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DUE DILIGENCE IN MORTGAGE

REPURCHASES AND FANNIE MAE:

THE FIRST BENEFICIAL MORTGAGE CASE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

OVERSIGHT AND INVESTIGATIONS

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

MARCH 10, 2005

Printed for the use of the Committee on Financial Services

Serial No. 109–7

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

SUE W. KELLY, New York, Chair

RON PAUL, Texas, Vice Chairman 

EDWARD R. ROYCE, California 

STEVEN C. LATOURETTE, Ohio 

MARK R. KENNEDY, Minnesota 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

MICHAEL G. OXLEY, Ohio 

LUIS V. GUTIERREZ, Illinois 

DENNIS MOORE, Kansas 

CAROLYN B. MALONEY, New York 

STEPHEN F. LYNCH, Massachusetts 

ARTUR DAVIS, Alabama 

EMANUEL CLEAVER, Missouri 

DAVID SCOTT, Georgia 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

March 10, 2005 ................................................................................................. 1

Appendix: 

March 10, 2005 ................................................................................................. 31

WITNESSES 

THURSDAY, MARCH 10, 2005

Donohue, Hon. Kenneth M. Sr., Inspector General, Department of Housing 

and Urban Development ...................................................................................... 3

Kennedy, John P., Associate General Counsel, Office of Finance and Regulatory Compliance, Department of Housing and Urban Development ............ 7

Pollard, Hon. Alfred M., General Counsel, Office of Federal Housing Enterprise Oversight ..................................................................................................... 9

Smith, Samuel III, Vice President, Single Family Operations, Federal National Mortgage Association ................................................................................ 5

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 32

Kelly, Hon. Sue W. ........................................................................................... 34

Harris, Hon. Katherine .................................................................................... 35

Wasserman Schultz, Hon. Debbie ................................................................... 36

Donohue, Hon. Kenneth M. Sr. ....................................................................... 37

Kennedy, John P. .............................................................................................. 44

Pollard, Hon. Alfred M. .................................................................................... 47

Smith, Samuel III ............................................................................................. 53

(1)

DUE DILIGENCE IN MORTGAGE 

REPURCHASES AND FANNIE MAE: 

THE FIRST BENEFICIAL MORTGAGE CASE 

Thursday, March 10, 2005

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:03 a.m., in Room 

2128, Rayburn House Office Building, Hon. Sue Kelly [chairwoman 

of the subcommittee] presiding. 

Present: Representatives Kelly, Kennedy, Garrett, Fitzpatrick, 

Davis of Kentucky, Oxley, Baker, Gutierrez, Moore of Kansas, 

Maloney, Cleaver, and Moore of Wisconsin. 

Mrs. KELLY. [Presiding.] This hearing of the Subcommittee on 

Oversight and Investigations will come to order. 

A bit of housekeeping before we actually begin. We are going to 

be called to the floor for a vote and the swearing-in of Doris Matsui, who won an election in California last night. So we will start 

the hearing, but I am going to have to recess the hearing temporarily for us to be able to do that. I wanted to explain that before 

we actually got into the deep of this. 

The committee is meeting today to hear testimony about the 

transfer of nonperforming financial instruments between First Beneficial and Ginnie Mae, with the knowledge of Fannie Mae. This 

transaction between a GSE, a wholly owned government corporation, and a private lender exposed taxpayers, investors and homeowners to harm and threatened the transparency and integrity of 

the financial networks that support homeownership in the United 

States. 

On December 22, 2004 I joined Chairman Ney and Chairman 

Baker in sending a letter to Fannie Mae requesting an accounting 

of its behavior in this case. The Office of Federal Housing Enterprise Oversight, the OFHEO, is now proposing new rules to require 

Fannie Mae to report its awareness of fraud and corruption. It 

should not take federal regulation to get Fannie Mae or any other 

well-run public company to exercise its responsibility as a corporate 

citizen to report possible wrongdoing and protect taxpayers. I am 

hopeful that this hearing will lead to better institutional controls 

within Fannie Mae and the industry in general, and government 

to prevent fraud and secure the safety and homeownership in the 

United States of America. 

2

I now yield to the ranking member of the subcommittee, the gentleman from Illinois, for an opening statement. 

Mr. GUTIERREZ. Good morning, and thank you, Chairwoman 

Kelly for calling this hearing today, ‘‘Due diligence in mortgage repurchases and Fannie Mae: The first Beneficial Mortgage case.’’ I 

have to say that it appears that the relationship with this institution was beneficial to no one. 

I have just started reading a book called ‘‘Thank You for Smoking,’’ by Christopher Buckley, a satire of the tobacco lobbyists, 

which they are currently making into a movie. I am told later in 

the book, a hearing is held in the Senate Committee on Hindsight. 

That is an easy shot at Congress. Most of us do what we do here 

necessarily in hindsight because we rarely are seeking to fix a 

problem that has yet to occur. While it is important for us to examine what happened, both in general here on the Oversight Committee, and in this specific instance at First Beneficial, it is even 

more important that we not spend all of our efforts in looking backwards. We must learn from these events and work to improve the 

landscape as we move forward with solutions, either through legislation or working with regulators or both. 

The fraudulent conduct at First Beneficial has been the subject 

of a court case. The criminals have been sent to jail. Fannie Mae 

has reorganized its operation and improved its information sharing, 

as indeed the entire industry did after September 11. They have 

provided some restitution to Ginnie Mae. OFHEO has recently 

issued a new proposed rule that would require GSEs to report possible mortgage fraud in a timely matter so that damage can be limited. It appears that we may need to amend the Bank Secrecy Act 

to ensure that GSEs are shielded from liability in this instance 

when they report potential fraud to their regulator or law enforcement bodies. 

I look forward to hearing from the witnesses regarding the lessons learned from the First Beneficial experience, and recommendations to detect and combat mortgage fraud as we move 

forward. 

I yield back the balance of my time. 

Mrs. KELLY. Thank you. Have you finished, Mr. Gutierrez? 

Mr. GUTIERREZ. Yes. 

Mrs. KELLY. Thank you. 

Mr. Fitzpatrick, you have no opening statement. Is that correct? 

I think we should begin with you, Mr. Donohue. If you have not 

testified before, there is a box on your table. When you start talking, that box will turn a green light on. When there is a yellow 

light, that means that you have one minute to sum up. With the 

red light, that means that you are asked to please sum up and end 

your testimony. 

I think we have time, depending on how long you talk, Mr. 

Donohue, I think we have time to start with you. Thank you. Mr. 

Donohue, please pull that microphone close to you and make sure 

it is on. I am not sure it is on. Push the button in front. 

3

STATEMENT OF HON. KENNETH M. DONOHUE, SR., INSPECTOR 

GENERAL, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT 

Mr. DONOHUE. Madam Chairwoman Kelly, ranking member 

Gutierrez, and other members of the subcommittee, good morning. 

I am pleased to have this opportunity to bring to the subcommittee’s attention the facts surrounding a recent case developed by the 

HUD Office of Inspector General and other law enforcement agencies against First Beneficial Mortgage Corporation of Charlotte, 

North Carolina and its importance as an area of concern for government-sponsored enterprises, regulatory agencies and those that 

oversee these organizations. 

Of importance are the crimes of the owners and the associates 

of First Beneficial, but also important is the lack of due diligence 

by some to take action to mitigate harm against the government. 

For whatever reasons, Fannie Mae did not pass information on 

First Beneficial’s transgressions to others, which allowed First Beneficial to continue to operate and to issue over $7.5 million in 

fraudulent mortgage-backed securities guaranteed by Ginnie Mae. 

On the easel is a flow chart of the case which shows in a compressed fashion the timeline of the events I will now discuss. 

Fannie Mae approved First Beneficial as a single-family mortgage 

lender in 1995. In 1997, First Beneficial was approved to sell Title 

I loans. Title I loans are home improvement loans and manufactured housing loans. In 1998, Fannie Mae was noticing problems 

with the Title I loan program nationwide, and decided to review 

First Beneficial’s loan portfolio. This review uncovered approximately $1 million in ineligible Title I loans to people without FHAinsured mortgages. 

During this review, First Beneficial was not truthful about 

whether the Title I loans were FHA-insured. At this time, Fannie 

Mae demanded that First Beneficial repurchase the portfolio, but 

First Beneficial did not have the funds to repurchase. Fannie Mae 

worked out a deal where they would purchase new pre-approved 

single-family loans from First Beneficial and apply the proceeds 

from the sale of these loans to repurchase the ineligible Title I 

loans. Fannie Mae placed an in-house suspension on First Beneficial at this time. 

After a few weeks, First Beneficial called Fannie Mae and said 

they had an investor who was willing to buy the bad Title I loans 

with a single cash payment. Accordingly, in September of 1998, 

First Beneficial paid Fannie Mae back the nearly $1 million. At 

this point in 1998, Fannie Mae did become suspicious of First 

Beneficial’s single-family loans as well, and began an inquiry into 

those it had purchased. They found that many loans were in the 

names of First Beneficial’s owners and employees, and that should 

have caused Fannie Mae’s concern. 

First Beneficial said the loans were investor loans and that they 

would repurchase them. On November 3, 1998, Fannie Mae wrote 

First Beneficial and said they would not purchase any more of 

these loans without prior approval. On November 19, 1998, Fannie 

Mae received a telephone call from a financial crimes investigator 

with the North Carolina Banking Commission who told them that 

First Beneficial was making loans without insurance and that First 

4

Beneficial was trying to get Ginnie Mae to buy the loans. The investigator gave Fannie Mae the names of the two First Beneficial 

employees who confirmed their effort to sell loans to Ginnie Mae. 

Fannie Mae learned that First Beneficial had only two investor 

sources, Ginnie Mae and Fannie Mae. On November 20, 1998, 

Fannie Mae suspended First Beneficial as a lender and called in 

the owner for a meeting. At this meeting, Fannie allegedly wanted 

to know more about the investors, but received no response from 

First Beneficial. Following this meeting, Fannie Mae did some review by taking the addresses of properties in the loan portfolio and 

going out to inspect. What they discovered was that many of the 

properties listed were in fact vacant lots. A check of the courthouse 

revealed that the main borrowers did not own the properties and 

that some were not even owned by First Beneficial. 

