Skip to main content

For more than five years, the SEC has been attempting to conceal the fact that its original accusations against Fannie Mae--that it committed "accounting fraud'--had no merit.

Remember when the SEC accused Fannie Mae of participating in a massive accounting fraud, involving violations of  the financial accounting standard for hedges and derivatives? Well, as it turns out, the SEC repudiated that position, for obvious reasons.  

In fact, scores of other large companies, and every major accounting firm, had been applying the relevant accounting standard, FAS 133, in precisely the same manner. Everyone else, like Fannie and its management, believed that they had been acting in good faith.

All the top accounting experts contended that Fannie's interpretation of the rule was correct. So PriceWaterhouse Coopers, Ernst & Young, KPMG, and Deloitte & Touche all got together and collaborated on a white paper concerning the application of FAS 133, which they then presented to the chief accountant of the SEC.  The white paper showed examples of how FAS 133 was being properly applied, in precisely the same manner used by Fannie Mae. In 2007, about a year after the agency filed a lawsuit accusing Fannie of committing an accounting fraud to the tune of $11 billion, the SEC said that it agreed with the interpretations of the four large accounting firms. As noted before, that $11 billion mark-to-market loss had always been fully disclosed, contrary to what  SEC alleged to Judge Reggie Walton.  

This embarrassing reversal may explain why the SEC refused to allow its former chief accountant, Donald Nicolaisen, to testify in a private class action lawsuit alleging instances of accounting fraud that mirrored the charges brought by the SEC and Fannie's regulator, the Office of Federal Housing Enterprise Oversight, or OFHEO.   In December 2004, Nicolaisen asserted, on behalf of the SEC, that Fannie's interpretation of FAS 133 could not be deemed acceptable by any professional accountant, and insisted that Fannie restate its earnings.  

Here's what The Wall Street Journal reported  eight years ago:

[Fannie CEO Franklin] Raines took issue with the accounting rule for derivatives, known as FAS 133, at the center of the controversy.

"Many companies can and do comply with the rules," Donald Nicolaisen, the SEC's chief accountant, shot back, according to two participants. "Sir, hedge accounting is a privilege, not a right," he continued. "[It] is applied only under strict circumstances, and you did not comply."

Mr. Raines seemed shocked, participants say. He then asked how far off Fannie's books had been in relation to FAS 133. In response, according to one participant, Mr. Nicolaisen held up a sheet of paper and told Mr. Raines that if it represented the four corners of the rule, "you were not even on the page."

That, "not even on the page," soundbite went viral, like George Tenet's supposed "slam dunk," explanation of Iraq's WMD.

But when compelled to testify, under an order handed down by Judge Richard Leon, Nicolaisen reversed himself with a standard, "perhaps I misspoke"  disclaimer. His stated excuse, which, strains credulity, was that he didn't realize that so many  others interpreted the standard differently from the way he did.

KPMG's lawyer, Scott Fink of  Gibson, Dunn & Crutcher, laid it all out in front of Judge Leon back on June 5, 2012. His singular objective was to demonstrate that the defendants had no intent to deceive anyone. The disconnect--between the SEC's original accusations against Fannie Mae and its current position on FAS 133--wasn't really relevant, which is why he glossed over the agency's lack of candor. Fink explained:

There was confusion out in the profession about this whole question [about interpreting FAS 133] that Fannie Mae faced and the SEC chief accountant, not Mr. Nicolaisen but the new SEC chief accountant three years later said I would like a white paper from the accounting profession to talk about this issue....

So we asked the big four, of which KPMG is one, to write a white paper and they did.   All the big four signed it. PriceWaterhouse Coopers, Ernst & Young, KPMG and Deloitte & Touche, which was Fannie Mae's auditor.   They signed.  And  this white paper gave examples and it said here are different ways you could interpret this language and we are going to tell  you, Mr. Chief Accountant, that this would be a reasonable interpretation the way Fannie Mae did it, or, you know, the way the SEC chief accountant originally did it, that would also be a reasonable interpretation.   It is not that one is black and the other is white and one is right or one is wrong.   It is just that both of them are reasonable.   You just need to decide and tell people basically so they know what to do.

And they put in examples and some of the examples were very much like what Fannie Mae was doing.

So the SEC came out with this interpretation in 2007. They read the white paper and they said the interpretation that Fannie Mae was using all along was acceptable.   It was okay.   They weren't saying the other one wa wrong. They were just saying this one was also okay. If people are out there doing it, it is okay.

The words of FAS 133 hadn't changed, but the SEC's interpretation of FAS 133 had evolved.   There had been confusion.  People had come in and said are you sure this doesn't work? And the   SEC said, you  know, on reflection those words are susceptible to that interpretation.

That cannot have been fraud in 2001 for somebody to read those words and say, you know, I think this is what it means; and the SEC ultimately said, yeah, gee, I am a little bit Plaintiffs stand up usually with great drama and they talk about how Mr. Nicolaisen said the accounting was not even on the page. They want the Court to believe that what Mr. Nicolaisen meant by that was that it was crazy, it was an extremely ridiculous interpretation.

