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22–157 PDF 2005

ACCOUNTING IRREGULARITIES

AT FANNIE MAE AND THE

EFFECT ON INVESTORS

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE AND 

GOVERNMENT SPONSORED ENTEREPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

FEBRUARY 9, 2005

Printed for the use of the Committee on Financial Services

Serial No. 109–1

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE AND GOVERNMENT SPONSORED

ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

VITO FOSSELLA, New York, 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

J. GRESHAM BARRETT, South Carolina 

GINNY BROWN-WAITE, Florida 

TOM FEENEY, Florida 

JIM GERLACH, Pennsylvania 

KATHERINE HARRIS, Florida 

JEB HENSARLING, Texas 

RICK RENZI, Arizona 

GEOFF DAVIS, Kentucky 

MICHAEL G. FITZPATRICK, Pennsylvania 

MICHAEL G. OXLEY, Ohio 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

ARTUR DAVIS, Alabama 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

February 9, 2005 .............................................................................................. 1

Appendix: 

February 9, 2005 .............................................................................................. 35

WITNESS 

WEDNESDAY, FEBRUARY 9, 2005

Nicolaisen, Donald T., Chief Accountant U.S. Securities and Exchange Commission .................................................................................................................. 12

APPENDIX 

Prepared statements: 

Baker, Hon. Richard H. ................................................................................... 36

Clay, Hon. Wm. Lacy ....................................................................................... 38

Gillmor, Hon. Paul E. ....................................................................................... 39

Hinojosa, Hon. Rube ́n ....................................................................................... 41

Kanjorski, Hon. Paul E. ................................................................................... 43

Royce, Hon. Edward R. .................................................................................... 45

Nicolaisen, Donald T. ....................................................................................... 46

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Israel, Hon. Steve: 

‘‘Barron’s Mailbag: Unhinged About Hedging’’, December 13, 2004 ............ 54

(1)

ACCOUNTING IRREGULARITIES 

AT FANNIE MAE AND THE 

EFFECT ON INVESTORS 

Wednesday, February 9, 2005

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, 

AND GOVERNMENT SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:05 a.m., in Room 

2128, Rayburn House Office Building, Hon. Richard H. Baker 

[chairman of the subcommittee] presiding. 

Present: Representatives Baker, Ryun, Shays, Gillmor, Lucas, 

Royce, Kelly, Biggert, Miller of California, Kennedy, Tiberi, Barrett, Brown-Waite, Hensarling, Renzi, Davis of Kentucky, 

Fitzpatrick, Kanjorski, Ackerman, Sherman, Meeks, Hinojosa, 

Crowley, Israel, McCarthy, Baca, Matheson, Lynch, Miller of North 

Carolina, Scott, Velazquez, Watt, Bean, Wasserman Schultz, and 

Waters. 

Chairman BAKER. I would like to call this meeting of the Subcommittee on Capital Markets to order. 

Our committee convenes today for the first time in this the 109th 

Congress. Accordingly, I would like to take this opportunity to introduce new members to our subcommittee, some of whom who are 

not new to the Congress or to Financial Services, merely to the 

Subcommittee on Capital Markets. 

Joining us from Financial Services is Mr. Barrett of South Carolina, Mr. Feeney of Florida, and Mr. Hensarling of Texas. 

New to the Congress, and of course to Financial Services, we welcome Mr. Davis of Kentucky and Mr. Fitzpatrick from Pennsylvania. We are certainly pleased to have the addition of the new 

members to the important work of this committee. 

I will leave the pleasure of making the introductions of the new 

members on the minority side to the gentleman from Pennsylvania, 

to Mr. Kanjorski, the ranking member. 

The committee also convenes today for another important purpose. Although not a pleasant task, it is I believe an essential one. 

What now seems a very long time ago, the Office of Federal Enterprise Housing Oversight, known as OFHEO, engaged an audit 

firm to conduct what is known in the business as a forensic accounting audit of Fannie Mae. This was the first time in the enterprise’s history that such an examination had been conducted. 

2

The audit, frankly not yet complete, resulted in the production 

of an interim report which was reviewed by officials at OFHEO and 

found to be of sufficient concern to result in a report to this committee of those findings. 

The principal issue centered around the manner by which the enterprise reported its financial condition and the risk exposure of its 

derivatives portfolio. 

When the committee last met, the director of OFHEO, Mr. 

Armando Falcon, was verbally assaulted by members of the committee on both sides for his irresponsible conduct or, perhaps even 

worse, pursuit of some undisclosed political or business agenda. 

It was the view of some that, on procedural appeal to the SEC, 

these accusations would be found to have no merit and be swept 

aside. 

Since the time of that hearing, the criticism of the agency and 

the attacks on the congressionally created regulator of the agency 

and Mr. Falcon have been more than just vindicated. 

The unfortunate finding of the SEC is that the accounting practices of Fannie Mae were not just a mere exercise of bad judgment 

or a one-time aberrant act, but a consistent misapplication, at best, 

or at the worst an intentional act of accounting misrepresentation. 

Today, we received the report from the chief accountant of the 

SEC, who I wish to publicly commend for his professional ability 

to first examine and then reach a very difficult decision. 

The review of the facts in this matter is not without great consequence. Fannie Mae was and remains a political institution of 

great persuasion. They have for many years been able to bully 

their way through myriad regulatory processes and political engagements unscathed. 

This time, the outcome was different because of the professionalism of those at OFHEO and at the SEC. This time, there cannot be more excuses. The facts are what they are. 

Officials at Fannie have stepped down in the wake of the disclosure. The board has promised to change the culture of mismanagement at the institution, and there is more. 

I remind members that the report that initiated the controversy 

was only an interim report. The work of the auditor is not yet completed and neither is the work of the SEC or the Justice Department. 

We will all await the results of these examinations for full and 

complete assessment and a finding of responsibility. 

In the course of questioning the SEC officials today, members 

should remember that answers to many questions may not yet be 

appropriate to disclose because of the continuing, pending inquiry. 

Legal counsel of the SEC will advise the committee as to the appropriateness of responses at the particular time. 

I should also note that in press reports, as of this morning, benefits, bonuses, and more have been initiated for the executives who 

only recently left the company before the finding of fact as to the 

appropriate responsibility for the disclosed deficiency. 

The regulator, OFHEO, does not apparently have the authority 

to unilaterally act on behalf of taxpayers or anyone else. Litigation 

will be required after the fact to reclaim, if possible, any ill-gotten 

gains. 

3

It is unfortunate that such significant adverse events were necessary to bring us to this day, but perhaps finally we will be able 

to produce legislation responsive to what is now a fact: and that 

is that Fannie Mae was not and is not the institution we had all 

hoped. They were subject to the same pernicious forces that affected others in pursuit of profit. 

Financial manipulation, even perhaps for the personal gain of executives, undermined the responsibility of their important charter 

mandate. It is now our task to return them to their principle task, 

in essence to pave the way to home ownership for all Americans, 

but with emphasis on those who have never had the opportunity 

to own their own home at all. 

I read the press reports this morning and the thought struck me 

that the monthly retirement benefits to one executive would be sufficient to buy a low-income individual a home outright every month 

for the remainder of that executive’s life: in excess of $114,000. 

It is also necessary to ensure that the risk-taking of the enterprise does not put at risk hardworking taxpayers of this country. 