At this point, it is my understanding Fannie was not under any 

legal obligation to notify Ginnie Mae, OFHEO or any law enforcement agency such as the OIG of the FBI. However, I do believe 

that a good corporate citizen should have done so. As you can see, 

First Beneficial sold a pool of loans which were fraudulent to 

Ginnie Mae investors on December 11, 1998 in order to repurchase 

on December 18, 1998, the same fraudulent loans from Ginnie Mae. 

In late 2000, Ginnie Mae discovered these transactions through a 

subsequent compliance audit. Because Fannie Mae did not tell 

Ginnie Mae of the dubious scruples of these lenders, the original 

fraud to Ginnie Mae ballooned in costs to Ginnie Mae. By the time 

it was all said and done, the American taxpayer was defrauded out 

of approximately $38 million. 

Essential to the scheme was the requirement that First Beneficial provide a mortgage document to Ginnie Mae’s document custodian. For example, there was a property listed at 9108 Pleasant 

Ridge, Charlotte, North Carolina. The note appeared to be at first 

glance a normal mortgage note. In reality, there was no such mortgage and the signature belonged to a relative of the owner of First 

Beneficial. The collateral listed on the note was a vacant lot not 

owned by the stated mortgagor. 

Four primary defendants have been convicted and sentenced. Defendant McLean was sentenced to 21 years in prison and $23.5 million in restitution has been ordered. Some might say this case is 

about a small amount or could be interpreted as a cost of doing 

business, particularly as it relates to the vast funds in the securities market. But you can see from the severe sentences that the 

court viewed this case as a serious matter. The full faith and credit 

of the United States stands behind Ginnie Mae and it is the integrity of the program that investors rely upon. No rule or regulation 

or law exists that made it incumbent on Fannie Mae to have told 

others about what they discovered. If they had, it may have saved 

taxpayers millions of dollars. 

Mrs. KELLY. Mr. Donohue, I reluctantly am going to have to ask 

you to sum up. 

Mr. DONOHUE. In sum up, Madam Chairman, I have spent some 

time with the Resolution Trust Corporation. During that time, we 

learned many different things from the failed savings and loans. 

One of the primary issues was the fact of the coordination effort 

that must exist between the regulatory agencies, between the enVerDate 0ct 09 2002 16:16 Oct 07, 2005 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 G:\DOCS\23734.TXT FIN1 PsN: MICAH
5

terprises, and between law enforcement and affected organizations. 

It seems to be the benchmark of this matter. As a result of that, 

I think that is, if I leave any thought here today, it is incumbent 

upon us to make sure that these types of matters do not happen 

again. 

I must say finally to thank my colleagues at the FBI and the IRS 

Criminal Division in the Department of Justice for their assistance 

in this case. 

Thank you. 

[The prepared statement of Hon. Kenneth M. Donohue, Sr. can 

be found on page 37 in the appendix.] 

Mrs. KELLY. I thank you very much. For the record, Mr. Kenneth 

M. Donohue, Sr., is the Inspector General from the Department of 

Housing and Urban Development. 

Thank you very much for your testimony. 

We have been called for this vote. I am going to reluctantly recess. I would imagine it will take us probably 15 to 20 minutes, 

and then we will be back as soon as possible. Thank you for your 

patience. 

[Recess.] 

Mrs. KELLY. Thank you for your indulgence. We have a new Congresswoman. 

Mr. Donohue has given us his testimony. We now will hear from 

Samuel Smith, the Vice President of Single-Family Operations for 

Fannie Mae. John Kennedy is next, Associate General Counsel of 

HUD, representing Ginnie Mae; and Alfred Pollard, General Counsel of the Office of Federal Housing Enterprise Oversight, the 

OFHEO. Mr. Pollard is a veteran of Capitol Hill and on the faculty 

at Georgetown University School of Business. 

We welcome all three of you, and all four of you. We will continue with you, Mr. Smith. 

STATEMENT OF SAMUEL SMITH III, VICE PRESIDENT, SINGLE 

FAMILY OPERATIONS, FEDERAL NATIONAL MORTGAGE ASSOCIATION 

Mr. SMITH. Thank you, Chairwoman Kelly, ranking member 

Gutierrez, and members of the subcommittee. 

My name is Sam Smith. I am Vice President of Single Family 

Operations for Fannie Mae, and I have worked in Fannie Mae’s Atlanta office since 1973. In my capacity as Vice President, I am currently responsible for the quality and underwriting of loans sold to 

Fannie Mae by lenders assigned to Fannie Mae’s Eastern Business 

Center. 

I welcome this opportunity to speak on mortgage fraud generally 

and also about issues arising out of the First Beneficial Mortgage 

Company matter. I want to thank the subcommittee for holding 

this hearing and for inviting me to be here today. I have prepared 

a written statement that I request be made part of the official 

hearing record. 

Fannie Mae takes the issue of mortgage fraud very seriously and 

has taken many significant steps since 1998 to improve its antifraud efforts. First Beneficial was a case involving institution-level 

‘‘fraud for profit.’’ Looking back upon the First Beneficial case with 

the benefit of 20/20 hindsight, there is no doubt we could have hanVerDate 0ct 09 2002 16:16 Oct 07, 2005 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 G:\DOCS\23734.TXT FIN1 PsN: MICAH
6

dled the lender relationship differently and better. As the Vice 

President in charge of the single family business for the Atlanta office at the time, I take full responsibility for my actions and for 

those of my team regarding First Beneficial. 

I have set forth in my written testimony a detailed account of my 

involvement in the First Beneficial case. Fannie Mae also engaged 

the law firm of Latham and Watkins to review how the matter was 

handled, and I would like to request that a copy of their detailed 

report, which was made available to the committee earlier this 

week, be made part of the record. 

Mrs. KELLY. With unanimous consent, so moved. 

Mr. SMITH. Thank you. 

These documents outline in detail the chronology of the facts as 

we know them. I welcome the subcommittee’s questions with respect to the materials and the actions the company took during this 

period. However, I would like to address one fundamental issue. 

The subcommittee’s invitation to me asks whether Fannie Mae 

staff knew that First Beneficial was perpetrating fraud against 

Ginnie Mae in order to secure repurchase funds for Fannie Mae. 

As the Latham and Watkins investigation concludes, the answer is 

that we did not know. However, looking back on the totality of the 

facts and learning the information that came out in the trial of 

James McLean, at which I testified as a government witness, I regret that there were signs that we missed and that we did not take 

more rigorous steps to further investigate First Beneficial’s activities in 1998. 

Under the policies and procedures now in place at Fannie Mae, 

I am confident that the First Beneficial matter would be handled 

much differently today. In 1998, when First Beneficial’s loan issues 

arose, Fannie Mae’s regional offices handled loan deficiencies and 

instances of suspected fraud on a case-by-case basis. Since that 

time, Fannie Mae’s operations and policies have evolved with 

changes in the marketplace, and we have strengthened a number 

of our operations and anti-fraud policies. 

First, we have adopted a company-wide anti-fraud policy. We are 

also implementing enhancements to our internal operational controls to further clarify roles, responsibilities and notification requirements on fraud matters. These internal protocols will immediately elevate patterns that suggest possible fraud to senior management and to our legal and compliance offices. 

Second, Fannie Mae has changed its requirements for approving 

lenders as seller-servicers, and has moved to a more centralized approval process that can, among other things, focus on the needs of 

smaller lenders in meeting the seller-servicer requirements. 

Third, as a result of changes in technology and in an effort to ensure consistency and leverage resources, the post-closing file review 

of all loans sold to Fannie Mae has been centralized. We now employ a systematic sampling model to select both newly delivered 

and defaulted loan files for review every month. For every loan delivered to our company, lenders contractually represent and warrant that the loans meet our credit, documentation and underwriting standards. If a loan does not meet those standards, the 

lender knows it may be obligated to repurchase the loan, reimburse 

us for losses, or take other corrective action. 

7

This contractual repurchase obligation provides incentive for 

lenders to implement procedures for quality underwriting and is 

one of the ways Fannie Mae manages the safety and soundness of 

its investments, manages its charter compliance obligations, and 

discourages inappropriate loan underwriting of all types. We have 

also created an investigations team that is focused on mortgage 

loan fraud reviews and reporting. 

Fourth, Fannie Mae is undertaking extensive efforts to assist our 

lenders in detecting and combating fraud by developing and encouraging the use of fraud detection tools at the point of sale 

through our automated underwriting system, Desktop Underwriter. 

Finally, as noted above, fraud is an industry-wide problem. 

Fannie Mae is working cooperatively with OFHEO on its recent 

proposed regulation regarding mortgage fraud reporting. We have 

stated publicly that we will work with Congress, HUD and law enforcement agencies to establish an appropriate process for sharing 

information. In addition, we are working closely with others in the 

industry to confront this growing problem, including participating 

today in the Mortgage Bankers Association’s summit on mortgage 

fraud. And we join with others in the industry in supporting legislative enactment through GSE reform legislation or otherwise of a 

requirement for mortgage fraud reporting, including a safe harbor 

from legal liability for reporters of potential fraud and an appropriate approach for increased information-sharing between government and industry. 

Thank you for inviting me here today, and I look forward to responding to your questions on these matters. 

[The prepared statement of Samuel Smith III can be found on 

page 53 in the appendix.] 

Mrs. KELLY. Thank you, Mr. Smith. 

Mr. Kennedy? 

STATEMENT OF JOHN P. KENNEDY, ASSOCIATE GENERAL 

COUNSEL, OFFICE OF FINANCE AND REGULATORY COMPLIANCE, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT 

Mr. KENNEDY. Chairman Kelly, ranking member Gutierrez and 

distinguished members of the committee, I am John P. Kennedy, 

associate general counsel for finance and regulatory compliance at 

the Department of Housing and Urban Development, and Senior 

Counsel to Ginnie Mae. I have been at HUD for approximately 35 

years. 

I am going to start this story from my point of view in terms of 

the Ginnie Mae involvement in this matter in late August of the 

year 2000. In a scheduled compliance first audit of First Beneficial, 

the auditor, Deloitte and Touche, started to get some indications 

that the records at First Beneficial were giving indications of serious problems. Ginnie Mae immediately put together what we call 

a default team, and deployed that team to Charlotte, North Carolina. 

