responsibility to determine if they are being used to avoid the strictures of the pay
freeze.

FHFA’s relatively limited oversight of non-executive employee compensation is consistent with
its view that delegating such day-to-day business decisions to the Enterprises is the most
effective means of managing the conservatorships. One FHFA official explained that the
Agency has focused its oversight on Enterprise executive compensation for several reasons,
including its relatively high level on a per capita basis as compared to other positions.

FHFA-OIG recognizes that the Agency views delegating responsibility for many day-to-day
business decisions as the most effective means to manage the Enterprises’ conservatorships.
Nevertheless, as described in this evaluation report, FHFA-OIG also believes that as the
Enterprises’ conservator, FHFA has a responsibility to gain reasonable assurance that the
Enterprises’ compensation controls effectively preserve and conserve their assets and limit
taxpayer-related costs.36 Moreover, it may be appropriate to enhance oversight of the
34
   An FHFA official said that since 2011 the Agency has reviewed and approved a total of 24 requests from the
Enterprises to promote their executives. The official also said that the Agency has disagreed with the Enterprises
over proposed compensation levels for newly promoted executives. In light of these disagreements, the official said,
the Enterprises will often revise their proposals.
35
  An FHFA compensation official said that in early 2012 the Agency commented on Freddie Mac’s proposed
changes to its compensation structure for senior professionals and other employees. These proposed changes, which
have been implemented, are discussed later in this evaluation report. The FHFA official also said that the Agency
approved proposed Enterprise retention payments for non-executive employees.
36
   FHFA-OIG is not necessarily advocating that FHFA exercise the same level of oversight and control of non-
executive compensation as is the case with executives (e.g., reviewing and approving total direct compensation
levels). Rather, FHFA-OIG believes the Agency should, either through reviews or examinations, independently
validate the Enterprises’ compensation structures, processes, or controls to gain assurance of their effectiveness.
FHFA-OIG made a similar recommendation with respect to FHFA’s oversight of certain Enterprise legal
expenditures. See FHFA-OIG, Evaluation of FHFA’s Management of Legal Fees for Indemnified Executives,
(EVL-2012-002) (February 22, 2012) (online at http://www.fhfaoig.gov/Content/Files/EVL-2012-002_0.pdf).


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                          16
Enterprises’ senior professionals since they are the most highly compensated group of employees
after executives and they—as a group of fewer than 2,000 individuals—collectively received
$455 million in cash compensation in 2011.

To foster a better understanding of areas where FHFA’s enhanced oversight may improve the
Enterprises’ effectiveness and efficiency, the following sections provide basic information about
the Enterprises’ senior professionals’ roles and responsibilities, the Enterprises’ approaches to
establishing their compensation, and their compensation levels in 2010 and 2011.

            A. The Enterprises’ Senior Professionals and Their Roles and Responsibilities

At the end of 2011, the Enterprises’ senior professionals numbered approximately 2,000, and
constituted about 14% of the Enterprises’ combined 11,900 member workforce.37 Figure 5,
below, shows the total number of VPs and Directors on the Enterprises’ payrolls in 2011,
including those who were onboard for only a portion of the year.

Figure 5: Senior Professionals at Both Enterprises in 201138

                                      Title       Number of Employees
                                      VP                 333
                                      Director          1,650
                                      Total             1,983


According to the Enterprises, senior professionals serve throughout their organizations,
occupying positions in a range of divisions responsible for single-family mortgage finance
underwriting and pricing, modeling and analytics, and legal support, among many others. By
way of illustration, and according to officials at one of the Enterprises, senior professionals are
responsible for the following business activities:

         Vice Presidents generally report to SVPs or EVPs and are responsible for staff
          management and work products within individual divisions, such as single-family
          mortgage underwriting. Among their responsibilities, VPs: (1) implement strategies set
          by division heads; (2) guide the resolution of complex business decisions; and (3) focus
          approximately 70% of their time on either customer or regulatory relations. Typically, a
          VP has 10 or more years of experience in his or her area of expertise.


37
     The 14% figure breaks down as follows: VPs made up 2.3% and Directors made up 11.7%.
38
  Source: Enterprise data provided to FHFA-OIG. The number of employees includes all senior professionals who
were on the Enterprises’ payrolls during any portion of the calendar year.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                       17
        Directors generally report to VPs or SVPs and are responsible for one or more
         departmental areas within a division. Among their responsibilities, Directors implement
         strategies set by division heads, have day-to-day responsibility for the work product
         produced by their departments, and interpret departmental and divisional directives for
         their staffs. They typically have eight or more years of relevant experience.