The enterprise can accomplish both goals, safety and soundness 

and mission compliance. They just apparently need vigilant oversight to ensure their success. 

It is my intention, working with Mr. Kanjorski and others on this 

committee, to see that happen this session of Congress. 

Mr. Kanjorski is recognized for an opening statement. 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

Mr. Chairman, before I start my statement, I would like to introduce our new members on the Democratic side of the committee: 

Mr. Mel Watt of North Carolina, Artur Davis of Alabama, Melissa 

Bean of Illinois, and Debbie Wasserman Schultz of Florida. 

Since, on the Democratic side, the Financial Services Committee 

has become an exclusive committee, it is important when we note 

several of these new members of the subcommittee and on the committee are freshman, and therefore only serve on the Financial 

Services Committee. 

Mr. Chairman, before we begin today’s session, I must note that 

this hearing is the first of our panel in the 109th Congress. Over 

the last decade, you and I have forged a close and productive relationship as chair and ranking member of the Capital Markets Subcommittee, and I look forward to working with you once again in 

this Congress. 

Four months ago, we convened our last hearing of the 108th Congress to discuss the special examination of Fannie Mae by the Office of Federal Housing Enterprise Oversight. 

It therefore seems fitting that we will begin our hearing this year 

with an examination of the recent decisions by the chief accountant 

of the Securities and Exchange Commission, related to Fannie 

Mae’s practices for the accounting of derivatives contracts and the 

amortization of discounts, premiums and fees involved in the purchase of home mortgages. 

Prior to the chief accountant’s decisions, Fannie Mae’s board had 

already agreed to adopt a number of reforms based on an initial 

report by the Office of Federal Housing Enterprise Oversight. 

Afterwards, Fannie Mae put in place additional changes, including 

4

removing its leadership team and hiring a new auditor. The company continues to make modifications. 

At our last hearing into these matters, I sought to determine 

whether the accounting problems at Fannie Mae constituted some 

form of a systemic risk for our economy. I was assured by all of 

those who participated at the hearing that these problems did not 

pose a systemic risk. 

Similarly, my primary focus at today’s hearing will be to determine whether our public entities that use derivatives could also 

have difficulty in accounting for those complex financial instruments. Although derivatives serve a useful purpose in spreading 

risk, I am concerned that if Fannie Mae encountered difficulties in 

accounting for these contracts, then other financial services providers may also have comparable problems that could cause difficulties for our economy. I hope the chief accountant, who is the 

sole witness appearing before us today, will offer me his candid assessment of these matters. 

As we proceed today, I also suspect that some of my colleagues 

will return to the question of how best to modify the regulation of 

government-sponsored enterprises. As you know, Mr. Chairman, I 

am one of the few remaining members of the committee who participated in the entire congressional battle to resolve the savings 

and loan crisis. I am, therefore, acutely aware of the need to protect taxpayers from risk. 

It is in the public’s interest that we ensure that Fannie Mae and 

Freddie Mac continue to operate safely and soundly. We must further ensure that these public-private entities achieve their public 

responsibilities for advancing home ownership opportunities. 

In fact, as I said at our very first hearing in March 2000 on the 

oversight of government-sponsored enterprises, ‘‘We need to have 

strong independent regulators that have the resources they need to 

get the job done.’’ I can assure everyone that I continue to support 

strong, world-class, and independent regulation for Fannie Mae 

and Freddie Mac. 

A strong, world-class, independent regulator will protect the continued viability of our capital markets and promote confidence in 

Fannie Mae and Freddie Mac. It will also insure taxpayers against 

systemic risk and expand housing opportunities for all Americans. 

Like many of my colleagues, I was greatly disappointed in the 

last Congress when the Bush administration rejected our bipartisan efforts to create an independent regulator. Politics, in my 

view, should not play a role in financial regulation. It is therefore 

my hope that when we revisit this issue in the 109th Congress, we 

will continue to remain resolute and unwavering in our bipartisan 

efforts to create a strong, independent and world-class regulator 

with appropriately robust powers and sufficiently adequate resources. As we proceed, it is also my hope that we will develop a 

balanced, deliberate and bipartisan plan of action for addressing 

these matters. 

In closing, Mr. Chairman, I commend you for your sustained 

leadership in these matters. Government-sponsored enterprises, 

with their public responsibilities and private backing, have a special obligation to operate fairly, safely and soundly. Your work, 

without question, has highlighted these issues for all of us. 

5

Thank you. 

[The prepared statement of Hon. Paul E. Kanjorski can be found 

on page 43 in the appendix.] 

Chairman BAKER. I thank the gentleman for his statement. 

It is my pleasure to introduce to the committee, not as a new 

member, but in a new capacity, the gentleman from Kansas, Mr. 

Ryun, who now serves as our vice chair. 

Mr. RYUN. Mr. Chairman, first of all, let me say thank you for 

holding this hearing. 

As we open a new Congress and a new year for the Financial 

Services Committee and the Capital Markets Subcommittee, we 

have some important issues to consider, certainly one of which is 

we are going to take up today. 

As this committee prepares to make complex decisions about the 

regulations of the GSEs, it is crucial that we gather information 

from an abundance of different sources. Today is an opportunity to 

begin that process. 

The very fact that the accounting irregularities at Fannie Mae 

were not discovered early strongly suggests that a more effective 

regulator is needed. 

As we work to make this happen, we must make sound decisions 

on what the regulator should look like and what powers it should 

have. I look forward to that debate. 

I also want to take a moment to just say thank you and I look 

forward to working with you, Mr. Chairman, on the issues that the 

subcommittee will consider this year. You have been a strong voice 

on many issues and I am confident that the subcommittee will do 

a much-needed job under your continued guidance. 

I look forward to the testimony, and I yield back my time. 

Chairman BAKER. I thank the gentleman and welcome him into 

his new responsibility. 

Just by way of announcement for new members, we for hearing 

purposes, recognize members for opening statements and questions 

in the order of arrival time. 

So the next on the Democrat side would be Mr. Scott. 

Mr. SCOTT. Thank you very much, Mr. Chairman. 

And I, too, want to commend you and Ranking Member Kanjorski for holding this hearing. It is very timely and, of course, very 

important as we get started on making sure that this nation has 

full confidence in Fannie Mae and that we move with good speed 

and with good production to make sure that we resolve any lingering feelings of insecurity about Fannie Mae. 

I am particularly concerned that Fannie Mae’s mission, which is 

so important, be not compromised or weakened, but strengthened. 

Last year, this committee met to discuss an OFHEO report 

which alleged that Fannie Mae inappropriately reduced earnings 

volatility and provided management with the flexibility to determine the amount of income and expense recognized in any accounting period. 

Fannie Mae questioned OFHEO’s ability to act on this report and 

the method by which the report was released. 

Fannie Mae asked the SEC to determine if its accounting practices complied with generally accepted accounting principles. And 

the SEC found that they were not in compliance. 

6

I think that there are a number of questions that certainly need 

to be examined. And paramount of those is did OFHEO consult 

with the Securities and Exchange Commission or FASB prior to 

making its findings as to whether Fannie accounting was consistent with generally accepted accounting principles. 

That was a major concern particularly brought up during our 

hearings with, as former distinguished chairman, Mr. Raines, and 

with the board. 

Again, I want to thank you, Mr. Nicolaisen, for appearing before 

the committee today. And I understand that your testimony will indeed be limited to the Securities and Exchange Commission’s review of Fannie Mae’s accounting practices. 

