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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.

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Fannie And The SEC

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	5/24/2006 7:07 AM
Yesterday, the Fannie Mae report was issued by the Office of Federal Housing Enterprise Oversight. At 348 pages, it's going to have to wait a while to be read. (Like I said in previous post - king-sized Accounting Observer piece is in the works.) A quick grasp of the accounting importance in the report can be found in the SEC lawsuit charging Fannie managers with fraudulent accounting: "... the Commission alleged that Fannie Mae failed to comply with the accounting requirements of Statement of Accounting Standards (SFAS) 91, which requires companies to recognize loan fees, premiums and discounts as an adjustment over the life of the applicable loans. In the fourth quarter of 1998, by not recording the full adjustment required by SFAS 91, Fannie Mae understated its expenses and overstated its income by a pre-tax amount of $199 million. Management's decision to book an amount significantly less than the adjustment amount required by SFAS 91 resulted in the company not only exceeding Wall Street expectations, but also hitting the earnings per share target necessary to trigger maximum bonuses. In the periods that followed, Fannie Mae made other departures from SFAS 91, including the implementation of a SFAS 91 Policy in 2000. Fannie Mae's SFAS 91 Policy used a "precision threshold" to determine the SFAS 91 adjustment amount the company would record. There is no support for the use of a threshold in SFAS 91. Implementation of the Policy led to misstatements of SFAS 91 amortization in all periods from the fourth quarter of 2000 through the second quarter of 2004. The Commission alleges that, on at least one occasion, Fannie Mae booked income when it was within its own Policy threshold, with the effect of meeting its earnings targets. The Commission's Complaint also alleges that Fannie Mae failed to comply with the accounting requirements of SFAS 133, which governs the accounting for derivative instruments and hedging activities. Fannie Mae disregarded the requirements of SFAS 133 and qualified transactions for certain hedge accounting treatment based on erroneous interpretations and an unjustified reliance on materiality. By failing to comply with the requirements of SFAS 133, the company failed to qualify for hedge accounting. This failure led to the company issuing materially false and misleading financial statements for the periods covering the first quarter of 2001 through the second quarter of 2004. The vast majority of the anticipated restatement of at least an $11 billion reduction of previously reported net income is a result of Fannie Mae's improper hedge accounting.Ã¢â‚¬Â There were other accounting transgressions mentioned in the suit, but these were the main issues. You can bet that the SEC learned a lot about the "practical application" by registrants of SFAS 91 and SFAS 133 during the study of Fannie's accounting. Maybe it wouldn't be a bad idea to take a break from the options backdating thrash to see which companies in your portfolio include SFAS 91 and SFAS 133 as part of their critical accounting policies. It might become more critical in the months ahead.

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