Summerford tracks ‘footsteps of the Beast’ in economic woes

Ralph Summerford A key element in detecting fraud is finding accounting anomalies – transactions that just don‘t make sense – forensic accountant Ralph Summerford told the chamber breakfast crowd of nearly 200 last week. Those anomalies constitute the “footsteps of the Beast,” and are not always difficult to find, he said. “The Beast” is Summerford’s figurative image for fraud.

The greatest incidence of accounting fraud is in companies with fewer than 100 employees, but it extends to some of the largest corporations in the country, he said. Scandals at Enron, Worldcomm, and HealthSouth in recent years are among those that helped establish the field of forensic accounting, of which he has become a leading practitioner.

“Everybody in business should be constantly looking for the Beast,” he said.

Without attributing the economic meltdown of the last two years to fraud as a major cause, Summerford said both greed and fraud have been conspicuous aspects of events involved in the subprime mortgage crisis and its subsequent consequences.

That crisis first became apparent in 2007, with widespread awareness and economic fallout beginning in 2008. It was an event triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, when real estate values began to decline nationally in the beginning in 2006. The result was a dramatic downturn that reverberated throughout the economic system, both domestically and globally.

Summerford traced its roots to lending practices that became widespread in the 1990s, exemplified by the Federal National Mortgage Association – known as Fannie Mae – and the Federal Home Loan Mortgage Corporation – Freddie Mac. Both were government-sponsored enterprises (GSEs), according to Summerford, that operated in an on-going conflict of interest from the time of their inception, since they were supported by both government funds and private stock ownership.

The mission for both agencies was defined as keeping interest rates low for home ownership and increasing support for affordable housing. Increasingly throughout the mortgage financing industry, loans were made to borrowers who had no realistic chance repaying them, due to lack of adequate income and assets. When real estate values declined, borrowers in some cases were left with the amount of their outstanding loans exceeding the market value of their property. The resulting flood of foreclosures, which continues, triggered the meltdown throughout the financial system.

Management of the GSEs was characterized by exorbitant executive compenby sation, with David Maxwell, Fannie Mae chief executive officer who retired in 1991 given a severance package of $27.5 million. His successor, James A. Johnson, was paid $6 million to $7 million annually until his retirement amid hints of scandal in 1998. By contrast, the postmaster of the United States, with 700,000 employees and a budget of $65 million annually, was paid an annual salary of only $170,000, Summerford said.

The next CEO, Franklin Raines, tied executive compensation at the agency to earnings per share. He earned $90 million in compensation over the period 1998- 2003. During an accounting fraud investigation in 2003, nine Fannie Mae executives were found to have been paid more that $3 million in annual compensation. During the same period, the agency was found to have fraudulently overstated its income by some $6 billion.

Summarizing the outcome, Summerford said the scandal cost over $1 billion to investigate, Raines received $1.38 million annually in retirement pay, and Fannie Mae was fined $400 million. As part of the settlement, it was agreed there would be no prosecution for wrongdoing. In addition, Summerford said the agency paid $175 million in lobbying fees to fight the government regulation that should have addressed the abuses entrenched in the agencies’ operations.

Summerford said many of the problems throughout the financial system can be traced to deregulation or to the failure of regulatory procedures that should have detected and prevented the worst abuses.

“The Securities and Exchange Commission allowed banks to regulate themselves. That doesn’t work. People left to their own devices work for their own benefit, and that’s what happened,” Summerford said.

“Executives can’t face their own mistakes,” Summerford said to explain the magnitude of many cases of fraud. “They cook the books once to cover up mistakes from their shareowners. It works once, so they do it again and again,” he said.

Speaking after the meeting about forensic accounting as a career field for graduating high school seniors, Summerford said it’s not a common specialty but that there are excellent college accounting programs with concentrations in forensic accounting in the region. He said the University of Alabama at Birmingham has an outstanding forensic accounting concentration. He also identified the University of North Alabama and Georgia Southern University as leading schools for forensic accounting.

Summerford is president of Forensic Strategic Solutions PC of Birmingham. He is a 1964 graduate of Oneonta High School.