Investigations into Fannie Mae’s accounting practices by the SEC 

and OFHEO are indeed ongoing. However, I do look forward to the 

report on these investigations at the proper time. 

And I look forward to having an opportunity to follow up on 

those questions if we have time in the question-and-answer period. 

Thank you again, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

Mr. Tiberi, did you have a statement? 

Mr. Hensarling? 

Mr. HENSARLING. Thank you, Mr. Chairman. 

I first want to take the opportunity to applaud you for your persistence and your leadership on this matter. 

Clearly the findings of the SEC are troubling. No one should dismiss this matter as inconsequential or not worthy of continued and 

detailed scrutiny. These are serious allegations that should not be 

politicized. 

We are looking into the possibility of incredible corporate malfeasance within an institution created by Congress and indirectly supported by American taxpayers. This is an institution that also happens to be the largest non-bank financial services company in the 

entire world, with more than $1 trillion in assets. 

Given the size and influence of Fannie Mae in our housing market, the possibility that the artificial smoothing of earnings volatility was taking place on a quarter-by-quarter basis is most disturbing. 

Further, the fact that this earnings manipulation may have 

served the purpose of providing enhanced bonuses to Fannie executives is disconcerting to say the least. 

As the largest source of mortgage financing in America, we simply cannot ignore the systemic risk that the institution poses. 

Chairman Alan Greenspan has warned us that the growth of 

Fannie Mae could cause systemic difficulty if Congress does not act 

to ensure that Fannie Mae is appropriately regulated. 

Personally, I do not need to see any additional proof that our 

housing GSEs are in dire need of a new and strengthened regulator. But the fact that both Fannie and Freddie have had similar 

earnings-manipulation issues in the recent past has greatly magnified the need for this new regulator. 

We are all aware of the economic damage that took place in the 

wake of other corporate accounting scandals, be it Enron, 

WorldCom or Tyco. And in 2001, in terms of assets, Enron was only 

about one-sixteenth the size that Fannie Mae is today, and 

7

WorldCom and Tyco were about one-tenth the size of Fannie in 

terms of assets. 

These facts cannot be ignored. 

For these reasons, I hope that no stone will be left unturned in 

these hearings and that, going forward, this committee will examine every legislative remedy aimed at maintaining investor confidence in our housing markets. 

I look forward to working with you, Chairman Baker, and the 

other members of our committee to help find a legislative solution 

that will ensure that Fannie Mae is adequately regulated as a 

GSE, keeping in mind the interests of future homeowners, investors and taxpayers. 

I yield back the balance of my time. 

Chairman BAKER. I thank the gentleman. 

Ms. McCarthy, did you have a statement? 

Mrs. MCCARTHY. Thank you, Mr. Chairman. And I just want to 

say thank you again for holding this hearing. 

I will withhold my opening statement and look forward to hearing the testimony and follow through with the questions at that 

time. 

Thank you. 

Chairman BAKER. I thank the gentlelady. 

Mr. Fitzpatrick? 

Ms. Biggert? 

Mr. Barrett? 

Mr. Renzi? 

Mr. Royce? 

Mr. ROYCE. Thank you, Mr. Chairman. And I thank you for holding this hearing on accounting irregularities at Fannie Mae and 

the impact on investors. 

I would also like to thank you, Mr. Chairman, on your work on 

oversight of the GSEs over the years. I think it has been very important. 

And as I said last October, during the first hearing on Fannie 

Mae’s accounting issues, I expect Fannie Mae to be a role model 

to other businesses as it fulfills its federally mandated mission. 

Fannie Mae should be conducting operations in a safe and in a 

sound way and, in my view, this should include strong internal 

controls in the risk-management department coupled with consistent and conservative application of accounting rules. 

The SEC ruling affirming OFHEO’s point that Fannie Mae was 

not GAAP-compliant is very troubling. Fannie owns slightly less 

than $1 trillion in financial assets. Most of these assets are in the 

form of mortgages, which means that Fannie Mae operates in a 

negatively convex environment. In other words, Fannie Mae can 

lose money if interest rates or if interest rates go down. 

And Fannie Mae and other GSEs attempt to mitigate this risk 

by issuing callable debt and by doing one other thing and that is 

by buying derivatives. And it is the accounting of these derivatives 

that has been found to be improper. 

Regulators and investors have a right to know and a need to 

know that Fannie Mae is managing interest rate risks appropriately. Fannie’s misapplication of FAS 133 prevents outsiders 

from getting a clean view of the true risk at the company. 

8

I am pleased that we are having this hearing to learn more about 

how that happened and to learn how we can prevent such occurrences in the future. 

In addition to our important oversight role in this committee, I 

hope that we will move swiftly to create a new regulatory structure 

for Fannie Mae, Freddie Mac and the Federal Home Loan Banks. 

This is a very simple solution. Congress must create a new regulator with powers at least equal to those of other financial regulators, such as the OCC or the Federal Reserve. 

I introduced legislation last session which would have enacted 

just such a reform. And I hope this committee will heed the advice 

of Chairman Greenspan and the entire Board of Governors, the 

Federal Reserve staff, the U.S. Treasury Department, the OECD 

and the IMF and countless others who have urged Congress to act. 

Mr. Chairman, thank you for your leadership and I yield back. 

Chairman BAKER. I thank the gentleman. 

Mr. Sherman? 

Mr. SHERMAN. Thank you, Mr. Chairman. 

Fannie Mae and its sister organizations play such an important 

role that if they didn’t exist we would have to create them. We 

need to provide for effective home ownership financing. 

That is why it is tragic that we have seen these accounting problems. We have every reason to delve into them. We look forward 

to hearing from the witness. We have every reason to correct them. 

We have every reason to seek the best possible regulation of 

GSEs. And it has been suggested that if that was in the Treasury 

Department that we would get a more effective regulation. 

Others though have pointed out that while the Treasury Department may have the expertise to look at safety, soundness and, particularly apropos to today, accounting standards and compliance 

and fair disclosure, that it might be more appropriate for the mission of these GSEs to be regulated and continue to be regulated by 

HUD, which, after all, is the agency we entrust to provide affordable housing for Americans. 

So I look forward to devising a regulatory system so that a decade from now we are not back here again looking at some accounting problem for a GSE. But at the same time these GSEs do all 

they can to provide for housing. 

Chairman BAKER. I thank the gentleman. 

Mr. Miller? 

Mr. MILLER OF CALIFORNIA. Yes. Thank you, Mr. Chairman. 

More of a comment than a statement. And I guess this—we have 

two separate issues we have to look at: one is safety and soundness, the other is the mission of Fannie, and I don’t think those 

should be mingled at all in this debate today. 

And I think we need to be very cautious of what we say. Because 

things that we say can have more of a burden and impact on the 

debt market than many of those who just basically overview and 

have insight into what they are doing. 

But we need to strengthen the regulation of GSEs to ensure safety and soundness; there is absolutely no doubt about that. We must 

be careful not to impact the actions that we take here on the debt 

market. 

9

Accounting irregularities demonstrate that we must change the 

way GSEs are regulated. And that, I think, is what we are about 

today. But it does not in any way suggest reforming the mission 

of GSEs. 

And I just wanted to put in the record, Mr. Chairman, I know 

you are heading in the direction of what I am saying, but we need 

to be very cautious about dealing with the mission and not commingling that with safety and soundness. 