Now, even if he had that opinion in 2004, we still win because we have shown through objective evidence that reasonable people disagreed about this including that the SEC changed its mind, but that was not his opinion; and I don't want to leave you with the impression that it was his opinion.   This is what he said when the Plaintiffs asked him about it at his deposition.

   (Whereupon, the videotape was played.)

MR. FINK:  And he was asked also by the Plaintiffs what he meant when he said in 2004 that Fannie Mae's interpretation was outside of professional standards.   Let's hear what he had to say.

   (Whereupon, the videotape was played.)

MR. FINK:  It was his professional judgment, it was an opinion, and, oh, by the way, a lot of other people concluded otherwise. He also admitted that at the time he didn't realize  just how many people didn't interpret FAS 133 the same way that he did. "Even I was surprised by the number of companies that  after the Fannie Mae restatement actually restated for 133."

So rather than supporting the Plaintiffs' position Mr. Nicolaisen's testimony completely proves Defendants' point. He acknowledged that other people in the profession didn't interpret 133 the way he did. He didn't label them fraudsters.

He didn't label them extremists.  The Nicolaisen remark helps the Plaintiffs prove scienter [i.e. fraudulent state of mind] not one bit.  

Nicolaisen's testimony is kept under seal by order of Judge Leon.
EMAIL TO A FRIEND X
Your Email has been sent.
You must add at least one tag to this diary before publishing it.

Add keywords that describe this diary. Separate multiple keywords with commas.
Tagging tips - Search For Tags - Browse For Tags

?

More Tagging tips:

A tag is a way to search for this diary. If someone is searching for "Barack Obama," is this a diary they'd be trying to find?

Use a person's full name, without any title. Senator Obama may become President Obama, and Michelle Obama might run for office.

If your diary covers an election or elected official, use election tags, which are generally the state abbreviation followed by the office. CA-01 is the first district House seat. CA-Sen covers both senate races. NY-GOV covers the New York governor's race.

Tags do not compound: that is, "education reform" is a completely different tag from "education". A tag like "reform" alone is probably not meaningful.

Consider if one or more of these tags fits your diary: Civil Rights, Community, Congress, Culture, Economy, Education, Elections, Energy, Environment, Health Care, International, Labor, Law, Media, Meta, National Security, Science, Transportation, or White House. If your diary is specific to a state, consider adding the state (California, Texas, etc). Keep in mind, though, that there are many wonderful and important diaries that don't fit in any of these tags. Don't worry if yours doesn't.

You can add a private note to this diary when hotlisting it:
Are you sure you want to remove this diary from your hotlist?
Are you sure you want to remove your recommendation? You can only recommend a diary once, so you will not be able to re-recommend it afterwards.
Rescue this diary, and add a note:
Are you sure you want to remove this diary from Rescue?
Choose where to republish this diary. The diary will be added to the queue for that group. Publish it from the queue to make it appear.

You must be a member of a group to use this feature.

Add a quick update to your diary without changing the diary itself:
Are you sure you want to remove this diary?
(The diary will be removed from the site and returned to your drafts for further editing.)
(The diary will be removed.)
Are you sure you want to save these changes to the published diary?

Comment Preferences

  •  Interesting stuff . .. . (0+ / 0-)

    I had no idea that the SEC had financial expertise in addition to maintaining all those top notch college football programs.

    But that's why I come to this site, I learn something virtually every day!

  •  Not sure this is accurate. (0+ / 0-)

    While the charges concerning SFAS 133 and the 11billion asset accounting issue seem to be bogus, most of the case was focused on manipulation of reported earnings by abusing FSAS 91 concerning the recognition of loan expenses and revenues in order to meet incentive (bonus) thresholds. Those issues are not addressed in the diary.

    I generally think that the GSEs were mostly scapegoated for the housing bubble, and if they had continued to operate as they had during the 90s and early 2000s, and the privately issued MBS market had not gone crazy, we would have avoided the mess. I have some suspicion that the charges against Fannie and Freddie were designed to force them to change policies in ways that supported the private lender gravy train, which ended up expanding the bubble in its final stages and made the GSEs which had generally been a brake on excesses into participants and ultimately bag holders.

    I would like to see more of that story told. Still by ignoring the SFAS 91 issues and claiming that redemption on the hedging represents exhonoration you are misrepresenting the original case.

    •  Let me set the record straight... (0+ / 0-)

      From the original SEC complaint:
      "The vast majority of the anticipated restatement of at least $11 billion previously reported net income is a result of Fannie Mae's improper hedge [i.e. FAS 133] accounting.
      http://www.sec.gov/...

      The purported FAS 91violations dealt with amounts that were less than $100 million.

      In three different decisions, Judge Leon ruled that the allegations of violations of FAS 91 were completely without merit. There was no evidence that anyone had done anything to manipulate earnings and there was no evidence that the accounting was improper.

      The allegations against Fannie are as baseless as the case for Iraq's WMD.

      http://www.law.du.edu/...

      http://docs.justia.com/...

      https://ecf.dcd.uscourts.gov/...

Subscribe or Donate to support Daily Kos.

Click here for the mobile view of the site