oversight

Update on FHFA's Oversight of the Enterprises' Non-Executive Compensation Practices

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-02-25.

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

                                        February 25, 2014


To:            Melvin L. Watt, Director


From:          Michael P. Stephens, Acting Inspector General


Subject:       Update on FHFA’s Oversight of the Enterprises’ Non-Executive Compensation
               Practices (EVL-2014-004)


Please find attached a staff memorandum report detailing our review of the examination work
conducted on the Enterprises’ non-executive compensation practices in 2013. FHFA examiners
found that neither Enterprise was able to document full compliance with FHFA’s pay freeze
directives covering calendar years 2011 and 2012. Moreover, FHFA has established supervisory
directives that the Enterprises address these weaknesses.

Enterprise executive and non-executive compensation were the subject of our December 2012
report entitled FHFA’s Oversight of the Enterprises’ Compensation of Their Executives and
Senior Professionals, and we believe that they remain important oversight areas pursued under
our mission of preventing and detecting waste, fraud, and abuse in the programs and operations
of FHFA and its regulated entities.

Please do not hesitate to contact me if you have any questions about this matter.
          EXPLANATION OF REDACTIONS IN THIS REPORT

Redactions in this report were made at the request of the Federal Housing Finance
Agency (FHFA). According to FHFA, the redacted information falls within the
bank examination privilege, which prohibits the disclosure of information
compiled as part of examinations of the Enterprises.




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                                               February 25, 2014


TO:               Michael P. Stephens, Acting Inspector General


FROM:             Richard Parker, Deputy Inspector General for Evaluations


SUBJECT:          Update on FHFA’s Oversight of the Enterprises’ Non-Executive Compensation
                  Practices


Summary

This memorandum updates and closes out our evaluation of the Federal Housing Finance
Agency’s (FHFA) oversight of Fannie Mae’s and Freddie Mac’s (collectively, the Enterprises)
non-executive compensation practices.

In December 2012, we published an evaluation report on FHFA’s oversight of the Enterprises’
compensation of their nearly 2,100 highest paid employees, i.e., about 90 executives and 2,000
non-executive senior professionals. 1

We concluded that FHFA had reviewed and examined the Enterprises’ executive compensation
practices, but not their non-executive senior professional compensation practices. Therefore,
the Agency had not ensured that the costs associated with the Enterprises’ non-executive
compensation practices were warranted. 2 Accordingly, we recommended that FHFA strengthen
its oversight of this area because, other than their executives, the Enterprises’ senior
professionals are their most highly compensated employees. 3


1
  See OIG, FHFA’s Oversight of the Enterprises’ Compensation of Their Executives and Senior Professionals
(EVL-2013-001, December 10, 2012) (online at http://www.fhfaoig.gov/Content/Files/EVL-2013-001.pdf).
For the purposes of the report, the Enterprise “executives” were their Chief Executive Officers, Executive Vice
Presidents, and Senior Vice Presidents. The Enterprises’ “senior professionals” were their Vice Presidents and
Directors.
2
  The Enterprises’ non-executive corps contain their senior professional personnel. We estimated that costs
associated with the Enterprises’ compensation of their senior professionals were approximately $455 million in
2011.
3
  On December 16, 2010, the former Acting Director of FHFA issued a pay freeze directive for 2011, limiting
individual salaries and pay scales at the Enterprises to 2010 levels, with some exceptions for “[a]ppropriately modest
pay increases associated with promotions or significant changes in an employee’s duties...consistent with your

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In accordance with our recommendation, FHFA conducted targeted examinations in 2013 of the
Enterprises’ compliance with the Agency’s directive to freeze their employees’ pay during
2011 and 2012. FHFA found deficiencies in the Enterprises’ compliance with the directive
and with their controls over senior professional compensation. For example,

                                                                          FHFA subsequently
instituted supervisory directives that require the Enterprises to remediate identified deficiencies.

Context

The Inspector General’s 2012 Report Identified Limitations in FHFA’s Oversight of the
Enterprises’ Senior Professional Compensation Practices
In our 2012 report, we noted that FHFA directly oversees the Enterprises’ compensation of their
executives as required by the Housing and Economic Recovery Act of 2008 4 and the Agency’s
senior preferred stock purchase agreements (PSPAs). 5 We also noted that FHFA had not
reviewed, examined, or tested the structures, processes, or controls by which the Enterprises
compensate their non-executive employees, including their senior professionals.

FHFA explained this distinction in oversight by noting that the Agency had largely delegated
to the Enterprises the responsibility to determine the compensation of their non-executive
employees. 6 An Agency official told us that such delegations of day-to-day business
responsibilities are the most effective means by which to manage the Enterprises in their
conservatorships. 7

We acknowledged the Agency’s rationale for delegating some day-to-day responsibilities to
the Enterprises. However, we noted that by delegating the responsibility for non-executive
compensation, the Agency severely constrained its ability to ensure that the costs incurred by the
Enterprises in compensating their senior professionals were, in fact, warranted.

