WASHINGTON — Fannie Mae selected a chief internal auditor with an "inherent conflict of interest" and the mortgage giant's process for filling the position was faulty, according to a watchdog report to be released Wednesday.

The report by the Federal Housing Finance Agency's inspector general said Fannie's chief executive and audit committee chair neglected to plan ahead to find a successor for the previous auditor, who had shifted to a new role at the mortgage giant. Then, after Fannie executives said no internal candidate was ready to take the position, the company chose to promote government-sponsored enterprise's chief credit officer in the single-family division to become chief auditor.

The watchdog said the promotion appeared to violate internal auditing practices for federal agencies because of his prior role in the single-family business. (The report does not name the auditor, but the description appears to fit that of Fannie's current chief auditing executive, John Forlines.)

The inspector general's report, which called the hiring process "haphazard, at best," said the FHFA approved the selection even though officials with Fannie's regulator had concerns.

"Several senior FHFA officials questioned the robustness of the hiring process among themselves but elected not to discuss those deficiencies with the Audit Committee after being informed of its selection or with the Fannie Mae Board before it approved the selection," the report said. "One senior FHFA official reported to us that he flagged concerns about the conflicts that the CCO would bring to the CAE position, but nothing in the record indicates that these concerns were raised directly with FHFA's then-Acting Director."

The report said officials did not adequately scrutinize the hiring even though doubts had been raised about the candidate's qualifications and objectivity. Internal FHFA emails show that concerns were raised about the new auditor's lack of auditing experience and the quick search process, but officials did not act to stop the hiring.

After the new chief auditor began the job, the FHFA pressed Fannie to assess the risks from any conflict of interest and to describe how it would manage those risks. But the company failed to respond adequately, the inspector general said. The regulator then sought an external review by an outside firm. The IG said the FHFA was unable to force Fannie to sufficiently manage the conflicts.

"FHFA's failure to insist that Fannie Mae thoroughly assess the scope of the CAE's conflicts and develop an adequate plan to manage those conflicts immediately upon the CAE's appointment meant that internal audit's independence and objectivity was called into question for a significant period of time," the report said.

The report said hired candidate did have some experience as an auditor prior to his work in Fannie Mae's single family credit division. He had worked with the GSE as an internal auditor for four years and prior to that as an auditor for a bank, which was acquired by BB&T. But that experience encompassed only half of the 15 years of auditing experience sought by the company's audit committee in the job description, the IG said.

A candidate was chosen by Fannie's audit committee despite there being no formal record of the committee meeting in person or by phone to discuss him or the other candidates, according to the watchdog.

The IG issued a whole host of recommendations, including that the FHFA director be kept better informed of issues and concerns raised by staff, discussions of Fannie's audit committee be better documented, the GSE's regulator evaluate the effectiveness of the audit committee and that there be a regular rotation of members on the audit committee.

In a response to the report, the FHFA said it agreed with the IG's findings and recommendations.

The "recommendations will help FHFA to ensure that it continues to improve the controls in place on issues of corporate governance," officials from the agency wrote in a March 7 letter.

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