           B. Overview of the Enterprises’ Senior Professional Compensation Packages

According to officials from both Enterprises, the general structure of their senior professionals’
compensation packages is similar to the structure of their executives’ compensation packages.
That is, senior professional compensation includes annual base pay plus other forms of
remunerations that can be referred to as “other compensation.” However, Enterprise officials
said that base salary accounts for a relatively larger share of senior professional compensation
than is the case with executives, and “other compensation” accounts for a relatively smaller
share.39 This is because senior professionals—as compared to executives—are less directly
accountable for the Enterprises’ overall performance. The “other compensation” category
includes elements such as short-term incentives and LTIs that can vary significantly based on the
Enterprises’ performance in meeting financial goals, as well as the individual employee’s
performance in attaining such goals.40

The Enterprises’ approaches to setting senior professional target compensation levels are
generally similar, but there are differences between them. They are similar in that both
Enterprises use market data as part of the process to establish compensation levels.41 Both
employ compensation consulting firms that conduct confidential market surveys intended to
identify compensation levels by position within a range of industries including the financial
services industry. Officials from both Enterprises also said that they seek to establish target
compensation for all of their employees, in the aggregate, at the median market level as
identified through their analyses of market data provided by consultants. 42



39
   One Enterprise’s officials said that LTIs account for the overwhelming majority of its senior professionals’ other
compensation. Officials at both Enterprises said that retention and one-time cash awards are made on a very
selective basis.
40
  Freddie Mac implemented a revised compensation structure in 2012 that further reduces other compensation as a
component of senior professional compensation.
41
   Enterprise officials said that it is critical that they offer compensation that is competitive with that offered by
financial services firms to ensure they could recruit and retain staff with the expertise and experience necessary to
run their large and complex operations.
42
   However, Enterprise officials emphasized that target compensation levels for individual employees may be above
or below the median for a variety of reasons including the employee’s skill levels and expertise.


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                           18
The two Enterprises’ structures for senior professional compensation differ as follows:

         Since 2009 Fannie Mae has employed market data provided by its consulting firm to
          establish a series of pay grades for senior professionals and other employees. The pay
          grades each have a salary range associated with them—minimum, midpoint, and
          maximum—as well as incentive award eligibility, all of which are informed by the
          market comparison data and other factors, including the criticality of the position to the
          Enterprise (e.g., senior professional positions with greater criticality are assigned higher
          grade and compensation levels).43 There may be a variety of senior professional and
          other positions grouped within each of the pay grades.

         Between 2008 and 2010, Freddie Mac transitioned from a pay grade system for senior
          professionals, such as the one used by Fannie Mae, to one in which compensation levels
          are determined on a position-by-position basis using the median points of market data.44
          Freddie Mac officials told FHFA-OIG that its human resource professionals identify
          comparable positions and attendant compensation levels for senior professionals and
          other positions by employing financial service industry compensation data provided by
          third party consulting firms.

According to officials from both Enterprises, the ongoing FHFA-established pay freeze has
generally kept overall compensation at 2010 levels. As discussed previously, senior
professionals and other employees will only receive increases in compensation if they are
promoted or there is a substantial increase in their duties and responsibilities.

             C. Enterprise Senior Professional Compensation in 2010 and 2011

Figure 6, below, shows the median total cash compensation paid to the Enterprises’ senior
professionals in 2011. The median value of the VPs’ total cash compensation paid was $388,000
and the median for Directors was $205,300.




43
     According to Fannie Mae, the midpoint for each pay grade represents the market median.
44
   Freddie Mac officials said that the new structure has several benefits, including flexibility and the ability to offer
targeted compensation levels more directly tied to particular positions than possible under a pay grade structure.
Further, the officials said that the new structure was critical to the Enterprise’s ability to recruit and retain employees
to fill critical roles.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                            19
Figure 6: Median Cash Compensation Paid to Senior Professionals at the Enterprises in
          201145, 46

                                                                         Total Cash
                             Title       Number of Employees
                                                                       Compensation
                              VP                    333                   $388,000
                           Director                1,650                  $205,300

Figure 7, below, shows that the median cash compensation paid to VPs and Directors in 2011
increased about 5.4% and 3.9%, respectively, from 2010, despite FHFA’s imposition of a general
pay freeze during that period. Enterprise officials explained that this increase is largely
attributable to the structure of their LTI payments under 2009 compensation packages. LTI
payments at both Enterprises are disbursed in installments over the course of two years. For
example, in 2010 Enterprise senior professionals would have received only the first portion of
their 2009 LTI payments, and in 2011 they would have received the second portion of their 2009
LTI payments and the first portion of their 2010 LTI payments. However, as described later in
this evaluation report, one Enterprise official told FHFA-OIG that promotions and changes in
responsibility also may have played a role in the increase in median compensation from 2010 to
2011. FHFA has not examined the implementation of the pay freeze to determine whether the
Enterprises may be using promotions and changes in responsibility to offset the impact of the
pay freeze.