I yield back. 

Chairman BAKER. I thank the gentleman. 

Mr. Ackerman is not here. 

Mr. Hinojosa? 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

Chairman BAKER. Oh, I am sorry, Mr. Ackerman. I am sorry. Mr. 

Ackerman passes. I thank the gentleman. 

Mr. Hinojosa, please? 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

Chairman Baker, I want to express my sincere appreciation to 

you and Ranking Member Kanjorski for holding this important 

hearing today. 

I also want to welcome our witness today, Mr. Donald T. 

Nicolaisen, the Securities Exchange Commission’s chief accountant. 

I look forward to your testimony. 

Over the past 2 years, we have been witness to several developments in the government-sponsored enterprises that have been less 

than pleasant. I am not going to go into them in great detail except 

to say that they have resulted in the need for Fannie Mae and for 

Freddie Mac to restate their earnings and take other corrective actions. 

In December, the Securities Exchange Commission—rather Mr. 

Nicolaisen, who is chief accountant, determined that Fannie Mae’s 

accounting was not consistent with generally accepted accounting 

practices. 

This determination allowed OFHEO to formally classify Fannie 

Mae as significantly undercapitalized and to require Fannie Mae to 

make prompt corrective actions to recapitalize. 

Although the accounting restatement amounts to approximately $9 billion, Fannie Mae has taken certain actions to recapitalize and 

to increase its capitalization with further actions likely in the near 

future to meet OFHEO’s requirements, with negotiations ongoing. 

Mr. Chairman, this hearing will play an important role in determining the type of legislation, if any, Congress will introduce and 

consider this Congress to reform the government-sponsored enterprise system. 

Senator Chuck Hagel has already introduced legislation that 

would consolidate oversight of Fannie Mae, Freddie Mac and the 

12 Federal Home Loan Banks under a single and new regulator 

with the power to set minimum capital requirements and to put 

Fannie Mae and Freddie Mac into receivership. 

I have also noticed that the legislation greatly expands the regulator’s ability to limit benefits and bonuses within the severance 

packages paid to GSE executives who leave those entities. 

That component of Senator Hagel’s bill is very important to me 

and to many of my colleagues here in Congress. 

10

It will be interesting to see if legislation will be introduced in the 

House to reform the government-sponsored enterprise system. And 

if so, what will it contain, how the committee will proceed with the 

consideration, and what ultimately will be the outcome of any and 

all actions taken by Congress. 

It seems to me that whatever actions Congress takes, we need 

to ensure that Fannie Mae and Freddie Mac continue to meet their 

primary mission of providing affordable housing. 

Mr. Chairman, we need to also ensure that whatever actions we 

take do not harm the housing industry, which has been the foundation for the nation’s economy since the market decline in the year 

2000. 

With that, Mr. Chairman, I yield back the remainder of my time. 

Chairman BAKER. I thank the gentleman. 

And, Ms. Kelly, did you have a statement? 

Mr. Gillmor? Paul, do you have a statement? 

Mr. GILLMOR. I have a statement I will just enter in the record. 

Thank you. 

Chairman BAKER. I appreciate the gentleman’s actions. 

Ms. Velazquez? 

Ms. VELAZQUEZ. Mr. Chairman, I will ask unanimous consent to 

enter my opening statement into the record. 

Chairman BAKER. Without objection. 

Mr. Baca? 

Mr. BACA. Thank you very much, Mr. Chairman and ranking 

members. And just for the record, I know a lot of us Hispanics look 

alike. When you were looking at me and saw Ruben on that side 

over there. But I appreciate that. 

Chairman BAKER. I plead innocence, because Mr. Kanjorski, as 

usual, was obstructing my view of the proper world. 

[Laughter.] 

Mr. BACA. Thank you very much, Mr. Chairman. 

I am very pleased to be here today to have the opportunity to ask 

questions of our witness. 

Now that we know the findings of the commission staff, we must 

continue to respect due process. And I state that: respect due process. That is the American system. 

These are very serious findings, and we should take them seriously, because the situation of the nature could injure Fannie Mae 

and its mission. 

I am saddened at the events that have occurred in light of the 

importance of preserving Fannie Mae’s historical duty to protect 

the underserved. I am troubled that the number of currently questionable practices have cast uncertainty on a company that has 

done good, and so much good throughout our country. And I state 

again: that has done so much good. 

As a member of this subcommittee, I will not rest until we have 

made sure that Fannie Mae has its books in order and is financially sound and it is on a continued footing to preserve first-time 

homebuyers, Hispanic and other minorities, in our neighborhoods. 

This is very important for my district and those other members 

of the subcommittee. Housing is the American dream. 

Fannie Mae has a number of innovative and highly successful 

programs to increase home ownership. I hope that as we continue 

11

to discuss this company, that we will focus on the good and also 

talk about such programs as those in the subcommittee. 

At the end of the day, we will be adopting legislation in the subcommittee, and I think it is important that we move forward rapidly and that we assure that Fannie Mae has a strong, well-funded 

regulator—and I state, a well-funded regulator—with the tools to 

carry out its missions—with the tools to carry out its regulatory 

missions. 

We must take from this the appropriate lesson and move on. But 

Fannie Mae has to assure us that it will be open, will be honest 

and thorough in its continued dealings, and it will make it right 

and get it right. 

We must ensure that we have an orderly house here and in the 

future to ensure that the integrity of the market, we must step 

forcefully, but let us make sure that we do not harm the core of 

the mission here, which is housing. 

I thank you, Mr. Chairman. 

I will submit my statement for the record. 

Chairman BAKER. I thank Mr. Baca for his statement. 

Mr. Lucas, did you have a statement? 

Ms. Bean? 

Ms. BEAN. Thank you, Mr. Chairman, for holding this important 

hearing concerning Fannie Mae’s accounting irregularities and disclosure practices. 

I would also like to thank Mr. Nicolaisen from the SEC for taking the time to share his views. 

As a new member to both Congress and Financial Services, I am 

eager to join the committee and to hear the witness’ testimony. 

Thank you. 

Chairman BAKER. I thank the gentlelady. 

Mr. Crowley? 

Mr. Lynch? 

Mr. LYNCH. Thank you, Mr. Chairman, and also the ranking 

member, for holding this hearing, and Mr. Nicolaisen for helping 

the committee with its work. 

I just have three areas that eventually I would like to hear from 

you on. 

One is the clarity of the rules that we are looking at here. I am 

not an accountant, but I am an attorney and I must admit that a 

lot of our earlier hearings sponsored by the chairman centered 

around the complexity of the rules. And I think it would be helpful 

to our GSEs during the new regulatory process that there be full 

understanding of the rules themselves. 

And also I would like to hear about the interaction between the 

regulator and the GSEs. These GSEs, Fannie Mae and Freddie 

Mac, are central to our national housing policy. And it need not be 

an adversarial relationship; it can be one of oversight and inducing 

responsibility. 

And lastly, the promptness of that oversight, not only from this 

committee, but from the regulator. Hopefully we would avoid a situation that we have a four-year restatement required by our GSEs 

in the amount of $9 billion. There should be a way that we can be 

more prompt in our oversight so that we don’t go so far down the 

road that that type of restatement and correction is necessary. 

12

That is all I have. 

Thank you, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

Ms. Wasserman Schultz? 