Further, we conducted a limited review of this area and identified evidence indicating that, in
the absence of FHFA oversight, the Enterprises did not always effectively control their senior


current pay programs.” The former Acting Director later extended the pay freeze to 2012 in a letter to the
Enterprises dated December 13, 2011. FHFA lifted the pay freeze for calendar year 2013.
4
    See 12 U.S.C. §§ 4502(12), 4518(a).
5
  Under the PSPAs, the Treasury Department has invested $187.5 billion in the Enterprises, thereby enabling them
to remain solvent and continue their operations. 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 named executive officer without obtaining the consent of the Director of FHFA, in consultation with the
Treasury Department.
6
  An Agency official told us that she reviewed some requests from the Enterprises concerning non-executive pay
that related primarily to retention payments.
7
  FHFA became the Enterprises’ conservator in September 2008. For a discussion of FHFA’s duties and
responsibilities in this capacity, see OIG, White Paper: 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).

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professional compensation costs. Specifically, we determined that during 2011 – the first year of
the Agency-directed pay freeze – the following occurred:
      x   The median compensation paid to the Enterprises’ senior professionals increased by as
          much as 5%; 8 and
      x   Salary offers to candidates for senior professional positions at one of the Enterprises
          exceeded the target median of comparable private sector salaries in 8 of 10 cases we
          examined. In 2 of the 8 cases, the Enterprise offered a salary that was over 20 percentage
          points above the median.

To address this situation we recommended that the Agency strengthen its oversight of non-
executive compensation and consider reviewing the Enterprises’:
      x   Structures, processes, and cost controls for senior professional compensation;
      x   Controls over compensation offers to new hires; and
      x   Compliance with the Agency-directed pay freeze.

FHFA agreed with our recommendation.

FHFA Conducted Examinations in 2013 that Identified Deficiencies in the Enterprises’
Compliance with the Agency-Directed Pay Freeze
In accordance with our recommendation, FHFA conducted targeted examinations in 2013 of the
Enterprises’ compliance with the Agency-directed pay freeze during 2011 and 2012. The
examiners found that neither Enterprise was able to demonstrate that it had complied fully with
the pay freeze. We describe their compliance deficiencies below.

          a. Fannie Mae

The examination of Fannie Mae revealed that in 2011 and 2012 its management




8
 Enterprise officials explained that the increase was likely due to the disbursement in 2011 of long-term incentive
payments earned in prior years. In addition, one official said that promotions and changes in responsibility might
have accounted for some of the increase in pay.
9
    FHFA documentation indicates that




10
     According to an FHFA analysis,



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The examiners determined that




On November 19, 2013, FHFA directed Fannie Mae to improve “its policies, procedures,
supporting documentation, and governance over compensation programs in a manner that will
ensure its ability to demonstrate that these programs are being implemented in an appropriate,
consistent, and transparent manner.”

           b. Freddie Mac
As part of its 2013 examination of Freddie Mac’s compliance with the pay freeze, FHFA
identified




FHFA examiners also concluded that

             In June 2013, FHFA issued a binding supervisory requirement to the Enterprise.
Under it, Freddie Mac must implement a formal oversight program to ensure compliance with


11
     In their analysis memorandum, the FHFA examiners said that

12
     The examiners defined


13
     Freddie Mac officials told FHFA examiners that



14
     FHFA examiners determined that in 2012




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FHFA’s conservatorship directives. The Enterprise submitted a remediation plan in August,
which FHFA reviewed and accepted.

FHFA Has Instituted an Oversight Program for Senior Professional Hires and Promotions
In 2013, in response to our recommendation, FHFA instituted a procedure under which it
reviews the Enterprises’ compensation of their senior professionals. Specifically, FHFA reviews
quarterly reports prepared by the Enterprises in which the salaries paid to new hires and recently
promoted employees are compared to the median pay offered to similar private sector positions.
We believe that this procedure is a step in the right direction in that it provides FHFA with some
ability to assess Enterprise senior professional compensation practices going forward. However,
reviewing the Agency’s implementation of this procedure exceeded the scope of our work.

Conclusion

In accordance with our recommendation, FHFA conducted targeted examinations in 2013 of the
Enterprises’ non-executive compensation practices. Its examiners identified a number of issues
that validate the need for FHFA to conduct ongoing monitoring in this area. To its credit, FHFA
undertook corrective measures, and it has begun a limited oversight regimen based upon the
quarterly reporting of senior professional salaries by the Enterprises. FHFA’s examination
findings also demonstrate the importance of ongoing Agency oversight of the Enterprises’
compliance with its conservatorship directives, which we discussed in a previous report. 15




15
  See OIG, FHFA’s Conservator Approval Process for Fannie Mae and Freddie Mac Business Decisions (AUD-
2012-008, September 27, 2012) (online at http://www.fhfaoig.gov/Content/Files/AUD-2012-008 2.pdf).

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