45
   Source: Enterprise data provided to FHFA-OIG. For VPs and Directors, total cash compensation paid includes
base salary and “other compensation” such as cash bonuses, LTI payments, short-term incentive payments, retention
awards, vested restricted stock, sign-on bonuses, referral bonuses, variable compensation plan awards, and merit
awards. The number of employees includes all senior professionals who were on the Enterprises’ payrolls during
any portion of the calendar year.
46
   The median compensation numbers provided in Figure 6 represent a mid-point of all employees’ compensation
within each rank. By definition, half of all employees are compensated at levels higher than the median and the
other half are compensated at levels lower than the median. In addition, very few, if any, employees are
compensated exactly at the median due to the natural dispersion of compensation data points.


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                       20
Figure 7: Median Cash Compensation Paid to Enterprise Senior Professionals in 2010 and
          201147

                $400,000

                $350,000

                $300,000

                $250,000

                $200,000

                $150,000

                $100,000

                 $50,000

                      $0
                             VP 2010       VP 2011                  Director 2010 Director 2011




47
     Source: Enterprise data provided to FHFA-OIG.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                       21
FINDINGS
Generally, FHFA can enhance its oversight of the Enterprises’ non-executive compensation
structures, processes, and controls. Although FHFA has controlled the Enterprises’ non-
executive compensation levels through the ongoing pay freeze, the Agency’s oversight of the
related compensation structures and processes has been limited.48 FHFA has not conducted any
reviews or examinations to gain assurance that the Enterprises’ non-executive compensation
costs are reasonable and justified, even though, according to FHFA-OIG estimates, senior
professional compensation costs alone were approximately $455 million in 2011. As the
Enterprises’ conservator, FHFA has a responsibility to preserve and conserve effectively their
assets and limit taxpayer costs. To help do so, FHFA-OIG believes that the Agency should gain
reasonable assurance that the Enterprises’ compensation controls are effective. Thus, FHFA
should enhance its current non-executive compensation oversight efforts. FHFA-OIG also
believes it may be sufficient for FHFA to focus this enhanced oversight on the Enterprises’
compensation of their senior professionals given that they are the next most highly compensated
group after executives.49

The remainder of this section discusses: (1) general senior professional compensation issues and
risks potentially meriting FHFA’s review; (2) the potential need for FHFA to review Enterprise
controls pertaining to compensation offers to senior professional candidates; and (3) the potential
need for FHFA to review the Enterprises’ compliance with the terms of its pay freeze directive.

1. Several General Issues and Risks Associated with Enterprise Senior Professional
   Compensation Structures Merit Review by FHFA

During the course of this evaluation, FHFA-OIG identified several potential issues and risks
associated with the Enterprises’ senior professional compensation systems, processes, and
controls that FHFA should consider reviewing. Specifically:

        The Enterprises employ different structures for compensating senior professionals and
         other employees. Fannie Mae uses a pay grade structure whereas Freddie Mac sets target
         compensation for each position. It is possible that one structure offers greater benefits

48
   As discussed previously, FHFA reviewed and commented on proposed changes to Freddie Mac’s compensation
structure for senior professionals in 2012 and reviewed the Enterprises’ proposals to make retention payments to
senior professionals and other employees.
49
   Although the Enterprises’ EVPs and SVPs individually may have much higher compensation levels than VPs or
Directors, the estimated $455 million in cash compensation paid to the Enterprises’ 2,000 senior professionals was
almost five times higher than the estimated $92 million in cash compensation paid to their nearly 90 executives in
2011.


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                        22
         than the other with respect to, among other things, managing the costs associated with
         senior professional compensation.50 FHFA could assess this issue and determine whether
         it would be appropriate to adopt a standard approach that would enable the Enterprises to
         achieve greater efficiencies.51

        The Enterprises use market compensation data provided by consulting firms as part of the
         process to establish senior professionals’ and other employees’ target compensation
         levels. There is a risk that there may be differences in the use of this market data that
         could result in one Enterprise paying materially higher compensation for similar senior
         professional positions than the other Enterprise. FHFA could assess this risk and take
         actions to ensure consistency in the use of market data and, thereby, control costs
         appropriately.52