Ms. WASSERMAN SCHULTZ. Thank you, Mr. Chairman. 

I, too, look forward to being a member of this subcommittee and 

hearing from Mr. Nicolaisen on the concerns that he has over the 

ongoing investigation related to Fannie Mae. There are certainly 

issues that appear to be important for us to hear about. 

And I look forward to his statement and to making sure that we 

can review the situation and address the concerns. 

Thank you. 

Chairman BAKER. I thank the gentlelady. 

If there is no other member wishing to make an opening statement at this time, I would like to welcome to our committee the 

chief accountant for the Securities and Exchange Commission, Mr. 

Donald T. Nicolaisen, who has done exemplary work in my opinion. 

And please proceed at your own pace. 

STATEMENT OF DONALD T. NICOLAISEN, CHIEF ACCOUNTANT, 

U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. NICOLAISEN. Chairman Baker, Ranking Member Kanjorski 

and members of the subcommittee, thank you for this opportunity 

to testify today concerning accounting issues related to deferred 

purchase price adjustments and to derivatives and hedging activities. 

My name is Don Nicolaisen and I am the chief accountant at the 

Securities and Exchange Commission. As the chief accountant, I 

am the principle adviser to the commission on accounting and auditing matters. 

The views I express today, however, are my personal views and 

my testimony has not been reviewed or approved by the commission. 

As the subcommittee has requested, my testimony addresses my 

decision of December of 2004, that certain accounting practices of 

Fannie Mae did not comply in material respects with specific provisions within generally accepted accounting principles, also known 

as GAAP. 

Fannie Mae has disclosed that the commission is investigating 

certain issues associated with Fannie Mae’s accounting and disclosure practices. I and others at the commission appreciate the subcommittee’s recognition of the non-public nature of the commission’s active investigation. 

In light of the commission’s ongoing enforcement actions, I ask 

that the subcommittee understand my reluctance to address at this 

time specific issues related to Fannie Mae’s compliance with federal securities laws. You may be assured that the commission staff 

thoroughly is investigating any evidence of financial reporting impropriety. 

My statements today will be confined to the public record. And 

because the commission has not expressed any opinion or views on 

these matters, my statements should not be attributed to the commission. 

13

Fannie Mae is the largest non-bank financial services company 

in the world and the nation’s largest source of financing for home 

mortgages. Fannie Mae’s common stock is listed on the New York 

Stock Exchange and, after discussions with the commission’s staff, 

on March 31, 2003, Fannie Mae voluntarily registered its common 

stock with the commission under Section 12(g) of the Securities and 

Exchange Act of 1934. 

As the subcommittee is aware, the Office of Federal Housing Enterprise Oversight, or OFHEO, Fannie Mae’s safety and soundness 

regulator, reviewed several of Fannie Mae’s accounting practices, 

focusing on the implications of those practices on the adequacy of 

Fannie Mae’s regulatory capital, the quality of its management and 

the overall safety and soundness of the enterprise. 

OFHEO issued a report of its findings on September 17th, 2004, 

and last October officials from both OFHEO and Fannie Mae testified before this subcommittee on issues discussed in that report. 

Following the issuance of OFHEO’s report, Fannie Mae sought 

guidance from the commission’s accounting staff regarding Fannie 

Mae’s compliance with Statement of Financial Accounting Standard 91, entitled, ‘‘Accounting for Non-refundable Fees and Costs 

Associated with Originating or Acquiring Loans in Indirect Cost of 

Leases,’’ and Statement of Financial Accounting Standard 133, entitled, ‘‘Accounting for Derivative Instruments and Edging Activities.’’

Although the SEC accounting staff may choose not to provide 

such guidance while there are pending investigations by the commission and other agencies, Fannie Mae requested our guidance because, in its view, these accounting issues received extraordinary 

public attention and resulted in the mortgage and capital markets 

experiencing uncertainty. 

To facilitate our review, Fannie Mae and OFHEO voluntarily 

provided the commission’s accounting staff with information and 

with explanations of their views of the applications of Statements 

91 and 133. 

Fannie Mae did not ask the accounting staff to express any views 

regarding whether the information provided by Fannie Mae or 

OFHEO was accurate or complete, or to develop additional facts. 

And in providing the requested accounting guidance we did not do 

so. 

Accordingly, the accounting staff’s guidance was based on the information voluntarily provided by Fannie and OFHEO and, in addition, the SEC’s accounting staff did not consider the appropriateness of Fannie Mae’s business decisions to use financial or derivative instruments, or to hedge its risk, but limited its consideration 

to whether the accounting used to record those transactions complied with Statements 91 and 133. 

In light of the public attention and uncertainties cited by Fannie 

Mae, on December 15, 2004, the commission’s accounting staff 

issued a press statement containing our views. 

In that press release, the SEC accounting staff indicated that, 

based upon our review of the information provided by Fannie Mae 

and OFHEO during the period of 2001 to mid-2004, Fannie Mae’s 

accounting practices did not comply in material respects with the 

accounting requirements of Statements 91 and 133. 

14

Regarding Statement 91, during the period under the staff’s review, Fannie Mae failed to record timely adjustments to the recorded amount of its loans based on changes in the estimated speed 

with which these loans would be prepaid. 

Among other requirements, Statement 91 provides that when applying the method used by Fannie Mae, an entity should use its 

best estimate of expected prepayment rates in calculating the carrying amount of these loans. 

Fannie Mae already had concluded that its methodology for performing these calculations for interim balance sheet dates in the 

periods 2001 through 2002 were not consistent with Statement 91 

and had stated that it has changed its accounting practices to, 

among other things, calculate the amounts based on quarter-end 

positions, rather than projected year-end positions. 

It also appears that, contrary to Statement 91, Fannie Mae recognized adjustments to the carrying amount of its loans only if 

they exceeded a self-defined materiality limit referred to as a precision threshold. 

Fannie Mae has represented that it has initiated additional 

changes to eliminate the precision threshold and is working with 

OFHEO to further amend its accounting practices under Statement 

91. 

Regarding Statement 133, one of the principles underlying that 

statement is that derivative instruments are to be reported at their 

fair value with changes in fair value being reported in earnings. 

If certain detailed hedge criteria and procedures are satisfied, 

Statement 133 affords special accounting for the hedge relationship. If the detailed hedging requirements are not satisfied, then 

special hedge accounting is not available. 

Fannie Mae internally developed its own methodology to assess 

whether hedge accounting was appropriate. Fannie Mae’s methodology, however, did not qualify for hedge accounting because of deficiencies in its application of 133. Among other things, Fannie 

Mae’s methodology of assessing, measuring, and documenting 

hedge ineffectiveness was not supported by Statement 133. 

As a result of the staff’s review, on December 15, 2004, the commission’s accounting staff advised Fannie Mae that to be consistent 

with Statements 91 and 133 and to provide investors with appropriate information, Fannie Mae should restate its financial statements filed with the commission to eliminate the use of hedge accounting; evaluate the accounting under Statement 91 and restate 

its financial statements filed with the commission if the amounts 

required for correction are material; reevaluate the information 

prepared under generally accepted accounting principles in nonGAAP information that Fannie Mae previously provided to investors, particularly in view of the decision that hedge accounting is 

not appropriate. 

In a report on Form 8-K filed with the commission on December 

17, 2004, Fannie Mae stated, ‘‘As a result of the commission accounting staff’s findings, Fannie Mae will restate its financial results for the periods from 2001 to mid-2004 to comply fully with 

the commission accounting staff’s determination.’’