At that same time, Ginnie Mae was in a position to declare default under the guaranty agreement with First Beneficial, and that 

was the purpose of the team’s going there. It became apparent almost immediately that it was not just a contractual enforcement 

8

case. The initial findings, the draft findings of Deloitte and Touche 

made it clear to us that we had a potential criminal matter. At that 

point, immediately the Department of HUD, the General Counsel’s 

office in Ginnie Mae, started to cooperate in working with the U.S. 

Attorney, not the Civil Division, the Criminal Division, in order to 

give them whatever technical assistance that we could to proceed 

with the criminal case. The IG was also notified and immediately 

deployed its IG investigators, not auditors, investigators to Charlotte, North Carolina to assist in the investigation. 

Probably the telling fact for us was that we noticed that we 

looked at 42 properties and determined that 37 of the properties 

were either vacant properties or properties under construction, 

clearly, not a case where you could have a mortgagor that would 

be appropriate for an FHA-insured mortgage in a Ginnie Mae pool. 

So at that point, we were mostly providing assistance to the U.S. 

Attorney to prepare the search and seizure warrant for the records 

of First Beneficial. Within a period of a little over 3 days, the 

Ginnie Mae team went from a contractual enforcement case to assistance on a criminal matter, and a search and seizure of the 

records. On the same day that the search and seizure warrants 

were issued, Ginnie Mae also delivered its default letter. That happened on the same day and Ginnie Mae declared them in default 

and in essence took over the bank accounts, the records and all 

records pertaining to the mortgages in the pools. 

At the same time, on literally day two of that, the attorney that 

was representing Ginnie Mae at that point, was looking at the public records to identify all assets, personal and real, of First Beneficial and its principals for the purposes of seizing those records to 

ultimately to satisfy any losses that would pertain to Ginnie Mae 

in the pools. 

The FBI, HUD’s IG and the IRS, of course, then conducted a 

lengthy and extremely tedious and detailed investigation of the operations of First Beneficial. The outcome of that, as you know and 

has been stated, are convictions and terms of 21 years for the principals. 

In a rather unusual situation, Ron Rosenfeld, the President of 

Ginnie Mae, actually flew to North Carolina to attend the sentencing hearing. Obviously, this was a case of significance to 

Ginnie Mae. A large financial loss did occur because of the actions 

or, or inaction of First Beneficial. It is the only time in my 35 years 

that I have seen a President of Ginnie Mae actually go to a sentencing hearing and present his testimony to make sure the judge 

understood the gravity of this case. 

I would also note, and I do not think it has been mentioned yet, 

that the accountant for First Beneficial was also indicted and convicted. That becomes relevant because when you have a situation 

where the chief operating officer and the accountant worked together in a scheme to defraud, it is going to make it difficult for 

everybody. It is going to make it more difficult for people to find 

that fraud. But that case was handled, the IG assisted in that, and 

the person has been convicted and is serving a sentence of one year 

under a plea agreement. 

At that point, when all of the criminal action was over, that is 

when we started focusing, ‘‘we’’ Ginnie Mae and OGC, started foVerDate 0ct 09 2002 16:16 Oct 07, 2005 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 G:\DOCS\23734.TXT FIN1 PsN: MICAH
9

cusing on well, how do we recover the monies for Ginnie Mae. They 

suffered extensive losses. We started looking at different theories 

and different opportunities for capturing monies that were a part 

of the criminal conspiracy. Let me just say that on January 16, 

2004, I visited main Justice, the Department of Justice, Mike 

Hurd, Civil Fraud Section, and we started thinking about different 

theories under which we could recover monies. 

As I said in the very beginning, we had identified all of the as- sets of First Beneficial, and that is roughly $8 million. I should say 

that in that regard, we identified 100 parcels of property, 20 bank 

accounts, 7 vehicles, a boat and the personal residence of the owners of the company. All of that was available to us in a forfeiture 

process. That has since, through the U.S. Attorney’s office, come to 

fruition, and $300,000 has been paid already to other victims, and 

at the end of the day the remaining monies of that $8 million will 

come to Ginnie Mae to satisfy that. 

More importantly, I think, we started looking at the facts that 

were available to us from the criminal case. When we looked at the 

facts surrounding Fannie Mae’s behavior, it occurred to us that 

possibly that might be an avenue that we could look at. That was 

the purpose of my visit to the Department of Justice, and over a 

period of months, we ended up working with them, an incredible 

effort on the part of the Department of Justice and the U.S. Attorney’s office, Paul Taylor specifically in the U.S. Attorney’s office, a 

criminal forfeiture case was filed. The outcome of that, as you already know, was that Fannie Mae looked at that. They looked at 

the evidence surrounding that that was available to them, and 

elected to pay $7.5 million, which included $1 million in interest. 

In terms of the acts or omissions of Fannie Mae, my look at the 

evidence convinced me that at a minimum they either did know or 

should have known that Fannie Mae was going to be the ultimate 

victim of this fraud scheme that they did not report. 

[The prepared statement of John P. Kennedy can be found on 

page 44 in the appendix.] 

Mrs. KELLY. Thank you, Mr. Kennedy. 

Mr. Pollard? 

STATEMENT OF ALFRED M. POLLARD, GENERAL COUNSEL, 

OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT 

Mr. POLLARD. Madam Chair, ranking member Gutierrez, and 

members of the subcommittee, I am pleased to represent the Office 

of Federal Housing Enterprise oversight as you conduct these hearings. Director Falcon has given clear instructions to the staff, the 

General Counsel’s office and our examiners, to deploy the needed 

resources to address matters relating to mortgage fraud involving 

Fannie Mae and Freddie Mac, including any misconduct by employees. 

OFHEO as a safety and soundness regulator does not enforce 

criminal laws. OFHEO refers violation of criminal laws to federal 

or state agencies with appropriate jurisdiction for their review and 

action. Like bank regulators, however, OFHEO does inquire into 

the conduct of business operations, particularly to assure safe and 

sound practices. Criminal conduct by or against an enterprise 

clearly is a threat to safe and sound operations. 

10

OFHEO has been fortunate to be one of the agencies to be made 

a member of the President’s Task Force on Corporate Fraud led by 

Deputy Attorney General James Comey. This includes the Justice 

Department, U.S. Attorneys, the SEC, CFTC, IRS and others. We 

have learned much about fraud remediation and that inures to our 

benefit in seeking to enhance our efforts at fraud prevention. In 

other words, fraud prosecution has relevance for fraud prevention. 

OFHEO has been active in working on mortgage fraud. In the 

past, we have sponsored seminars on mortgage fraud that included 

some of our colleagues at the table today, and has even provided 

a training program for the FBI at their Quantico facility. Now, 

OFHEO has undertaken initiatives to improve mortgage fraud reporting and to address deficiencies that exist in enterprise operations and systems. 

OFHEO has proposed, for public comment, a rule that will require the enterprises to report on possible or actual mortgage 

fraud, to do so in a timely manner and to create the training programs and operating systems necessary to meet those obligations. 

The finalization of a rule on reporting mortgage fraud and the 

implementation of a reporting regime should improve overall reporting, lead to earlier intervention to avoid fraud, and permit 

OFHEO to expeditiously introduce needed changes to enterprise 

operations. 

I would note that we are well aware of the challenges in implementing a rule that provides OFHEO the information needed to do 

its job, while being operationally smooth at the enterprises and 

permitting them to meet their mission. I do not see any obstacles 

to addressing and meeting those challenges and we will work with 

the enterprises, as well as with regulators and law enforcement 

personnel. 

As the public comment period is open on the rule, I will not discuss the rule in any greater detail as we must await those comments and give them due consideration prior to issuance of a final 

rule and implementing the formal reporting. 

As this subcommittee well knows, the enactment of the Bank Secrecy Act and the use of suspicious activities reports have important elements in law enforcement, likewise for regulators. Banks 

today have SAR forms and supporting instructions on a wide range 

of consumer and business fraud. The instructions highlight key 

forms of practices that should raise concerns. The enterprises, engaging in a narrower band of business activities, will require the 

creation of forms and instructions by OFHEO tailored to their businesses and at the same time generating information needed by us 

and by law enforcement. 

It is my hope that the enterprises will respond favorably to the 

mortgage fraud proposal, and I believe we can work to achieve a 

goal of moving as close as possible to a fraud free zone at the 

GSEs. Realistically, this subcommittee knows full well that fraud 

may be deterred, but not fully prevented. We are committed to 

making sure the deterrence is as strong as possible. 

You have heard comments on the Bank Secrecy Act, on the need 

for safe harbor and other provisions. OFHEO believes that would 

be useful. The General Counsel’s office is looking in to a procedure 

where OFHEO would share information it develops on mortgage 

11

fraud with other government agencies. I would note we have benefited greatly from the expertise, information and views provided by 

the Treasury Department, Financial Crimes Enforcement Network, 

Federal Bureau of Investigation, and the U.S. Attorney. Coming 

from the private sector and hearing of jurisdictional squabbles, I 

can report in this instance strong cooperation among agencies, and 

I am pleased to have the commitment of these experts as we move 

forward toward a final rule and implementation. 

On First Beneficial, I will note in my remaining 20 seconds, that 

we are currently reviewing changes that Fannie Mae has undertaken to determine if those changes are adequate, but as well to 

see if enhancements are needed. In particular, we believe that a 

strong set of guidance documents, backed by a strong and centralized compliance regime, is essential regardless of whether a business model provides for centralized or decentralized operations. 

In sum, both enterprises should strive for best practices in seeking to avoid mortgage fraud and a strong, aggressive program 

aimed at prevention and detection is imperative for safe and sound 

operations. 

Again, I appreciate the opportunity to appear before you. 

[The prepared statement of Alfred M. Pollard can be found on 

page 47 in the appendix.] 

Mrs. KELLY. Thank you very much, Mr. Pollard. 

Just so you gentlemen know, your full written statements will be 

made part of the record. 

Mr. Donohue, following your examination of the facts that surrounded the First Beneficial matter, would you consider Fannie 

Mae’s internal controls to be adequate in identifying and reporting 

fraud? 

Mr. DONOHUE. Well, first of all, as you well know, I have no statutory authority over Fannie Mae as far as what they are proposing 

to do, but I have made comments, as was discussed by the OFHEO 

representative, as far as the new proposed regulation. 

Mrs. KELLY. I thank you very much. If you have suggestions, we 

would like to work with you. 