        The Enterprises seek to control the costs associated with senior professional and other
         employee compensation by targeting such costs—in the aggregate—to the median market
         level. However, it is not clear that the Enterprises have sufficient reporting systems to
         ensure that this objective is being met.53 Officials from both Enterprises said they do not
         routinely prepare reports for senior management and the Boards of Directors showing
         whether the targeted compensation levels are being met, although officials from one
         Enterprise claimed that such reports are prepared on an “ad hoc” basis.54 FHFA could

50
   As noted earlier, this observation concerning the potential economies and efficiencies that could be achieved
through a standardized approach to the compensation of senior professionals is consistent with an observation in a
previous FHFA-OIG report in which it was observed that the Agency has a responsibility to ensure that, when
appropriate, the Enterprises achieve greater efficiency in their management of certain legal expenses through the use
of a standardized approach to the management of such costs. See FHFA-OIG, Evaluation of FHFA’s Management
of Legal Fees for Indemnified Executives (EVL-2012-002), (February 22, 2012), (online at
http://www.fhfaoig.gov/Content/Files/EVL-2012-002.pdf).
51
   FHFA-OIG observes that the Agency is taking a number of steps to align the Enterprises’ operations to ensure
consistency. For example, FHFA is working with the Enterprises to develop a uniform platform for their MBS
issuances. For more detail, see FHFA, The Conservatorships of Fannie Mae and Freddie Mac: An Update on
Current and Future Operations, Remarks as Delivered by Acting Director Edward J. DeMarco at the American
Mortgage Conference, at 8, 9 (September 10, 2012), (online at
http://www.fhfa.gov/webfiles/24365/2012DeMarcoNCSpeechFinal.pdf).
52
   An FHFA official said that the Agency recently reached an agreement with the Boards of Directors of the
Enterprises in which the Enterprises will use the same financial services industry comparator group to establish
executive compensation levels. The official also said that the Enterprises will use the same consulting firm to
provide this data.
53
   The U.S. Government Accountability Office (GAO) has stated that internal and external financial reporting is a
critical internal control. See GAO, Standards for Internal Control in the Federal Government (GAO-AIMD-OC-
21.3.1) (November 1999).
54
   FHFA-OIG requested that the Enterprises provide copies of past reports showing compliance with the targeted
compensation levels. In response, the Enterprises did not produce evidence of prior reporting, but instead provided
reports that were generated specifically in response to FHFA-OIG’s request. The reports indicate that the


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                         23
         assess the extent to which, in the absence of such routine reports, the Enterprises can be
         assured that their compensation targets are being met and corrective actions are being
         undertaken to ensure compliance with them.

2. A Limited Test by FHFA-OIG Indicates That FHFA Should Consider Assessing
   Enterprise Compensation Offers to Newly Hired Senior Professionals

FHFA-OIG tested compensation offers made in 2011 by the Enterprises to prospective
employees at a particular senior professional rank.55 The results of the limited test suggest the
need for FHFA to consider assessing the effectiveness of the Enterprises’ controls over the offers
of compensation they make to newly-employed senior professionals. Specifically, both
Enterprises use the median market compensation level as a reference point in developing such
offers of compensation. However, FHFA-OIG’s test found that one Enterprise’s compensation
offers were consistently higher than the established median.56

FHFA-OIG reviewed offers of compensation made by the Enterprises to 19 of 21 individuals
hired to fill a specific type of senior professional rank in 2011. Enterprise A hired 9 of these 19
individuals, and Enterprise B hired the complementary 10 individuals (see Figure 8 below).57
Enterprise A offered five of its nine candidates (55%) base salaries below the position’s median,
and it offered the remaining four candidates (45%) salaries above the median.58 In only 1 of
these 4 cases did the compensation offer exceed the median by 10 or more percentage points.

Enterprise B, on the other hand, offered 8 of its 10 hires (80%) base salaries that exceeded the
established median level. In 2 of the 8 cases the base salary offered exceeded the median by 20


Enterprises generally paid their senior professionals base salaries that were at or below the median level, but in some
cases the averages were higher than the median level. FHFA-OIG further notes that the reports do not “tell the
whole story” in that they do not include information about other compensation, such as bonuses, received by the
senior professionals. Finally, FHFA-OIG notes that it was not within the scope of this evaluation to test the
methodology employed by the Enterprises in preparing these reports or to determine independently the reliability of
the data underlying them.
55
   FHFA-OIG is not disclosing additional information about the senior professional rank out of concern that doing
so could have a negative impact on the Enterprises’ capacity to negotiate compensation with individuals seeking
employment at this rank.
56
   FHFA-OIG’s test focused on the base salary offered to these senior professional job candidates and excludes
various forms of “other compensation.”
57
   The Enterprises hired approximately 100 senior professionals in 2011. Consequently, the FHFA-OIG test
covered nearly 20% of these new hires. Enterprise B could not establish a median base salary for two of the senior
professionals it hired and, therefore, these two cases were excluded from the FHFA-OIG review.
58
   FHFA-OIG determined that the median compensation levels offered by the Enterprises for these particular senior
professionals were generally similar.


