Speech by SEC Staff:
Statement regarding Fannie Mae

by

Linda Chatman Thomsen

Director, Division of Enforcement
U.S. Securities and Exchange Commission

Washington, DC
May 23, 2006

Good afternoon.

Thank you Mr. Chairman. I'd like to spend just a moment outlining for you some of the high points behind the settlement reached with Fannie Mae.

As the Chairman emphasized, the internal controls at Fannie Mae were wholly inadequate for the complexity and sophistication of Fannie Mae's business. Without sufficient controls in place, the numerous departures from generally accepted accounting principles, GAAP, became commonplace. The consequence here will be one of the largest restatements in this country's history.

The Commission's complaint seeking a permanent injunction against Fannie Mae describes in some detail the accounting fraud found that occurred at the company. It shows how two of the most important accounting principles critical to Fannie Mae's business — accounting for nonrefundable fees and costs associated with loans, known as SFAS 91, and accounting for derivative instruments and hedge activities, known as SFAS 133 — were violated. The complaint also describes the many errors in Fannie Mae's books and records.

The Commission's complaint describes conduct from at least 1998 through the second quarter of 2004, during which Fannie Mae issued financial reports that were materially false and misleading, primarily due to its failure to comply with the two accounting rules I've just mentioned.

Let me give you a few quick examples of the kind of conduct we describe in the complaint:

At the end of 1998, senior management manipulated earnings in order to obtain the highest available bonus payout. Senior management of the company determined that certain expenses would not be booked even though GAAP required they be recorded. At the same time, senior management engaged in a series of additional inappropriate adjustments to the company's income statement so that the company hit the EPS target necessary to trigger maximum bonuses.

In addition, after SFAS 133, the hedge accounting rule, took effect, Fannie Mae did not have the systems or personnel adequate to comply with its provisions, in particular, with what is called, long-haul accounting. Moreover, if Fannie Mae had used the long-haul method, it would have resulted in the income statement volatility that senior management wanted to avoid. Fannie Mae also sought, without any basis in the accounting literature, to fit the vast majority of its transactions into a hedge accounting exception, even though the transactions simply did not qualify for such treatment under GAAP.

Now, it is fair to ask why Fannie Mae engaged in such conduct. And the answer is that this fraud was driven by senior management's desire to show stable earnings growth, and reduced income statement volatility.

None of these objectives are unlawful by themselves, but when they overshadow compliance with the requirements of GAAP, the law is broken and investors lose. While we can all acknowledge the complexity of certain accounting rules, including hedge accounting, it is important to keep two things in mind. One, complexity cannot be an excuse for non-compliance with the rules, and two, and perhaps more important, this was a situation in which senior management stressed stable earnings growth without also stressing the need for GAAP compliance and ensuring that sufficient accounting systems and personnel were in place to provide proper accounting treatment. That culture contributed to and provided the backdrop for much of the GAAP departures evident at the company.

Let me conclude by taking note of the extraordinary work done by our staff on this investigation. Our team includes, Peter H. Bresnan, Paul R. Berger, Richard W. Grime, Jordan A. Thomas, Charles E. Cain, Margaret S. McGuire, Rachel E. Schwartz, Bryan J. Sillaman, Susan Markel, Peter Rossario, and Steven Richards.

http://www.sec.gov/news/speech/2006/spch052306lct.htm