I have reached over here, because I have a sworn statement from 

Mark Heimbach, Special Agent, United States Department of 

Housing and Urban Development. He is from your office. In this 

sworn statement, he discusses something that I am going to talk 

with you, Mr. Smith, about. You say you regret your lack of knowledge about this. According to this, Mark Heimbach says prior to 

Fannie Mae receiving these transfers, Fannie Mae officials were 

aware that the source of these funds was Ginnie Mae and that the 

McLeans had repaid this money to Fannie Mae simply by re-selling 

the fraudulent loan packages to Ginnie Mae and thereby defrauding that entity. 

That is a sworn statement, sir. I know you regret the lack of 

knowledge, but apparently someone there had knowledge. To that 

end, Mr. Baker and Mr. Ney and I sent a letter to Fannie Mae in 

December of 2004 asking if Fannie Mae was aware of any other instances where an entity of the Federal Government was sold fraudulent loans held at one time by the enterprise. In its response, 

Fannie Mae exempted loans that it assigned to the Federal Government in connection with insurance claims. Why did Fannie Mae’s 

12

Atlanta office employees fail to inform, and what do you know 

about that statement that I just gave you? What can you tell us 

about the fact that you, in the response, exempted loans that you 

assigned to the Federal Government in connection with insurance 

claims? 

Mr. SMITH. Well, as the Latham and Watkins support shows, 

there was an e-mail message from Debra Brown to me and a few 

other people at Fannie Mae which had an attachment. The attachment described some conversations that Debra Brown had with the 

North Carolina Banking Commission, along with two employees, or 

two people that represented themselves as employees of First Beneficial. In that attachment to that e-mail message there was a reference, a couple of references, to First Beneficial’s intention to sell 

loans to Ginnie Mae. 

Now, I do not recall seeing that e-mail message or the attachment until much later, actually in 2001, after Fannie Mae’s records 

had been subpoenaed by the government as it was preparing its 

case against James McLean. Fannie Mae responded to the subpoena and gave the government all of our records. Government attorneys came to Fannie Mae’s office in Atlanta and asked me about 

that e-mail message. I was shocked at the time to see those references in the attachment to the e-mail message. I do not remember seeing the e-mail message or the attachment in 1998. 

I do recall discussions with my staff and especially with Debra 

Brown, about the phone calls that she had from the North Carolina 

Banking Commission and the two employees, but the focus of those 

discussions was that the North Carolina Banking Commission and 

the two employees were pointing to activities at First Beneficial 

that they felt were improper. I do not recall at the time any discussions about Ginnie Mae. In fact, the Latham and Watkins report 

interviewed a number of people, some of whom have left Fannie 

Mae years ago, but who were there at the time of this situation. 

None of us recall any conversation about the reference to Ginnie 

Mae. 

So yes, in retrospect, now looking at the facts, the file does show 

that there was in an attachment to a single e-mail message a reference to Ginnie Mae, but none of us at Fannie Mae can recall ever 

discussing that or having knowledge that James McLean intended 

to sell loans to Ginnie Mae. In fact, in October of 2000, when I received a copy of HUD’s letter to First Beneficial suspending or terminating them, I can recall shock and disbelief that a small lender 

like First Beneficial Mortgage had even been approved to do business with Ginnie Mae. That was the first revelation that I had, the 

first information that I can remember when I first became aware 

that First Beneficial had been involved with Ginnie Mae. 

Mrs. KELLY. Yet the testimony of Debra Brown indicates that on 

or about November 19, 1998, she took a call from a man named 

Warren Harper, the federal crimes investigator with the North 

Carolina Banking Commission. To sum up that testimony, the indication in that conversation was that they were trying to get Ginnie 

to buy loans now. They were trying to buy them out of Fannie to 

Ginnie. So there was someone there who was an employee who 

Debra Brown seemed to know about it. I would like to ask you, Mr. 

Donohue, if you would respond to what Mr. Smith just said. 

13

Mr. DONOHUE. I think I misunderstood your question before. I 

would love to respond. It is my feeling, in looking over the record 

myself and reviewing and speaking to our investigative personnel, 

it certainly does appear to be the preponderance of the facts in my 

mind that Fannie knew that these securities were destined to 

Ginnie Mae based on these comments, based on the North Carolina 

investigator, and based on the correspondence that went on discussion with regard to other people that provided testimony. 

So my feeling is, to answer your question, yes I do believe that 

reasonably so there was a preponderance that Fannie knew that 

these were destined for Ginnie, and as a result, as I have been 

quoted, I felt they should have notified Ginnie as appropriate. 

Mrs. KELLY. Thank you very much. 

I am out of time. I will turn to Mr. Gutierrez. 

Gentlemen, I wanted to let you know that we have been joined 

by Chairman Oxley. I am delighted to see him here as well. 

Mr. Gutierrez? 

Mr. GUTIERREZ. Thank you. 

Thank you, gentlemen, for your testimony this morning. I do not 

think we are going to figure out when Fannie Mae knew or whether they knew exactly, because it just seems to me that if Mr. 

Donohue is correct, then Mr. Smith lied to the FBI and to the U.S. 

Attorney’s office. We have his sworn testimony here. He also lied 

at trial. I do not know of any investigation of the Federal Government into Mr. Smith or the collusion. I mean, it would have to be 

a pretty broad-based conspiracy at Fannie Mae, not only between 

Mr. Smith and Mr. Smith and other former employees and current 

employees at Fannie Mae. They all have to be in collusion. I am 

not trying to say that they cannot do that, but given the extensive 

investigation that has been done. As a matter of fact, then, the 

Federal Government had Mr. Smith testify on their behalf against 

First Beneficial. 

So I guess the Federal Government might have thought then 

that he was lying and used him as a witness in the case against 

First Beneficial. I am not a lawyer. I am just listening to the testimony of everyone here today. 

So I think there is certainly enough reason to suspect that 

Fannie Mae should have known better, that they should have been 

more judicious, because as I look at this, and I will just ask anybody, when Fannie Mae went to First Beneficial, and said First 

Beneficial, you know, we just can’t. We want you to repurchase this 

portfolio that we have with you. It was not because they had done 

something illegal. Otherwise, it seems to me Fannie Mae would 

have turned them over for criminal prosecution. They said it does 

not fit our underwriting guidelines; you do not have proper documentation; you have shoddy paperwork here; we do not want these 

loans. 

And indeed, we have the gentleman from First Beneficial, the 

former CEO, saying to Fannie Mae, we will get the money from 

subprime lenders; we will get the money from these people. That 

is the testimony at trial that that is where you are going to get the 

money. So there were other reasons given for the testimony. 

So if there was no criminal, and I have not read anything in the 

record that Fannie Mae knew of any criminal involvement or activVerDate 0ct 09 2002 16:16 Oct 07, 2005 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 G:\DOCS\23734.TXT FIN1 PsN: MICAH
14

ity of First Beneficial, that this was an underwriting issue and that 

they did not want to keep these loans, and they were asking them 

to basically give their money back to Fannie Mae, and saying we 

do not want these loans, and they have to go out and get those 

loans. Otherwise, it would seem to me that they would know about 

it. 

So as I look at this, I guess my question is, Mr. Smith, what 

would happen differently today, corporation, bank, First Beneficial, 

you have $7.5 million in loans or money owed to you. How would 

you do things differently today and what changes have been made 

to do things differently today so that another governmental agency, 

Ginnie Mae, or as a matter of fact, any others, they are all insured 

by us, that you would not be able to take loans and simply allow 

someone else to take them up? 

Mr. SMITH. Certainly, there is an extreme heightened sense of 

awareness at Fannie Mae about all matters pertaining to fraud. 

Fannie Mae has implemented a corporate-wide anti-fraud policy in 

writing that requires every employee when they have knowledge or 

suspect fraud, to take action and report it. 

We have also centralized our lender approval process into a single office that will allow that office to better focus on the needs of 

smaller lenders and to properly judge those lenders and their qualifications to be Fannie Mae-approved lenders. We have also centralized our review of individual files in our Dallas office. We have implemented some models which are designed to try to target for review those files that would perhaps have some indicators of irregularities. 

Also in the Dallas office we have created a fraud investigation 

team that when they pick up on the potential for fraudulent activity, they will do investigations and find out exactly what is going 

on. We have also implemented in our automated underwriting tool, 

Desktop Underwriter, some fraud detection tools designed to help 

our lenders at point of sale spot potential fraudulent activity. 

Mr. GUTIERREZ. Let me just ask you a follow-up question, as my 

time has expired. Does Fannie Mae expose itself to liability when 

it reports possible fraud that turns out to be botched paperwork? 

Could Fannie Mae be sued for libel? 

Mr. SMITH. That has certainly been on my mind when I have 

dealt with some of these issues. When we were working with First 

Beneficial, First Beneficial represented that the ineligible loans 

were due to misunderstandings and poor management. If I had, on 

my own, taken actions that were inappropriate in retrospect, and 

in fact if James McLean’s claims had been valid and he could 

prove——

Mr. GUTIERREZ. Let me just say this. I do not want to go over. 

The gentlelady has been very kind with me this morning. Let me 

just say that there are those of us in Congress and across the country that count on Fannie Mae to do the kind of work that allows 

people to purchase homes and to rebuild neighborhoods. Let me 

just say that while I believe you, I certainly think that Fannie Mae 

needs to do a lot. I want you to do well. 

I look at the record. I can see there are mistakes. But even when 

you make a mistake, you made a mistake. I think you admit you 

made a mistake and there are consequences to mistakes. And we 

15

do not want you to make these mistakes any further because they 

harm the American public and the American investing community, 

and they harm the goals and the purposes that Congress when 

they enacted and made you what you are today, and gave you the 

authority to do what you do today. 

So let me just say that I believe you, but I can understand why 

others might not. I certainly hope that in the future you take much 

more aggressive action when you see that loans, these were suspicious loans that you did not want in your portfolio. Before you 

get rid of something, and you say I do not really want this, that 

you figure out how to just not get harmed by what you do not 

want. 

Thank you very much for your testimony this morning. 

Mrs. KELLY. Thank you, Mr. Gutierrez. 

Mr. Oxley? 

Mr. OXLEY. Thank you, Madam Chairwoman. Thank you for your 

leadership on this important issue. 