As of the date of this testimony, Fannie Mae has not yet filed revised financial statements with the commission. It is my underVerDate 0ct 09 2002 15:45 Jul 06, 2005 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 G:\DOCS\22157.TXT FIN1 PsN: MICAH
15

standing that investigation into these and related matters by 

Fannie Mae’s special review committee, the commission and others 

are continuing. 

As I noted previously, in order not to compromise the commission’s ongoing investigation, my statement today is based only on 

the information voluntarily provided to the SEC accounting staff by 

Fannie Mae and OFHEO when Fannie Mae requested the accounting guidance provided in our December 15, 2004, press release. 

I thank you for the opportunity to appear today. I am pleased to 

try to respond to any questions the members of the subcommittee 

may have. 

[The prepared statement of Donald T. Nicolaisen can be found on 

page 46 in the appendix.] 

Chairman BAKER. Thank you, Mr. Nicolaisen. I appreciate your 

statement and your good work. 

Let me start with the manner by which these events occurred. 

As a result of the OFHEO finding, Fannie Mae came to your 

agency voluntarily and presumably would have had time to present 

their most favorable presentation of the facts as they viewed it. 

Would that be a correct observation? You didn’t just drop in one 

morning and say, ‘‘Let me see. What have you got?’’

Mr. NICOLAISEN. That is correct. They made the request and they 

submitted everything they believed to be relevant. 

Chairman BAKER. And as to process, once a registrant comes to 

the SEC for financial determinations—although it is clear your testimony this morning only speaks to the facts presented by Fannie 

on their voluntary appearance—notwithstanding, once a registrant 

comes to the SEC for financial determinations, that does engage 

the ability or responsibility of the SEC to look more broadly at the 

agency’s activities. 

And you are making no comment as to whether you are doing so, 

but you have the process authority to engage in a broader examination. 

Mr. NICOLAISEN. That is correct. 

Chairman BAKER. In your finding, it appears that the accounting 

methodology was not just an aberrant act. It wasn’t with regard to 

a single transaction. It wasn’t with regard to a single quarter. It 

wasn’t with regard to an annual statement. It was year-over-year 

practice, is that correct? 

Mr. NICOLAISEN. With respect to the two issues that we looked 

at, they were across all of the years that I referred to 2001 through 

2004. 

Chairman BAKER. Some have suggested that this could have 

been what is discussed as an interpretive judgment: Two artists 

looking at the same picture would see two different things. 

In your view of the findings and the determinations made, was 

this just a matter of interpretive judgment where two people could 

have come to varying conclusions, or was this clearly outside professional accounting standards? 

Mr. NICOLAISEN. In my view, it was outside professional accounting standards. 

Chairman BAKER. Is it so difficult for a public operating company 

to comply with FAS 91 and 133 that it is pattern and practice within the rest of the public operating company world that companies 

16

just don’t get it right? Or are there other companies out there who, 

in your view, do find appropriate manner in which to comply with 

the rules as you see them? 

Mr. NICOLAISEN. Well, I believe that other companies are complying with Statements 91 and 133. I have reason to believe that 

the standards are workable and are being followed. 

Chairman BAKER. It may be difficult, but as a matter of customary practice, accountants and CPAs in public operating companies across the country do conform with your rules on a day-to-day 

basis? 

Mr. NICOLAISEN. Yes. 

Chairman BAKER. All right. 

Then if these determinations occurred over a matter of years, the 

judgments were clearly outside the scope of professional accounting 

conduct. Since it was not an accident or a matter of interpretative 

judgment, it would lead me to conclude that this was the result of 

a managerial plan to report in this fashion. 

Would that be a correct observation, or do you agree with that 

observation? 

Mr. NICOLAISEN. That is an area I would prefer not to address, 

because we have an active investigation in process. 

Chairman BAKER. Certainly. Let me restate my question. 

Given the fact that you have agreed, you have not reached a conclusion as to how this occurred? 

Mr. NICOLAISEN. I have not. 

Chairman BAKER. Okay. 

Let me reach a conclusion. 

If, in fact, this was—to which you do not have to agree or make 

comments since there is a pending investigation. 

Since it was not aberrant, since it was not interpretative, since 

it occurred year to year, since it was clearly outside the scope of 

accounting practice, as you described and examined, it must have 

been a determined managerial strategy to represent the agency’s financial condition in the manner in which it has been reported and 

presented by the enterprise on its own motion for your review. 

Then that leads me to ask the question, if there was that intent, 

was it only for the purpose of reducing volatility reports to the 

market as we—some know? 

Freddie Mac, for example, has the reputation Steady Freddie. 

And many in the market of all reporting companies look to these 

two to be the most stable in earnings performance over the past 

two decades, a powerful incentive for management to present that 

face to the investing public. 

On the other hand, there is one other factor which has not yet 

been discussed, and I assume at its appropriate time would be reviewed by the agency or others, and that is that management intended to manage its earnings for the purpose of hitting that earnings-per-share target that was hit to the one-thousandth of a cent 

accuracy, pursuant to a GAAP-noncompliant action of deferring 

$200 million of expenses, not to the next quarter, but over an entire year, for the purpose of hitting that earnings target, which 

then triggered not only bonuses, but the maximum bonuses permissible pursuant to compensation agreements. 

17

I am just going to leave it at that and hope that the agency continues its fine work in making the appropriate findings and reporting to this committee on the actions that are responsible for us to 

take. 

My time has expired. 

Mr. Kanjorski? 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

I am not going to attempt to conclude whether there was malfeasance or misfeasance here because I think it would be reasonable 

to say your investigation is not complete and has reached no finding one way or another. Is that correct? 

Mr. NICOLAISEN. That is correct. 

Mr. KANJORSKI. What I am curious about is this: At prior hearings we had the regulators testify that they participated at the exit 

audits over the period of 4 years, when the application of these two 

rules were made. As a matter of fact, the internal auditor had used 

one rule, and an external auditor was hired and concurred with the 

final determination of what should be done in applying these two 

accounting principles. 

So we have had a four-year regulator participation, internal 

auditor participation, external auditor participation, all generally 

arriving at the application of these two rules. 

Now, I cannot speak for the executives of this company or any 

other company, but I would highly suspect that a standard CEO, 

chairman or even members of the board are not sufficiently familiar with the technicalities of these rules or other accounting rules. 

They probably would be of much use in deciding whether or not the 

statement reflects the financial position of the company in accordance with GAAP. 

That is generally what your profession is all about. 

Mr. NICOLAISEN. That is what my profession is about. 

Mr. KANJORSKI. I mean, isn’t that why when I file an income tax 

return, I go to an accountant? I don’t sit there and do all the 

things, although I am responsible for, ultimately, the conclusions 

of the accountant. 

In very complicated accounting situations, it isn’t necessarily the 

executives or the owners or the directors of the company that really 

understand the application of rules, whether they comply or don’t 

comply with GAAP. 

Mr. NICOLAISEN. With respect to this particular set of facts, I do 

want to be very clear. There were only two issues that we dealt 

with. My office did not look to the cause of why there was noncompliance to GAAP with respect to those issues. 

But we do have in place an ongoing investigation. And, as that 

investigation continues, I can assure you we will look for those 

courses. 