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                          24
percentage points or more. In another case, the compensation offered exceeded the median by
18 percentage points.

Enterprise B officials emphasized that it targets total employee compensation in the aggregate—
rather than the compensation of any individual employee—to the median market level. The
officials also said that compensation can exceed the median level based on a candidate’s skills
and expertise. Finally, the officials said that in some cases it was necessary to offer
compensation well above the median level in order to persuade candidates who already had
comparable offers from other organizations or to fill positions that had been vacant for extended
periods.59

Figure 8: Base Salaries for Nineteen Senior Professionals Hired in 2011 Compared to the
          Market or Grade-Level Median Base Salary Amount60

                                                                                        Samples’ Average
                                          Above the       >10 Percentage Points
          Title           New Hires                                                   Percent Ratio Above or
                                           Median           Above the Median
                                                                                        Below the Median
      Enterprise A             9               4                      1                        -2%
      Enterprise B            10               8                      3                        +7%

Although the reasons supporting individual compensation will necessarily vary by
circumstances, FHFA-OIG believes that the aggregate data discussed above suggest the
existence of variation sufficient to warrant further scrutiny by FHFA. Both Enterprises use
median market data as a reference point in making compensation offers, yet Enterprise B
exceeded the median level 80% of the time. Additionally, in 3 of the cases, the offers exceeded
the standard by 18 percentage points or more. Further, although several of the justifications
offered by Enterprise B officials are plausible (e.g., the need to offer relatively high
compensation to attract candidates with other outstanding offers), they have not been
independently tested and verified. Without such testing and verification on a larger scale, FHFA
lacks assurance that Enterprise compensation offers to senior professionals, which translate into
compensation levels, can be supported.




59
  Officials from the Enterprise said that in one case they offered compensation above the median to a candidate
who would assist the Enterprise in designing and implementing a key business objective.
60
     Source: Enterprise data sampled by FHFA-OIG.


          Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                        25
3. FHFA Has Not Examined the Enterprises’ Implementation of the Pay Freeze for Senior
   Professionals

In furtherance of its December 2010 directive to the Enterprises, the Agency has established a
process to review their implementation of the mandated pay freeze with respect to their
executives. Specifically, the Enterprises submit proposed executive promotions to the Agency
for review and approval.

On the other hand, FHFA has not conducted any similar reviews or examinations with respect to
the Enterprises’ senior professionals and other employees, but Agency officials said they are
planning to do so. FHFA-OIG observes that the median cash compensation paid to the
Enterprises’ senior professionals increased as much as 5% in 2011, despite the imposition of the
pay freeze. It is possible that the structure of the Enterprises’ LTI payments accounts for much
of this increase, but promotions and changes in responsibility also may have played a role.61
However, because FHFA has not yet conducted any reviews or examinations, it is not in a
position to determine whether the Enterprises are enforcing consistently the pay freeze or,
alternatively, are using promotions and/or changes in responsibility as a means to offset the
effects of the pay freeze on senior professional compensation.




61
   One Enterprise official advised that a portion of the increase in median compensation may be attributed to
promotion-based pay increases.


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                         26
CONCLUSIONS
Over the past year, FHFA has increased its control and oversight of the Enterprises’ executive
compensation, which amounts to an estimated $92 million annually. Although this focus is
appropriate, executive compensation is a comparatively small portion of the Enterprises’ overall
expenditures in this area. Indeed, senior professional compensation alone amounts to $455
million annually. Accordingly, FHFA-OIG believes that FHFA has a responsibility to enhance
its current non-executive compensation oversight through reviews or examinations. By focusing
this increased oversight on senior professional compensation, FHFA could assess the
effectiveness of the processes and controls in place for a relatively highly compensated group of
employees while mitigating the impact on the Agency’s available resources.




RECOMMENDATION
FHFA should develop a long term plan to strengthen its oversight of the Enterprises’ non-
executive compensation through reviews or examinations, focusing on senior professional
compensation. The plan should set priorities, ensure that available staffing resources are
commensurate with them, and establish an appropriate timeframe for its implementation. With
respect to the reviews and examinations contemplated by its plan, the Agency should consider
including the following items as priorities:

      the Enterprises’ general structures, processes, and cost controls for senior professional
       compensation;

      the Enterprises’ controls over compensation offers to new hires; and

      the Enterprises’ compliance with the pay freeze with respect to the use of promotions and
       changes in responsibility.




       Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                    27
OBJECTIVES, SCOPE, AND METHODOLOGY
Objectives

In March 2011, FHFA-OIG issued a report that evaluated the Enterprises’ executive
compensation programs and specifically examined pay practices for their six most senior
executives. This report examines pay practices affecting the Enterprises’ approximately 2,100
most highly compensated employees, including all 90 executives and 2,000 senior professionals.
The objectives of this report were to: (1) provide an update on: (a) the steps FHFA has taken
since the issuance of FHFA-OIG’s report on the Agency’s oversight of executive compensation,
and (b) executive compensation levels in 2010 and 2011;62 and (2) evaluate the Agency’s
approach to non-executive compensation oversight with a focus on the compensation of senior
professionals in 2010 and 2011.

General Methodology

To meet these objectives generally, FHFA-OIG interviewed FHFA officials responsible for the
Agency’s Enterprise compensation oversight analysis. Further, FHFA-OIG interviewed
compensation officials at both Enterprises. Additionally, FHFA-OIG reviewed FHFA and
Enterprise compensation oversight documents, including the Enterprises’ Form 10-K filings with
the U.S. Securities and Exchange Commission and documents that describe the process for
“benchmarking” executive and senior professional compensation against compensation in the
financial services industry. FHFA-OIG also reviewed federal standards for internal controls.63

Enterprise Compensation Analysis Methodology

With respect to executive and senior professional compensation levels for 2010 and 2011, the
evaluation uses the “cash compensation paid out annually” approach. This approach shows the
cash compensation that the Enterprises paid to their executives and senior professionals in 2010




62
   See FHFA-OIG, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie
Mac’s Executive Compensation Programs (EVL-2011-002) (March 31, 2011) (online at
http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final%2C%20signed.pdf).
63
   See GAO, Standards for Internal Control in the Federal Government, GAO/AIMD–00.21.3.1 (November 1999)
(online at http://www.gao.gov/special.pubs/ai00021p.pdf); and Office of Management and Budget, Management’s
Responsibility for Internal Control, OMB Circular No. A-123 Revised (December 2004) (online at
http://www.whitehouse.gov/omb/circulars_a123_rev/).


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                     28
and 2011. Thus, it differs somewhat from the “total direct compensation” approach, which is
employed by the Agency and the Enterprises.64

FHFA-OIG believes the cash compensation paid approach represents an appropriate basis for the
compensation analysis used in the evaluation for the following reasons:

        It captures all forms of cash compensation paid in a given year. For example, in some
         cases Enterprise executives received cash income in 2010 that was earned in and related
         to a prior period and that, therefore, was not a component of their FHFA-approved total
         direct compensation packages. Without using the cash compensation paid approach this
         cash income would not be reflected in the reported compensation for Enterprise
         executives in 2010 and 2011.

        It allows for consistent comparisons over time for approximately 2,100 Enterprise
         executives and senior professionals. It would be impossible to make such large
         comparisons using executive or senior professional compensation plans upon which their
         “total direct compensation” is generally based because such plans vary by position and by
         individual and are generally carried out over a period of several years, rather than in one
         calendar year. Moreover, the cash compensation paid approach is often used in large-
         scale compensation analyses similar to the one contained in this report.65

FHFA-OIG requested Enterprise cash compensation paid data for all executives and senior
professionals for calendar years 2009, 2010, and 2011.66 FHFA-OIG performed some data

64
  FHFA-OIG, however, recognizes that executives’ “total direct compensation” largely governs the cash
compensation they will receive each year.
65
   For example, the widely cited triennial publication of the Survey of Consumer Finances by the Federal Reserve
Board uses a family’s cash income, before all taxes, for the full calendar year. See Board of Governors of the
Federal Reserve System, Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of
Consumer Finances, Federal Reserve Bulletin, Vol. 98, No. 2, at 5, footnote 4 (June 2012) (online at
http://www.federalreserve.gov/pubs/bulletin/2012/PDF/scf12.pdf). In addition, many compensation studies rely on
income data from individual and corporate IRS filings, such as Form 1040 and Form 990, which summarize all cash
compensation paid-out in a given calendar year. For example, Charity Navigator frequently publishes reports on
Charity CEOs’ compensation utilizing data from Form 990 filings. See Charity Navigator, 2010 CEO
Compensation Study (August 2010) (online at
http://www.charitynavigator.org/__asset__/studies/2010_CEO_Compensation_Study_Revised_Final.pdf). Finally,
the United States Census Bureau conducts household income surveys annually. These surveys ask for the total
household income received during a 12-month period. See United States Census Bureau, American Community
Survey, Income Questions (online at http://www.census.gov/acs/www/about_the_survey/income_questions/).
66
   Based on discussions with FHFA and Enterprise officials, FHFA-OIG concludes that 2009 was a transition year
for both Enterprises during which they were migrating from their legacy compensation structures to a new
framework devised by FHFA in consultation with Treasury that was not entirely implemented for a full year (i.e.,
until calendar year 2010). Consequently, FHFA-OIG has decided not to present the 2009 compensation and other
information in this report.


         Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                       29
quality analyses to help ensure the accuracy and completeness of the cash compensation paid
data submitted by the Enterprises. For example, FHFA-OIG compared compensation levels
provided by the Enterprises for particular position categories (e.g., VPs and Directors) to ensure
that compensation levels were in the same general range. In addition, FHFA-OIG performed an
analysis on each employee’s start date and/or termination date to ensure the completeness of the
data. FHFA-OIG also engaged in extensive discussions with FHFA and Enterprise officials
regarding the data it was provided by the Enterprises and, in one case, FHFA-OIG identified
missing data. FHFA-OIG notified the Enterprise in question about the omissions and the
Enterprise was able to provide the missing data.

Aggregation of the Enterprises’ Compensation Data

Although both Enterprises individually provided their executive and senior professional
compensation data to FHFA-OIG, the data have been aggregated in this report. That is, FHFA-
OIG combined the reported data for both Enterprises (except for their CEOs) rather than
reporting it separately for each Enterprise. FHFA-OIG did so to address Agency and Enterprise
concerns about the confidentiality of the compensation data. FHFA-OIG does not believe that
aggregating the data has had a material effect on the analyses contained in this evaluation report.

Median Level of Compensation

For most compensation calculations in this evaluation report, FHFA-OIG presents a “median”
measure for each group of employees, rather than an “average” or “mean” measure. In statistics,
the median is described as the numerical value separating the higher half of observations from
the lower half. The median of a finite list of numbers can be found by arranging all the
observations from lowest value to highest value and then picking the middle value. If there is an
even number of observations, then there is no single middle value; the median is, therefore,
defined as the mean of the two middle values. The median is sometimes also referred to as the
50th percentile number.

Statistically, a median is less likely to be a skewed number than an average because an average
can be dramatically affected by a few exceptionally high or low paid individuals in the group
(i.e., outliers). Therefore, the median is a more representative figure of the center of a series of
compensation values than the average.

Partial-Year Employee Compensation Adjustment

In the case of an employee who was, for whatever reason, at an Enterprise only for part of a year,
FHFA-OIG annualized the employee’s base salary for the full calendar year. The annualization
process, however, is not applicable to “other compensation” (e.g., LTI or short-term incentive


       Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                    30
awards). This is because many components of other compensation have a one-time payout
feature and, therefore, they are not replicated in constant increments throughout a calendar year.

The partial-year adjustment methodology has the advantage of keeping necessary data points
while not skewing the median for each employee rank. For example, take the case of an
Enterprise VP on the payroll for the four-month period from January through April who receives
a base salary of $100,000 and is replaced in September by a second VP who receives a base
salary of $90,000 for the four-month period from September through December. FHFA-OIG’s
adjustment will show the first VP’s annualized base salary to be $300,000 ($100,000 times three)
and the second VP’s annualized base salary to be $270,000 ($90,000 times three). The median
for this group would be $285,000 per annum.

Using the partial-year adjustment method FHFA-OIG was able to retain in the analysis both data
points from the above example. If, on the other hand, FHFA-OIG had excluded all partial-year
employees, neither of the above two VPs would be included in the median calculation. Given
the small size and relatively high turnover rate in some executive ranks, excluding partial-year
employees would nearly eliminate all data points in the analysis.

The preparation of this evaluation report was conducted under the authority of the Inspector
General Act and in accordance with the Quality Standards for Inspection and Evaluation
(January 2012), which were promulgated by the Council of the Inspectors General on Integrity
and Efficiency. These standards require FHFA-OIG to plan and perform evaluations that, among
other things, result in evidence sufficient to provide a reasonable basis for findings and
recommendations. FHFA-OIG believes that the findings and conclusions contained in this report
meet these standards.

FHFA-OIG provided FHFA staff with briefings and presentations concerning the results of its
field work and provided FHFA with an opportunity to respond to a draft of this evaluation. In its
comments, which are reprinted in their entirely in Appendix B, FHFA agreed with the evaluation
report’s recommendation.