Mr. Smith, it is my understanding that in 1998 once a lender 

was approved to sell Title I notes, you would cease further due diligence regarding the underlying basis for the loans, and instead, 

Fannie would rely on the lender’s approval status and assurances 

outlined in your contract for sale. Was this substantially the standard operating procedure then? 

Mr. SMITH. Yes. After a lender becomes approved, we rely on 

lender warranties. The lender by selling loans to Fannie Mae warrants that the loans meet Fannie Mae’s standards. 

Mr. OXLEY. And what role at that point did the Fannie Mae 

headquarters play when the fraud was detected? 

Mr. SMITH. The regional offices back in 1998 handled repurchase 

issues, matters involving ineligible loans, investigations, pretty 

much on its own and was under no obligation to inform the Washington office or seek advice from Washington unless we felt it was 

necessary. 

Mr. OXLEY. Could you take the committee through the structured 

changes that have been made structurally so that if the same set 

of facts were presented today it would be handled differently? The 

reason I raise that is I just came from a panel discussion over at 

the Georgetown Law Center with Senator Sarbanes. He made an 

excellent point in terms of what we describe as structural changes 

in the corporate structure to make certain that the Enron and the 

WorldCom do not happen again. Obviously, some of these things 

like we are talking about today, we talk about after the fact. The 

damage has already been done. 

The goal, of course, was to provide necessary internal controls in 

the law so that this would be detected early on. From your perspective, what has Fannie done to provide the kind of internal controls, 

checks and balances necessary in the future? 

Mr. SMITH. As a result of Sarbanes-Oxley 404, we have developed 

and implemented a formal company-wide anti-fraud policy that requires that any employee who suspects fraud or wrongdoing report 

that fraud up through appropriate channels. We have certainly all 

at Fannie Mae, we all have a heightened sense of awareness about 

all issues pertaining to fraud. 

16

We have centralized lender approvals in our Chicago office to 

really focus on the lender approval process to ensure that the lenders that we approve have the appropriate capabilities that Fannie 

Mae would require. We have also centralized our post-purchase 

loan file reviews in our Dallas office, and we select the files that 

we want to review with some models we have developed that would 

prompt Fannie Mae to ask that those files that contain certain risk 

factors be the files that we request from the lender for review. 

We have also created in the Dallas office a fraud team. By having the file reviews in a single office instead of the five offices, it 

is a little bit easier to spot trends of fraud across many lenders. 

There could be a real estate professional, an appraiser or a real estate broker that is involved in some improper arrangements, but if 

that professional or broker is involved with several lenders, each 

lender only sees a small piece of the arrangement. But by having 

Fannie Mae’s one office look at the file reviews, we can better spot 

whenever there is a real estate professional or a broker that is 

feeding to a number of lenders loans that are improper. The fraud 

team helps us do that. 

Mr. OXLEY. You say that is in Dallas? 

Mr. SMITH. That is in our Dallas office which we call the National Underwriting Center. 

Mr. OXLEY. And how many personnel do you have on that? Obviously, you have some sophisticated software to aid those folks in 

their endeavors. 

Mr. SMITH. I do not know the number. I think the number of people, I am speculating that the number of people in the Dallas National Underwriting Center could be 150 to 200 total. This fraud 

team I am speaking about has a director and a staff of several. I 

do not specifically know the number. 

Mr. OXLEY. And they have the necessary technology to be able 

to follow those leads? 

Mr. SMITH. They investigate issues and do whatever they need 

to do. 

Mr. OXLEY. What is the role of modern technology? Are these just 

basically gumshoes that follow the paper trail? Or do they have a 

sophisticated computerized operation? 

Mr. SMITH. I really do not know. I am not involved in that operation. I really do not know. 

Mr. OXLEY. Okay. Thank you. 

Thank you, Madam Chairman. 

Mrs. KELLY. Thank you, Mr. Chairman. 

Mr. Cleaver? 

Mr. CLEAVER. Thank you, Madam Chair. 

Either Mr. Donohue or Mr. Kennedy, we deal with this in every 

aspect of government and life now, and I want to bring it to you 

in the same way we deal with it in other arenas. It appears as if 

more and more cases of fraud are uncovered every year. The question is, is that due to the fact that we have a much better, far more 

sophisticated system of detection? Or are we simply having more 

and more fraud, and that it is significantly higher than it was in 

previous years? I mean, how many cases of fraud does Ginnie Mae 

encounter each year, or Fannie Mae for that matter? 

17

Mr. DONOHUE. That is a very good question, sir. I think the answer to that is both. I think what I have seen is in different areas, 

the queue seems to be, as the cooperation and the reporting from 

these GSEs or the regulatory departments to the respective appropriate federal law enforcement agencies address these issues. So I 

think the first answer is I think better cooperation, communications, we are getting more cases we might not have seen in the 

past. 

I will comment to you, however. I have spoken to outside counsel 

of various banking institutions. One of the things they tell me is 

this. They tell me that often in the industry that at times the industry is reluctant to pass this information on, on criminal matters 

and on civil litigation, because of the costs involved and so on. 

Cases involving bad publicity can come out of these matters. 

What I try to do and encourage upon them is to try and make 

sure they pass that information on because my graves concern, as 

I found out when I was at the RTC, is the very people that perpetrate these crimes go on to another one and go on to another one 

and go on to another one. So I think that is the benchmark with 

regard to it. 

Do I think there is better reporting? Yes, I do. Do I think coordination is better? Yes, I do. And we have our own task. We work 

very closely with the FBI and ourselves in doing many of these 

cases as well. I, as you well know, my jurisdiction rests with the 

FHA and Ginnie Mae and Fannie Mae, unless it has a relationship 

to it. 

Mr. CLEAVER. What happens if someone makes an accusation 

that is proven untrue? I mean, if someone, for example, goes out 

and says I have reason to believe that fraud is taking place here 

or there, and it is investigated and it is found to be untrue. What 

happens to that person? Are they liable? Are they going to lose 

their job? Do they end up in court? 

Mr. DONOHUE. The way it comes to us, when it finally comes to 

us, of course we are looking at the notion about the evidentiary aspect to it. We study the case, look at it, and investigate the case 

entirely, which is within our full jurisdiction, and present that matter to the U.S. Attorney’s office for the outcome. Typically with 

cases involving us, when the person is found to be, I should say, 

not prosecuted or declined prosecution, we attempt to notify those 

people, let them know the fact that the case has been resolved or 

will not be criminally adjudicated. It then does take a civil component to it. The Federal system has a way to be able to deal with 

those matters. But I think the question as far as the liability issue 

needs to be directed to these other folks here. 

Mr. KENNEDY. If I may in terms of, from the Ginnie Mae perspective. Clearly, if you look at this case, First Beneficial, there are 

lessons to be learned from it. Almost immediately, within a matter 

of days, Ginnie Mae looked at the case and rather than go through 

a rulemaking process to change their procedures, they instituted 

immediately a process whereby all issuers were looked at and compared in terms of a profile to see whether or not there were indicators in the files that suggested that an issuer might have problems. 

But I think we should be clear about one thing. As soon as 

Ginnie Mae found out that there were loans in the files for which 

18

there was a piece of vacant property, no house, no mortgagor, we 

do not tend to characterize that as an irregularity. It was clear to 

us that given that set of facts, we had a fraud case. I think that 

at this point Fannie Mae would view that same set of facts the 

same way. It is not a question of irregularities and the loans are 

not eligible for the pool. It is a question of these are fictitious mortgages. 

I think that clearly Fannie Mae has indicated their desire to 

raise the expectations, even within their own offices, that can find 

those kinds of cases. That is not an irregularity. I should say, and 

I will say it here, that based on Ginnie Mae’s immediate change 

in its procedures, another case was discovered, very similar. Immediate action was taken to suspend their approval as a Ginnie Mae 

issuer. That was done because they acted quickly based on the 

facts before them. It is a good example of how it can work and how 

it should work. Those matters were referred to the IG and to the 

enforcement folks. 

Mrs. KELLY. Thank you very much. 

Mr. CLEAVER. Thank you, Madam Chair. 

Mrs. KELLY. Mr. Garrett? 

Mr. GARRETT. Thank you, Madam Chairman, and thank you, 

gentlemen for being with us this morning. 

As with much of what we do here, as was said, it is appropriate 

that we examine this, and it is good that the barn door is now 

being closed after the horse got out. Of course, we are trying to go 

forward from there. 

Let me take a step back and look at the big picture. Fannie Mae 

obviously exists as different from other financial institutions, and 

that is because it has a status as a creation of Congress. Because 

of that, Fannie Mae has special benefits that are not available to 

other financial institutions, such as having that line of credit from 

the Department of Treasury, the exemption from state and local 

corporate income taxes, and the perception that your securities are 

backed by the Federal Government, and until recently, an exemption from the registration with the SEC. 

So the big question that I think people will be asking is, is it in 

your opinion that you as a responsible corporate citizen with all of 

these added advantages that you have, with relationship to the 

Federal Government, that you silence when you discovered a major 

fraud fell below what is an appropriate conduct for a corporation 

that has this connection to the Federal Government? 

Mr. SMITH. At the time, and we are looking back with 20/20 

hindsight, at the time, James McLean, when I confronted him with 

these irregularities and I explained that the loans sold to Fannie 

Mae were not eligible for sale to Fannie Mae, that they did not 

meet our requirements, Mr. McLean stated that the errors were 

due to poor management and a poor understanding of Fannie Mae’s 

requirements. Given the fact that First Beneficial was such a small 

lender, it was credible to me that misunderstandings might have 

occurred and that the misunderstandings might be corrected 

through additional training for First Beneficial and that the loans 

sold to Fannie Mae, the ineligible loans, that breach of contract 

could be cured by James McLean repurchasing the loans from 

Fannie Mae. 

19

Certainly, when I look back now and with the heightened sense 

of awareness about all matters pertaining to fraud, I think Fannie 

Mae clearly could have done a better job in how it handled that situation. 

Mr. GARRETT. Mr. Donohue indicated that, from your experience, 

and you have seen cases of fraud, that the entity does not do it 

once. They do it, I think you said, over and over and over again 

in different circumstances. So again back to you, Mr. Smith, in essence do you feel that everything occurred as it did, and you basically got your money back. Was there no obligation then to ensure 

that First Beneficial would not try to simply push these bad loans 

off onto some other unsuspecting investor and not to allow the 

fraud to continue to perpetuate itself as Mr. Donohue indicates is 

often the track record of these? 