Mr. KANJORSKI. At this point in time, you were the ‘‘supreme 

court’’ of the application of these principles, which heretofore went 

through a regulator that didn’t raise any questions for 4 years, so 

we didn’t see any noncompliance. 

The internal auditors saw relatively no problem. The external 

auditors saw no problems. And I think even a second outside auditing firm was hired and saw no problem. And then the issue was 

18

put together and submitted to you. It was your final judgment, as 

the supreme court, that Fannie Mae didn’t comply. 

Now, I am a little worried about that. I am hearing from a lot 

of executives across America and a lot of companies. With the advent of Sarbanes-Oxley, we are asking these folks to certify and 

subject themselves to criminal and civil liability for the disclosures 

made in financial statements when, in fact, they have to rely on 

the expertise of either internal auditors or external auditors of the 

finest quality, who now we have seen for 4 years have made a mistake on the largest financial institution in the world. 

Now, my question is: Have you had the opportunity to examine 

other corporations as to the application of these two principles? 

Mr. NICOLAISEN. In my career, yes. 

Mr. KANJORSKI. Have you found any others that have not applied, and I don’t mean misapplied them in the same way Fannie 

Mae may have, but where there is a misapplication of GAAP rules? 

Mr. NICOLAISEN. There is nothing that really comes to mind in 

that area. 

Mr. KANJORSKI. What would your thought be if we did, in fact, 

have a forensic autopsy audit of, say, the Fortune 500 companies, 

what would be the likelihood of finding the misapplication of these 

two rules or other GAAP rules in that autopsy, that was ultimately, with all of its findings and facts, were submitted to you for 

evaluation? 

Do you have the opinion that every one of them would be absolutely crystal clear? 

Mr. NICOLAISEN. I certainly would not have a basis to have an 

opinion on that one way or the other. 

I can give you a few thoughts on this, though. 

Mr. KANJORSKI. Yes. 

Mr. NICOLAISEN. Fannie Mae is, perhaps, the largest user of derivatives in the world. In that sense they are different than many 

other Fortune 500 companies. The business that they engage in, 

they have chosen to do hedging transactions because they are trying to minimize risk, is the way they have described it in their public statements. 

And in that context, I would imagine that they are perhaps different than many other companies in America. 

Mr. KANJORSKI. I think that is probably a reasonable conclusion. 

I certainly accept it. But how about other financial institutions that 

are involved in the use of derivatives to a large extent to balance 

risk? 

Mr. NICOLAISEN. You started out with a very good analogy to income taxes. And if you don’t mind, perhaps I could use that as a 

comparison to what we are dealing with here to try and bring it 

closer for those who are not day-to-day working with Statement 91 

or 133. 

If you consider the tax code, we are all required to submit income 

taxes every year. We prepare our returns, or we have them prepared for us. But we do have the responsibility to report all of the 

income that we have earned during the course of the year. That is 

a very clear responsibility, basic. It is a basic principle that exists. 

Similarly, within the accounting world, we have accounting 

standards like 133 which requires all companies in principle to reVerDate 0ct 09 2002 15:45 Jul 06, 2005 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 G:\DOCS\22157.TXT FIN1 PsN: MICAH
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port true earnings at their value, including their interest in derivative transactions. 

In the detailed area, I would submit that the income tax code 

would be viewed by many people as complex, that it has a lot of 

attributes to it that the average person may in fact find to be complex, but they are still required to comply with it. 

The accounting literature also has complexities to it, and I think 

people would generally acknowledge that 133 is one of those standards that has a fair amount of guidance and detail attached to it. 

In your income taxes, while you are required to report all income, 

if you choose to deduct certain expenses in your income tax returns, you are required to follow the rules of the IRS. You are required to comply and have forms and detailed procedures and fully 

enact all of those things if you want to qualify for a deduction. 

Similarly, under Statement 133 there is an exception to the basic 

principle, and that exception says you can do hedge accounting, 

and hedge accounting is appropriate, so long as you follow certain 

rules. 

Those rules are not overly complex. I think those rules are clear. 

They are laid out. They are laid about because the FASB thought 

it was important to maintain the financial integrity of reporting—

when exceptions to basic rules are followed, that you had to comply 

with these essential elements. 

And they exist, and I do believe that those large financial institutions who engage in derivative transactions are familiar with those 

rules. 

That is a very long answer. 

Mr. KANJORSKI. No, that is okay. I appreciate that answer. But 

it takes me right back to the beginning of my examination. 

How do you account for the fact that—it is a mystery to me; I 

am trying to search out—over a period of 4 years the same rules 

were interpreted and applied the same way, the federal regulator 

was present; the issues were raised in the exit audit each year, internal auditors gave opinions that concurred and said the rules 

were properly interpreted; and external audits of the finest accounting firms in the world, one of the major fours, rendered the 

same opinion? 

How does that happen? 

Mr. NICOLAISEN. What you are asking is an important question. 

It is not one that I can respond to today. We do have an ongoing 

investigation into the causal aspects——

Mr. KANJORSKI. I understand that. You are in an investigation. 

I am not asking you opine on it. I am talking about the hypothetical now, moving it away from Fannie Mae. 

If that happened for 4 years with a regulator present, an exit 

audit raising the question, internal auditors concurring in the opinion of how the rule was applied and an external auditor of a major 

accounting firm opining the same way, why should we assume that 

that does not exist in every other financial institution in the country or has a strong possibility? 

And if so, what are we doing or what is the SEC doing to make 

sure it is not the case? 

Mr. NICOLAISEN. I can’t really respond to that in a generic sense. 

I think that the rules, the practices, the enactment of SarbanesVerDate 0ct 09 2002 15:45 Jul 06, 2005 Jkt 000000 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 G:\DOCS\22157.TXT FIN1 PsN: MICAH
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Oxley, the various disclosure requirements that exist, the checks 

and balances provided, intended to be provided by having management prepare financial statements, auditors review and opine on 

those financial statements, boards of directors engaged in oversight 

activities. That combination is what is in place to provide what I 

think Congress has believed to be the appropriate safeguards. I am 

not sure I could tell you in every instance everyone in that chain 

of supply has preformed to the fullest ability. 

Mr. KANJORSKI. Just the question: Since it happened in a quasipublic operation that has a regulator, has oversight by Congress 

and has all these protections that really don’t exist in many other 

financial institutions to that extent, do we have any reason to believe or worry about the fact that this may be systemic in dealing 

with derivatives? Are they not necessarily being properly accounted 

for? 

Chairman BAKER. And that will be the gentleman’s last attempt 

at it, because his time has really expired—one more time. 

Mr. NICOLAISEN. I really can’t address what others are doing in 

that level of detail. 

The two issues that we looked at were reasonably narrowly confined. We addressed all the facts that were specific to Fannie Mae 

in reaching our conclusion. 

I do understand the importance of——

Mr. KANJORSKI. I am not really worried whether you have something to worry about. Do we have something to worry about, our 

responsibility? 

Mr. NICOLAISEN. I think it is an important consideration for you. 

Chairman BAKER. The gentleman’s time has expired again. 

Ms. Biggert? 

Mrs. BIGGERT. Thank you, Mr. Chairman. 

Mr. Nicolaisen, at this time both Fannie Mae and Freddie Mac 

are in the process of restating their financials. 

Does your office require public companies that are not current 

with their books to resort regularly to the FTC? 