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APPENDIX A
Enterprise Executive and Senior Professional Attrition Rates

FHFA-OIG obtained trend data related to the voluntary attrition of executives from the
Enterprises over the period 2004 through 2012.67 The data indicate that the rate at which
executives voluntarily left the Enterprises has fluctuated significantly over time (see Figure 9
below).68 For example, the voluntary attrition rates for EVPs and SVPs at Enterprise A ranged
from 0% at the height of the housing boom in 2006 to more than 20% during the initial stages of
the FHFA conservatorship in 2009.69 Over the past several years Enterprise B’s executive
voluntary attrition rates have followed a similar fluctuating pattern: they fell to 0% in 2010, rose
dramatically to more than 15% in 2011, and then declined substantially to about 5% in 2012.

Figure 9: Annual Voluntary Attrition Rates for the Enterprises’ EVPs and SVPs over the
          Period 2004 Through 201270

               25%

               20%

               15%

               10%

                5%

                0%
                       2004     2005     2006     2007      2008    2009     2010     2011     2012

                                             Enterprise A          Enterprise B


67
   These data include resignations, retirements, and all other departures with the exception of those by non-
voluntary means, such as layoffs. The Enterprises use voluntary attrition rates to assess retention trends and
employee morale.
68
   The relatively small number of Enterprise executives (about 90 in 2011) could help explain these seemingly wide
fluctuations. For example, the departure of 5 executives in 1 year would represent a 10% voluntary attrition rate for
an Enterprise with 50 executives, whereas the departure of 2 in another year would be just 4%.
69
   FHFA-OIG has not identified the Enterprises in connection with the attrition data discussed in this report given
the Enterprises’ concerns about the confidentiality of the data.
70
   Source: Enterprise data provided to FHFA-OIG. The voluntary attrition rates for 2012 have been annualized
based on year-to-date data (June 20, 2012 for Fannie Mae and August 7, 2012 for Freddie Mac).


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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As depicted in Figure 10, below, annual senior professional voluntary attrition rates at both
Enterprises generally fluctuated within a range of 5% to 10% during the period 2004 through
2012. The data indicate that the voluntary attrition rate of Directors at Enterprise A has steadily
increased since 2008; it rose from below 5% to 12% on an annualized basis from 2008 through
2012. Although the voluntary attrition of Enterprise A’s VPs more than doubled from 2008 to
2010 (from 4.3% to 10.5%), it remained relatively stable in 2011 and has declined on an
annualized basis to about 9% in 2012.

Meanwhile, voluntary attrition for Directors at Enterprise B has remained below 10% since
2006, and its VP attrition rate has performed similarly since 2010. However, Enterprise B
officials told FHFA-OIG that they have faced challenges in retaining individuals with specialized
skills, such as information security experts and internal auditors.

Figure 10: Annual Voluntary Attrition Rates for the Senior Professionals at the
           Enterprises During the Period of 2004 Through 201271

              15%



              10%



               5%



               0%
                      2004    2005     2006    2007     2008    2009     2010    2011     2012

                                   Enterprise A VP             Enterprise A Director
                                   Enterprise B VP             Enterprise B Director




71
   Source: Enterprise data provided to FHFA-OIG. The voluntary attrition rates for 2012 have been annualized
based on year-to-date data (June 20, 2012 for Fannie Mae and August 7, 2012 for Freddie Mac).


        Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
                                                      33
APPENDIX B
FHFA’s Comments on FHFA-OIG’s Findings and Recommendation




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                                             36
APPENDIX C
FHFA-OIG’s Response to FHFA’s Comments

On November 29, 2012, FHFA provided comments on a draft of this report in which it agreed
with the recommendation and identified the actions that it will take to implement it. FHFA-OIG
considers FHFA’s proposed actions to be sufficient to resolve the recommendation, which will
remain open until FHFA-OIG determines that the Agency’s corrective actions are completed in a
manner that is responsive to the recommendation. FHFA-OIG has attached the Agency’s full
response (see Appendix B), which was considered in finalizing this report.




       Federal Housing Finance Agency Office of Inspector General • EVL-2013-001 • December 10, 2012
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ADDITIONAL INFORMATION AND COPIES


For additional copies of this report:

      Call the Office of Inspector General (OIG) at: 202-730-0880

      Fax your request to: 202-318-0239

      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 your written complaint to: 202-318-0358

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

      Write to us at: FHFA Office of Inspector General
                       Attn: Office of Investigation – Hotline
                       400 7th Street, SW
                       Washington, DC 20024




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