Mr. SMITH. It was my belief at the time that the problems were 

due to a small lender making poor judgments and not understanding Fannie Mae’s requirements. 

Mr. GARRETT. Okay. 

Mr. SMITH. It was only when I got a copy of HUD’s termination 

letter where Ginnie Mae was terminating First Beneficial, that I 

became aware of the fact that James had even been involved with 

Ginnie Mae, and it became apparent to me at that time, looking 

back, that the issues we had uncovered might have been more than 

simple misunderstandings. 

Mr. GARRETT. And you have just said twice now that it was a 

small lender. In your earlier testimony, I think you said that you 

were shocked at how small a lender they were and that they were 

approved to do business with Fannie Mae. 

A couple of questions. Have you done an investigation? Have you 

looked to see whether there are other similarly situated small lenders that shocked you that they are doing business with Fannie 

Mae? Are there others that you think you need to make a review 

on going forward? Are there policies in place that you make sure 

that it does not occur again at inappropriately sized lenders? 

I guess it goes to the ‘‘also’’ question. Is any of this driven by the 

fact that, are any of the occurrences here as far as approving of 

these lenders, or are any of the facts as far as the miscues, if you 

will, as far as seeing what was occurring with them, tied to the fact 

that compensation packages were maybe tied to whether or not we 

are going to approve these numbers of small lenders, or compensation packages were tied to the fact that these loans would continue 

to go through? 

Mr. SMITH. In my earlier remarks when I spoke about being 

shocked, what I was referring to was when I got HUD’s termination letter I was shocked that a small lender like First Beneficial, who had been selling single loans to Fannie Mae, not selling 

groups of loans and doing mortgage-backed securities. My shock 

was that a small lender like First Beneficial could have been doing 

business with Ginnie Mae. 

I am the person at Fannie Mae that actually approved First Beneficial to become a seller-servicer. I knew that he was a small lender, and we at Fannie Mae in fact tried to provide James McLean 

and First Beneficial with extra training to help them really understand how to do business with Fannie Mae. So if I said earlier, if 

20

I said I was shocked that First Beneficial was Fannie Mae-approved, I meant to say Ginnie Mae. 

Mr. GARRETT. Okay. 

Mr. SMITH. On the issue of compensation, back in 1998, as best 

as I can recall, I personally had about 40 goals that I was held accountable for and that would influence my bonus. Only one of those 

goals in any way in my opinion touched on this kind of an issue. 

That goal was to hold Fannie Mae’s overall credit losses, it was either at the same point or slightly less than the previous year. That 

was a national goal, not a goal for the Atlanta office or for lenders 

in North Carolina. 

However, looking back on this situation in 1998, the vacant lot 

loans were discovered in December of 1998, and even if the loans 

had not been repurchased, Fannie Mae would not have foreclosed 

on those loans, until sometime in 1999, and we would not have realized any losses, actual losses on those loans until we had sold the 

real estate and then booked the loss and that probably would have 

occurred in 1999. During this period of time, none of the decisions 

I made about First Beneficial were influenced by matters of compensation. 

Mr. GARRETT. I see my time has expired. Thank you. 

Mrs. KELLY. Thank you, Mr. Garrett. 

Mr. Baker? 

Mr. BAKER. Thank you, Madam Chair. 

I want to go at a couple of underlying principles here as to their 

being no obligation to report, as a beginning point. The conclusion 

reached, Mr. Donohue, in your prepared testimony, the last line indicating there needs to be the view that there was a systemic 

weakness that needs to be addressed, and had there been better 

communication these problems perhaps would not have occurred. If 

we go to Fannie Mae’s Web page and go to their code of business 

conduct, we go to page four of the code of business conduct, employees must report any violation of the code or related, it goes on and 

on. 

If we go to page 14 of the code, they must obey the spirit and 

letter of all laws and regulations in every area in which they do 

business. We must support commitment to conduct our business 

with all government officials at the highest ethical standard. The 

possible consequences of violation of the established code is termination. That is element one. If we go to the D.C. Bar standard for 

ethical conduct and we look at a lawyer’s obligation to report another’s questionable conduct to the D.C. Bar, it is very clear and 

forthright that one attorney conducting enterprise with another 

must report to the bar on matters of ethical concern. 

If we go to the Sarbanes-Oxley act and look at Section 404 requirements, if we go to an executive summary I have gotten off the 

SEC Web page, must report accurately all financial data. I am 

skipping over details, just for the sake of mercy. If we go to the requirements to disclose, if there is a material weakness existing at 

year-end, it must disclose this fact. I would suggest that by December of 1998, someone should have figured out there was a material 

weakness in the financial review process and made, as required 

under Section 404, the required disclosures, which were not made. 

21

If I got to the Department of Justice Web page and look at a recent decision relative to the Riggs Bank, and quoting from the Department of Justice finding, ‘‘the financial enterprise was obligated 

to take steps to ensure that its services would not be utilized for 

illegal purposes,’’ and it goes on. 

My point in bringing all these to your attention is there were 

clear, legal, regulatory, statutory obligations on the part of someone within this enterprise when they knew that their assets, which 

were fraudulently represented, were to be sold to another governmentally related enterprise. My first question is, when, based on 

your observations, did officials at Fannie have constructive knowledge of the material facts of the disposition of assets to Ginnie 

Mae? Prior to closing or after? 

Mr. SMITH. During the period of time in 1998, I did not believe 

that what we were looking at were fraudulent activities. 

Mr. BAKER. Let me interrupt and go on to the facts then. As I 

understand it, First Beneficial offered to repurchase the entire 

portfolio of $35 million. That offer was not accepted by Fannie. In 

December, Fannie then demanded a repurchase of a package of 

loans valued at $4.8 million. Somebody had to do due diligence at 

that point, to sit across the table, look at documents, and make determinations. 

It was then subsequent to that determination, 60 days later, in 

February, the vacant lot transaction to which you refer, an additional repurchase of $1.7 million of the 17 lots was demanded. Obviously at that point, someone made the determination in Fannie’s 

organization, these are bad things; we have to get them off our 

books. What really troubles me about the last quarter of 1998 was 

that was the quarter in which the $200 million of expenses was deferred into 1999, then repaid as affecting that earnings-per-share 

target. 

Now, it is just a question. I am not making an allegation. Somebody needs to make an examination of these facts, one, to determine when Fannie officials knew, when judgments were made to 

sell these assets to Ginnie, and did they know prior to the execution of that sale that Ginnie was the recipient. The fact that subsequent to examination by the inspector general, a consent order and 

agreement was reached for the payment of a fine of $7.5 million 

says to me somebody knew something or else we would not have 

levied a fine of $7.5 million equal in value to the repurchase value 

of that portfolio. 

But yet to my knowledge, no individual or group of individuals 

was held personally accountable despite the clear regulatory and 

statutory obligations leading up to termination of those employees 

for obviously fraudulent conduct. Is there any explanation? 

Mr. SMITH. I was the senior person on the spot at the time, and 

I did not believe that this was fraudulent activity. I believed that 

what we had was a small lender that had——

Mr. BAKER. I know it was a small lender that was trying to dupe 

Fannie Mae. That is obvious, and apparently they succeeded. There 

were no internal controls at any point in this process which would 

have led a reasonable man to conclude that there was something 

to it? Let me go at it a different way. Why did you reject the $35 

22

million repurchase offer and simply select the handful of what now 

appears to be fraudulent transactions to rescind? 

Mr. SMITH. Our research had revealed that the entire portfolio 

was not a bad portfolio. 

Mr. BAKER. Yes, your research. That means somebody looked at 

it, and made an examination. You went document-by-document, 

loan-by-loan. That was knowledge. Somebody made a business decision, and you made the business decision to dump the fraudulent 

stuff on somebody else. 

Mr. SMITH. Fannie Mae as a general practice relies on warranties made to Fannie Mae by sellers of loans to Fannie Mae. 

Mr. BAKER. I understand that. When you have a bulk and you 

have thousands of transactions, you cannot sit down every day and 

look at every one of them, but when you have constructive knowledge there is something wrong and you sit down and do the examination and you refuse a $35 million offer to dump the whole portfolio, and selectively, selectively pick about $7 million in transactions to rescind, there is your problem. Somebody had knowledge. 

Somebody made a business decision. Somebody decided we have to 

get rid of these. And it also, as an ancillary effect, impacted the 

bonus calculations and the earnings-per-share target for 1998. 

I have been way over time. I am sorry, Madam Chairman. 

Mrs. KELLY. Thank you very much, Mr. Baker. 

I do not think we have completed our inquiry right now, gentlemen, and I am going to initiate a second round of questions here. 

I have a question I would like to go back to, Mr. Smith, because 

I really did not get a clear answer from you. I would like to know, 

Mr. Baker, Mr. Ney and I sent a letter to Fannie in December of 

2004, and I am going to repeat this question. We asked if Fannie 

Mae was aware of any other instances where an entity of the Federal Government was sold fraudulent loans held at one time by the 

enterprise. In its respond, Fannie Mae exempted loans that it assigned to the Federal Government in connection with insurance 

claims. I want to understand that. So will you answer me about 

why that was exempted in your response to our letter to you. 

Mr. SMITH. I believe Fannie Mae’s interpretation of your inquiry, 

especially as it pertained to First Beneficial, was targeted to the 

sale of loans back to First Beneficial or others, that might have 

been sold elsewhere. With First Beneficial, the Title I loans turned 

out not to be Title I loans at all, that there was never any insurance on the Title I loans. They were never loans that could have 

had a claim paid, and in fact Fannie Mae never received any claim 

payments on the Title I First Beneficial loans. 

Mrs. KELLY. Mr. Baker, would you like to jump in here? 

Mr. BAKER. I thought you would never ask. Thank you, Madam 

Chair. 

I am going to go back to Mr. Donohue and the findings reached 

in your testimony as to enhanced communication would have resolved this problem. Do you believe that there was not an intentional decision, business decision made by executives at Fannie to 

dispose of these troubled assets? How do we come to the conclusion 

that if we had all gotten around the table and talked we would 

have not had this circumstance? 

