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SEC Tells Fannie Mae To Restate Earnings

Accounting Practices Faulted; $9 Billion Loss Could Result

By David S. Hilzenrath and Carrie Johnson
Washington Post Staff Writers
Thursday, December 16, 2004; Page A01

The Securities and Exchange Commission's top accountant last night told mortgage funding giant Fannie Mae that it should correct its past accounting, a directive that could erase 38 percent of the profit the government-sponsored company has claimed since the beginning of 2001.

Fannie said last month that if it was required to make such a correction, it might have to record $9 billion of previously unreported losses.

_____In Today's Post_____
Fannie Took the Shortcut (The Washington Post, Dec 16, 2004)
_____Related Coverage_____
Lawmakers Ask Fannie To Explain Tainted Funds (The Washington Post, Dec 2, 2004)
Fannie Must Forfeit $6.5 Million (The Washington Post, Dec 1, 2004)
Fannie Supports New Regulator, But Wants a Say (The Washington Post, Nov 26, 2004)
Ohio Sues Fannie Mae, Alleges Securities Fraud (The Washington Post, Nov 20, 2004)
Fannie Mae Misses SEC Filing Deadline (The Washington Post, Nov 16, 2004)
Fannie's Issues: Simple or Not? (The Washington Post, Oct 23, 2004)
_____Background_____
Timeline: Fannie Mae (washingtonpost.com, Oct 8, 2004)

"Fannie Mae's accounting did not comply in material respects" with two major accounting rules, the SEC's chief accountant, Donald T. Nicolaisen, said in a written statement. Instead of following requirements, "Fannie Mae internally developed its own unique methodology," Nicolaisen said.

Nicolaisen's statement was a powerful rebuke to District-based Fannie Mae, which had appealed to the SEC after another agency accused it of manipulating accounting estimates to achieve desired financial results and deliberately violating other accounting requirements to make its earnings smoother.

Fannie Mae spokesman Charles V. Greener said in a statement that the company "will take the steps necessary to comply fully with the SEC's determination." He said the action would leave Fannie Mae with less capital than it is required to hold in reserve against a financial downturn. "The determination made by the SEC will have a negative impact on our minimum capital position, and we are committed to taking the steps necessary to comply with our minimum capital requirement."

Nicolaisen said Fannie Mae did not meet the requirements for "hedge accounting," which allows companies under stringent conditions to exclude from reported earnings changes in the value of financial instruments known as derivatives. Fannie has argued that the rule was misguided.

The total size of the potential hedge accounting correction Fannie Mae warned of last month was $18 billion -- $13.5 billion of previously unreported losses and $4.5 billion of previously unreported gains, which would net a $9 billion reduction in past earnings.

"It's the kind of thing that shakes your confidence in financial statements," said Charles W. Mulford, an accounting professor at the Georgia Institute of Technology.

Rep. Michael G. Oxley (R-Ohio), chairman of the House Financial Services Committee, said in a statement, "I am deeply disturbed that investors, the markets, and Congress were misled by deceptive practices at Fannie Mae." He said he intends to hold hearings early next year.

Fannie's accounting remains the subject of a criminal investigation by the Justice Department, a civil investigation by the SEC's enforcement division, class-action lawsuits by shareholders, and an outside review commissioned by Fannie's board.

Defending the company at a House hearing in October, chairman and chief executive Franklin D. Raines said the accounting rules at issue "are highly complex and require determinations over which experts often disagree." Fannie "intended to do the right thing and we took care to do the right thing," said Raines, who headed the Office of Management and Budget in the Clinton administration.

But the director of the Office of Federal Housing Enterprise Oversight, which had spent months scrutinizing Fannie's accounting and produced a scathing 198-page report in September, called the company's violations "pervasive and willful."

"It's not a matter where they made a good-faith effort to try to comply with the rules," OFHEO Director Armando Falcon Jr. told lawmakers. "They did not comply with rules that they clearly understood."

OFHEO alleged that, in one instance in 1998, Fannie delayed booking $200 million of expenses, enabling top executives to receive millions of dollars of bonuses.

The SEC official's assessment was a vindication of OFHEO, which, according to comments by its deputy director in a recent report by the inspector general of the Department of Housing and Urban Development, was humiliated last year when Fannie's rival, Freddie Mac, admitted that its financial reports contained billions of dollars of accounting errors and distortions. OFHEO had given Freddie Mac's auditing and internal controls a favorable review shortly before Freddie disclosed that it had problems.

The scandal at Freddie prompted OFHEO to take a closer look at Fannie Mae, with help from the accounting firm Deloitte & Touche LLP. During the scandal at Freddie, Raines vehemently denied that Fannie had similar problems and complained that Fannie was being tarred with the same brush.

Fannie's allies on Capitol Hill have accused OFHEO of pursuing its examination of Fannie in an overzealous and abusive manner.

Raines reminded members of Congress at the October hearing that he had certified the company's financial statements.

Under a law passed in the aftermath of the accounting scandal at Enron Corp., if a company corrects its past financial reports, its chief executive and chief financial officer can be required to give up bonuses, stock gains and other compensation tied to the false financial reports.

Chartered by the government in the 1930s, Fannie Mae plays a behind-the-scenes role in the mortgage business. It borrows money from investors by issuing bonds and purchases mortgages from lenders, giving them cash to make more loans. It also packages mortgages into securities that can be sold to investors.

Freddie Mac, which disclosed its problems in early 2003, has yet to resume issuing quarterly financial reports on a timely basis and has spent hundreds of millions of dollars on the clean up.

Federal Reserve Chairman Alan Greenspan and other government officials have called for tighter restraints on Fannie and Freddie, saying that, if left unchecked, they could expose the government to a potential bailout.

The SEC issued its statement as Fannie Mae employees were attending a company holiday party.


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