23

Mr. DONOHUE. Sir, I am an investigator by my experience, and 

having listened to what you said carefully, I use the word ‘‘preponderance.’’ It appears to me in my mind, looking at all the factors 

involved here, the fact being of a construction loan, the fact that 

at one point reference to Mr. Smith’s comments, he indicated that 

they were denied access to First Beneficial to be able to review the 

files that they were investigating. There are a host of matters that 

come to mind here that tells me that it is reasonable for me to say 

that something was wrong, as indicated. And I think I have stated 

to that effect. 

Mr. BAKER. Is the matter closed as far as you are concerned? I 

know Fannie wants to look forward, and we are not going to do this 

again, but are the facts relating to these transactions from your 

perspective a closed matter? 

Mr. DONOHUE. We consider it at this point a closed case, sir. 

Mr. BAKER. Well, I can only express regret, and believe me, I 

have not had a lot of time to do this. I have only spent maybe the 

last day looking at the facts. I have come to a very troubled conclusion about what really transpired in moving these assets off 

Fannie’s books to Ginnie Mae’s, and the fact that they were as a 

corporation fined at a corporate level, and there was no personal 

accountability assigned to anyone is very troubling. 

Now, I know Fannie has recently gone through managerial 

changes and they are perhaps engaging the new folks to direct the 

ship in a different manner. But in any other enterprise, if this had 

been publicly reported, somebody would have had some consequences. 

Mr. DONOHUE. We worked closely with the U.S. Attorney’s office 

in discussion about the case, but I want to point out as well that 

I do not have legal authority over Fannie Mae as far as the disposition of what they do. All I can do is work with the U.S. Attorney’s 

office as far as the investigation, and at that point we felt the outcome of the case, the prosecution and the resolution of the forfeiture for this particular matter was addressed. 

Mr. BAKER. I certainly understand. You are the fellow who digs 

up the facts and creates the presentation, and it is up to the U.S. 

Attorney’s office to make judgments about how to proceed. I am not 

going to say anything about a U.S. Attorney. But I would certainly 

conclude that resolution in this matter was perhaps not well balanced and that is just my perspective. 

I yield back, Madam Chair. 

Mrs. KELLY. Reclaiming my time, I would like to ask this board 

a question. The state was asking for help when it called Fannie 

Mae. I would like to ask this board what happens now? What kind 

of a set-up is there available for Fannie Mae or for any entity to 

respond to a state when they ask for help? We can start with you, 

Mr. Smith. 

Mr. SMITH. If we get a call from a state agency and they claim 

that fraudulent activity has taken place or is about to take place, 

then under Fannie Mae’s corporate-wide anti-fraud policy, the employee receiving that call would be compelled to report that to the 

Office of Corporate Justice. 

Mrs. KELLY. Excuse me, Mr. Smith. Is that a new policy? 

Mr. SMITH. That policy was enacted last year. 

24

Mrs. KELLY. So it is a new policy. It was not in place in 1998. 

Mr. SMITH. That is correct. 

Mrs. KELLY. And what have you done to inform your employees 

of that policy? 

Mr. SMITH. It is my recollection that when we adopted that policy, an e-mail message was sent to every employee. The policy appeared on Fannie Mae’s internal Web site, and managers were 

asked to be sure that all of their employees read and understood 

that policy. 

Mrs. KELLY. My time is up. I am going to turn now to Mr. Cleaver. 

Mr. CLEAVER. Thank you. 

I think this question would go to Mr. Pollard, and I am going 

back to what I raised earlier. My colleague has talked about someone knew or someone possibly knew. The question that I want to 

deal with really relates more to whistleblowers. I maybe did not 

ask the question as clearly as I should have the last time. I want 

to know two things. One, do you think that whistleblowers are inhibited by providing information about some kind of fraudulent 

transaction because of what may happen to them, particularly if an 

allegation proves to be untrue? And then secondly, whether or not 

you think there is a need to amend the Bank Secrecy Act in order 

to try to provide some protection for GSEs who would give information about some kind of fraudulent transaction? 

Mr. POLLARD. Mr. Cleaver, you addressed that to me. I will be 

happy to answer. 

First, we believe there is an obligation to report fraud, known 

fraud, to government officials at the time it happens. Secondly, and 

this is where people try and distinguish, is the concern about suspicion of fraud, that I might have a suspicion of fraud and be sued 

under the Fourth Amendment for liability. I do not want to take 

off my OFHEO hat, but if I can I will comment a bit on the Bank 

Secrecy Act. 

First, before the Bank Secrecy Act was enacted in 1970, there 

was an exception called the bank records exception that gave certain comfort to institutions that if they provided information to a 

government inquiry, they would be protected, particularly if a 

criminal investigation is involved. That line of cases ended with 

that sort of statement in the Donaldson case, because the Bank Secrecy Act was passed. In this committee, the Annunzio-Wylie bill 

added that protection, that safe harbor that parties have mentioned to you, that if you turn in someone on a suspicion and it 

turns out not to be correct, that you are given a safe harbor. You 

cannot be sued. Okay? 

So I think almost everyone that has commented to the committee 

has said indeed that the Bank Secrecy Act should be revised to include Fannie and Freddie. But what I would note is that OFHEO 

in its current actions, and I will put back on that hat, is looking 

to see what we can do to share information within the parameters 

of the law that would not raise liability for the enterprise. That is 

what I mentioned in my testimony that my office is looking into 

right now. So we are trying to see if the very concerns that are 

there can be alleviated through practices or procedures by the regulator as opposed to the company. 

25

Mr. CLEAVER. Thank you, Mr. Pollard. 

Thank you, Madam Chair. 

Mrs. KELLY. Thank you very much. 

Mr. Baker? 

Mr. BAKER. Thank you, Madam Chair. 

I just had one quick question to Mr. Pollard, in the light of the 

Inspector’s comments. In your capacity as general counsel for 

OFHEO, do you view the matters relating to these circumstances 

now to be a closed case from your perspective? 

Mr. POLLARD. No, sir. 

Mr. BAKER. Great. And other than the revisions to the Bank Secrecy Act which you have just spoken to, are there other factors in 

statute which you think should be addressed in the current GSE 

regulatory reform act? 

Mr. POLLARD. Our director has endorsed those legislative 

changes that you have put in, Mr. Chairman. I think in terms of 

other matters for us, I have in my written testimony something 

that goes a little beyond our jurisdiction, but I would simply mention that there may be additional items that will help the U.S. Attorney and the Justice Department. Of course, their expertise is 

what is important here, not mine. 

Right now, the banks have a wide panoply of provisions that facilitate pursuit of those fraudulent parties. I think our goal, as 

someone said, I forget which, one of the committee members said 

or someone, is will people just move. There is always going to be 

fraud, but we need them to move, move out of any enterprises. I 

believe some of those provisions on Bank Fraud Act Section 311, 

some of the ones on fraudulent transactions in mortgages that 

HUD has, for example, that if you engage in fraudulent transactions with them, that is a crime. That would be helpful. 

I want to be very cautious, Mr. Chairman. I would say that is 

sort of my opinion today, that it should be looked into. Your expertise and the Justice Department would be the critical players to 

me. 

Mr. BAKER. I understand, you cannot enforce someone else’s 

rules and regulations, whether it is Section 404 of the SEC Act, if 

it is the Department of Justice. 

Mr. POLLARD. But we can sanction violations of those acts, however, if they occur. We have a proposed rule on corporate governance that will incorporate by reference provisions of the SarbanesOxley law. I was asked why, and I said, to make very clear that 

once the SEC should determine this type of violation, that we too 

will have sanctions, and more importantly, we too will seek remedial steps within the enterprise, not merely to sanction them to penalize them. The SEC might do that. We also look to structural 

changes. 

Mr. BAKER. I will formally follow up with a specific set of facts 

which I hope that your good office will examine and at the appropriate time report back. 

Madam Chair, did you wish me to yield to you? 

Mrs. KELLY. Mr. Chairman, you are out of time. 

Mr. BAKER. Thank you. 

Mrs. KELLY. Thank you. 

We turn to Ms. Maloney. 

26

Mrs. MALONEY. Thank you. 

Mr. Pollard, I am interested in your proposed rule on mortgage 

fraud. Can you explain how you plan to handle the information you 

receive from the GSEs under that proposed rule? 

Mr. POLLARD. First, we will be working with them in terms of 

the actual implementation of the rule, trying to develop both the 

information systems, the forms, the instructions which are very important in these cases, telling people what you want, and to be candid, what you do not want, letting them know that people’s names 

may have to be taken off at a certain point, ensuring that the information goes to elements of suspicious activities and the information 

received is in such a manner that may be useful to law enforcement. 

So all of that needs to be worked out. I think we are benefited 

by what has already taken place in the Bank Secrecy Act and with 

FinCEN, some of the lessons they have learned, the difficulties 

they have faced. Coming from the banking industry myself, at one 

point having viewed their side of it, I think we can work with them 

and with law enforcement to come up with a management of information that will run very smoothly. 

Mrs. MALONEY. And how will you coordinate that information 

with that which you currently receive through the SARs mechanism? 

Mr. POLLARD. We will not have a SARs. We will develop our own 

form. With the help of some of the folks I mentioned before you 

came in, Ms. Maloney, relating to the law enforcement personnel. 

We hope to develop a form that will be very useful to everyone, including enterprises in the long run. 

What I would note is our rule includes a provision that should 

another agency, Treasury or someone else, or the Congress passes 

Bank Secrecy Act reforms that requires another form, OFHEO will 

look at that form, and if it works we will accept that form. 

Mrs. MALONEY. Do you believe that the procedures that Fannie 

has put in place internally will be more effective in detecting mortgage fraud in the future? 

Mr. POLLARD. I would have to tell you that right now that is 

under our examination staff. We are reviewing them to determine 

if, first, they have fixed the problems of the past, and second, 

whether they should be enhanced. So I would not want to give you 

an answer to that today. 

Mrs. MALONEY. Okay. Also, representing OFHEO, given the facts 

that were available at the time of this investigation with Beneficial, do you believe that Fannie Mae should have concluded that 

First Beneficial was engaged in deliberate fraud, and should that 

suspicion have been reported to you? 

Mr. POLLARD. I think our major concerns were, in learning of 

this, was first, what were Fannie Mae’s decisions about what constituted fraud or suspicious activities. I have heard a lot about ineligible loans. If you are passing all of your transactions through 

a sieve of is it ineligible under our standards, and not also passing 

them through is there suspicious activity, then they may not have 

considered them suspicious. 

In terms of reporting to us, we had a rather informal system of 

expecting major items to be reported to us. We are still invesVerDate 0ct 09 2002 16:16 Oct 07, 2005 Jkt 000000 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 G:\DOCS\23734.TXT FIN1 PsN: MICAH
27

tigating whether, and as Mr. Smith admitted, the regional office 

was so isolated and decentralized that they would have not reported to the Washington office, the headquarters, with whom we 

normally deal. So I guess my answer to your question is we are 

still investigating to get a solid answer to that. 

Mrs. MALONEY. Okay. Who is representing Ginnie Mae? Anybody? Okay. 

Did the North Carolina authorities that contacted Fannie also 

contact you about their concerns? 

Mr. KENNEDY. No, not at that time. 

Mrs. MALONEY. They did not contact you? 

Mr. KENNEDY. Not at the time that the case first was initiated. 

Mrs. MALONEY. Okay. And what new procedures have you put in 

place to prevent the purchase of fraudulent loans, to prevent this 

happening in the future? 

Mr. KENNEDY. Almost immediately after the case was referred to 

the U.S. Attorney’s office in North Carolina, Ginnie Mae instituted 

an expedited process whereby instead of waiting, the previous policy that required a look at an issue within a year to see whether 

or not the documents were in the file, Ginnie Mae what we call a 

profile. The profile looked at each and every Ginnie Mae issuer to 

determine whether or not that issuer was within the normal 

ranges. For example, on the issue of mortgage insurance, the normal range is that after a period of time it was roughly 95 percent. 

Based on that kind of a review, this kind of fraud could not be repeated. 

Going back to the question of our involvement with bank examiners, if we ever receive a call that indicates that there is a potential criminal case, all Federal employees are under an obligation, 

under an executive order that I think was signed in 1990, that requires us to report that information to the investigation authority 

within HUD, which is the IG. In this case, that was done immediately, literally I think I got a call concerning the matter in New 

York, and within an hour I walked down to the IG one floor away 

and reported the information that I had gotten concerning the matter in New York, which had the appearance to me of a potential 

fraud. Potential, I did not know. 

It is not my job to investigate that, but it is my job to report that. 

That leads to investigations which then permits the agency at the 

end of the investigation, at the end of the criminal process, to initiate administrative sanctions under existing rules, under a statute 

passed by this Congress called the mortgagee review board that 

permits us to discipline lenders who violate the law or who violate 

the requirements of HUD. 

Mrs. KELLY. Thank you very much, Ms. Maloney. Your time is 

up. 

Mr. Davis? 

Mr. DAVIS OF KENTUCKY. Thank you, Madam Chair. 

I have a question for the Inspector General. Just considering the 

magnitude of fraud that seems to be getting rooted out through 

various GSEs, hearing this is very disturbing to me. I was curious 

if you could share with the panel the loss to the American taxpayer 

in dollars. 

Mr. DONOHUE. In regard to this matter, sir? 

28

Mr. DAVIS OF KENTUCKY. Yes. 

Mr. DONOHUE. Yes. The stated amount I believe is $32 million 

in total losses, calculated by Ginnie Mae in this matter. 

Mr. DAVIS OF KENTUCKY. How much of that has actually been recovered? 

Mr. DONOHUE. The forfeiture action is $7.5 million, and a number of forfeiture seizures against the defendants in this case total 

$15 million in recovery. 

Mr. DAVIS OF KENTUCKY. Do you anticipate more to be recovered? 

Mr. DONOHUE. No comment, sir. 

Mr. DAVIS OF KENTUCKY. Okay. Thank you. 

I yield back. 

Mrs. KELLY. Thank you, Mr. Davis. 

Mr. Pollard, in your statement on the very last page of your testimony for us today, you indicate that you were looking at Fannie 

Mae’s operations to examine whether or not they were excessively 

decentralized and uncontrolled, lacked adequate reporting and 

quality control, failed to distinguish functions between business development and problem workouts, and generally did not hold regional offices sufficiently accountable, that they did not take effective action to remedy deficiencies that they discovered, or to act in 

a timely manner to end their relationship with entities. 

I would like you to elaborate on what you found if you can go 

beyond just those words. 

Mr. POLLARD. I really have to leave it at that point based on my 

job and what the examiners do at our agency. What I would tell 

you is these subjects and some that have been provided to the committee in the letters from Fannie Mae and even in Mr. Smith’s 

statement today, we are trying to go a bit deeper, a bit further in 

the operational side. For example, one of the things we mentioned 

today is whether individuals who are in charge of making loans or 

making business arrangements in this case are also the same ones 

who are supposed to fix them. In the banking industry, if you make 

a loan and it does not go well, that is okay, but you have a workout 

team that takes it up and tries to clean it up and maybe recover 

some of the money. They have additional obligations. 

So if you would bear with me today, I would simply say that I 

feel our exam, these are the topics that we are looking into, but 

since that is ongoing and we are interviewing people, I have to 

leave it at that point today. 

Mrs. KELLY. I would hope that you would get back to this committee when you discover an end-point in your investigations. 

OFHEO recently entered into an agreement with the Fannie Mae 

board of directors, and then the board I believe agreed to make significant improvements to the internal controls of the company. Is 

the activity that has been discussed before the committee this 

morning representative of the lack of internal controls that OFHEO 

has found? 

Mr. POLLARD. First, I may comment that we have directed the 

board not only to undertake fixing internal controls, but to get outside help along with whatever help OFHEO will afford in this instance. So while we are looking at it ourselves, they do have additional parties. Our focus was on accounting. It is quite clear that 

29

controls of a general nature may affect what was going on in accounting. So we have, yes, identified all controls. Is this another example, a decentralization, a lack of control, even a lack of support 

for regional offices, as well as a lack of quality control emblematic 

of that? Yes, I believe so. 

Mrs. KELLY. Does anyone on this panel know, Mr. Smith, Mr. 

Donohue, Mr. Pollard, Mr. Kennedy, can you tell me whether or 

not Fannie Mae still is, among its 40 goals as Mr. Smith testified 

his bonus was tied to, is that still one of the 40 goals of Fannie 

Mae, making sure that Fannie Mae does well so that they get more 

money as a bonus? 

I will take an answer from anyone. 

Mr. POLLARD. I will answer in saying that it is a subject of our 

investigation, the level, is there a tie. But additionally, if an individual, as I said, is incented to make loans and to work them out, 

that may have a perverse incentive, without being specific that you 

should not have bad loans. It simply creates a situation where the 

two are sort of impossible to untangle. So we will be looking at 

compensation in this particular matter, and again that is the topic 

heading that we are following right now. 

Mrs. KELLY. Thank you. 

Anyone want to add to that? 

Mr. SMITH. Well, certainly at Fannie Mae from my aspect, it is 

an important part of my job to ensure that we properly manage 

Fannie Mae’s credit losses. The repurchase of ineligible loans is 

just a small piece of that. We also for any loan that goes toward 

foreclosure, goes seriously delinquent, we put forth great effort to 

work with the individual homeowner in loss mitigation efforts so 

that not only does Fannie Mae not have to take over the REO and 

sell the property and displace the homeowner, but we actively try 

to find a way to keep the homeowner in the property. 

So I would say that in reaction to your question, managing credit 

losses is a very important part of what Fannie Mae is focused on. 

Mrs. KELLY. Okay. I have a question for you, Mr. Kennedy, I am 

a little curious about. Why was Ginnie Mae purchasing conventional loans? That is not really their normal course of business, is 

it? How did this happen? 

Mr. KENNEDY. No. The loans in question were not viewed by 

Ginnie Mae as being conventional loans. There were fraudulent 

certifications in paperwork submitted to Ginnie Mae indicating 

that the loans were in fact FHA-insured. As I indicated earlier, 

both the principal in First Beneficial, James McLean, and for example the auditor, they had misled, they had falsified the documents. They had submitted false certification and information to 

Ginnie Mae. Ginnie Mae was under the impression at that time, 

based on the information that was available, that they were in fact 

FHA loans. 

When the scheduled audit that Ginnie Mae scheduled with them 

was commenced in August of 2000, very quickly it became clear 

that there was a fraudulent situation here and immediate action 

was taken on the part of Ginnie Mae to correct that and to default 

the issuer for the very reason that the loans were not in fact FHAinsured. They have to be under the law to be in the Ginnie Mae 

pool. 

30

Mrs. KELLY. Thank you. 

I have one final question for you, Mr. Pollard. With regard to 

your proposed rule, will Fannie and Freddie be obligated to inform 

law enforcement agencies or other governmental organizations 

when fraud is discovered? Or is this just going to be a mere notice? 

Will there be a rational reason for the law enforcement people to 

follow up? 

Mr. POLLARD. First, the rule does not provide for that. However, 

we are looking and working through what will be required in the 

instructions and to whom notice should be provided. First will be 

providing notice to us. As I mentioned, we are looking at what we 

can do to smoothly and at the same time afford protections to the 

enterprises and transfer that information. But we believe that 

when a fraud has been identified, there should be no inhibition on 

going to a state, federal, almost anybody you can contact in law enforcement and tell them there is a fraud. 

In this area of suspicious activities, that makes it a bit difficult, 

but again I believe that we will work through to some processes 

that may make that more doable. That is the best I can tell you 

at this time. 

Mrs. KELLY. I thank you. 

I think that what has occurred here this morning has been very 

interesting. I hope it makes a very clear statement that we in Congress expect the people who are operating government-secured enterprises to have a moral and ethical obligation to the people of the 

United States not to defraud them and to root out fraud wherever 

there is a possibility of it. I think it is very clear. 

I thank all of you very much for your indulgence, for being here 

for such a long period of time. This has been an interesting hearing. The Chair notes that some members may have additional 

questions for the panel. They may wish to submit those questions 

in writing, so without objection the record will remain open for 30 

days for members to submit written questions to these witnesses 

and to place their responses in the record. 

With that, this hearing is adjourned. Thank you very much. 

[Whereupon, at 12:13 p.m., the subcommittee was adjourned.] 

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A P P E N D I X

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