Mr. NICOLAISEN. That, actually, is not within my office, and I 

would be stepping outside of my bounds if I were to try to address 

that. 

I would say this: Good information, current information is important all the time for investors. We are looking at the investors’ interest in this. 

So as a general concept, I think you could assume that we are 

looking for current information. That is why our rules were written 

the way they have been written. But that is not my area of expertise. 

Mrs. BIGGERT. In your opinion, should companies that are not 

up-to-date with their financials be delisted or otherwise disciplined 

by the market? 

Mr. NICOLAISEN. Again, that is outside of my area of expertise. 

A lot of other people could make comments on that. 

Mrs. BIGGERT. What role will you play in the restatement of 

Fannie Mae? 

Do you have a sense of how long it will take to complete the restatement of Fannie Mae? 

21

Mr. NICOLAISEN. It is probably somewhat difficult to put a time 

table on the restatement. Let me describe the process as I would 

understand it. And perhaps that will help shed some light on that. 

My instructions to Fannie Mae were to restate their financial 

statements for these two issues. In the course of looking at those 

restatements, it is the primary responsibility of the company working with its advisers and others to develop responses to those restatements. 

That will likely take some time. They probably will have to look 

at the company’s books and records and get back to source documents. And I suspect there will be a number of months that will 

be required for them to do that. 

Following that, perhaps to some degree parallel to that, the external auditor will be required to report on the years 2001, 2002, 

and 2003, as restated. That will also take a fair amount of time. 

So while I can’t put a precise time period on this, I would imagine that we are talking a number of months, perhaps years. I hope 

it is not years. 

Mrs. BIGGERT. Some have said that FAS 91 and FAS 133 are 

overly complex accounting standards. 

Do you think that is a fair statement? 

Mr. NICOLAISEN. Well, I tried to address that a bit with Mr. Kanjorski. 

The statements are long. They do have a lot of attendant and interpretive guidance that is provided with it. 

The reasons for that, I don’t think, are because the statement is 

particularly complex. I think it is because the business world has 

reasonably complex transactions and iterative developments of different products sometimes require new interpretations. 

The basic principle is pretty straightforward. As I described, are 

recorded at fair—in the financial statements, derivative instruments that bear value with adjustments running through the income statement. 

The exception to that is for hedging. And where hedging is required, the hedging rules are straightforward, clear. Each company 

would have some interpretive aspects, no doubt, that they would 

deal with to various degrees as they apply, but I think they are 

very crystal-clear rules. 

Mrs. BIGGERT. Well, OFHEO Director Falcon stated before this 

committee last October that these are black and white accounting 

issues, and they are not issues of interpretation, and they are not 

issues where reasonable people can disagree. 

Do you agree with that statement? 

Mr. NICOLAISEN. Let me say this: We did our independent review 

of these two areas. We reached an independent conclusion based 

upon the facts as provided by Fannie Mae. We also read the information that was provided to us by OFHEO in OFHEO’s report. 

And it is my view that they—without addressing the causal issues, 

which, you know, is part of an ongoing investigation—it was my 

view, which I believe I stated clearly, that Fannie Mae did not comply with GAAP in material respects with respect to these two 

issues. 

Mrs. BIGGERT. Thank you very much. 

Thank you, Mr. Chairman. 

22

Chairman BAKER. I thank the gentlelady. 

Mr. Scott? 

Mr. SCOTT. Thank you, Mr. Chairman. 

Mr. Nicolaisen, I think that the charge that this investigation is 

on sort of falls on two prongs: One is the charge that Fannie Mae 

intentionally manipulated its accounting to one, smooth earnings 

and, two, they manipulated their accounting to meet earnings targets, to set in motion executive bonuses. 

Would you say that is the kernel of your investigation? 

Mr. NICOLAISEN. No. My investigation was only of the accounting 

for two issues. Whether or not it complied with GAAP did not in 

any way get to the question of intent or why this occurred. It is 

the question of the facts and my assessment of those facts. 

We do, though, as you know, have an ongoing investigation with 

our enforcement division, where other matters are being considered. 

Mr. SCOTT. How much weight are you giving to those two areas 

of the——

Mr. NICOLAISEN. Two areas being? 

Mr. SCOTT. Obviously, this is my point. The cloud over Fannie 

Mae is largely due to the fact that, one, that they allegedly cooked 

the books to smooth over earnings and they cooked the books so 

that they could get bonuses. 

That is what is in the minds of the nation, people that must have 

credibility. My question is simply: To what extent is the Securities 

and Exchange investigation looking into those two areas? 

Mr. NICOLAISEN. You should be confident that we are looking 

into those areas. 

Mr. SCOTT. All right, and it is safe to say then that you cannot 

go further into that because of the ongoing investigation. Is that 

what you are saying? 

Mr. NICOLAISEN. That is correct. 

Mr. SCOTT. Okay, let me ask you this: At what point did you get 

involved in this? 

Was it at the point of—because I noticed in your testimony, 

Fannie Mae came to you. Was that the point that you got involved 

in it, or did OFHEO consult with you prior to them making their 

announcement on this? 

Mr. NICOLAISEN. Let me, maybe, do a little chronology here. 

A few days before OFHEO released its report, they asked to meet 

with us. And in that meeting with us, they basically described 

what they would be saying in their report. 

In that context, they did not look for our agreement with what 

they had to say. They didn’t ask for that. They simply were informing us of what they were about to release. 

We often work with other agencies within the government. We 

think that is appropriate to do so. 

In this particular instance, though, it was not a situation where 

OFHEO had met with us and reviewed in detail with any kind of 

ability for us to be engaged in thinking about those accounting 

matters. 

As I think you know, shortly after—very shortly after—OFHEO 

released its report, Fannie Mae did come to us and asked if we 

would consider these issues. 

23

And we agreed to do so and asked for submissions of fact by 

Fannie Mae in the same manner that we would from any other registrants. 

Mr. SCOTT. So, then, it is safe to say that OFHEO contacted you 

first; OFHEO released their report and then Fannie Mae contacted 

you. 

Mr. NICOLAISEN. Yes. 

Mr. SCOTT. On these hedge accounting, or derivatives, how widespread is that with other companies? 

I mean, a company as large as Fannie Mae having trouble with 

this method of accounting—how widespread is that with other similar large financial institutions? 

Mr. NICOLAISEN. Use of hedge accounting is pervasive across the 

financial world, certainly as employed by others. And so I would 

say it has substantial use. 

Mr. SCOTT. Well, it is unclear at this time as to the extent to 

which Fannie Mae’s practice has differed from other financial companies that were subject to significant earnings volatility due to 

market-driven accounting adjustments, as well as Fannie Mae. 

Are you able to provide us with, maybe, just a general view of 

how, what percentage of other companies fails to properly account 

for their derivatives? 

Is it common for the Securities Exchange Commission to find 

companies not in compliance with, as said, FAS 133? 

Chairman BAKER. That will need to be the gentleman’s last question. 

Mr. NICOLAISEN. I have not studied that—may I respond? 

I have not studied that in the sense that I feel comfortable describing that to you today. I think that is certainly something, if 

you would like, we could provide additional insight to. 

We actually do not keep that kind of information within my office. 

And perhaps there are actually some public sources that may 

also provide insight to that. I did read a recent release on restatements of financial statements. That is in the public domain and 

can identify some of the issues that existed there. 

But what I do want to be cautious about, though, is I don’t think 

that it is axiomatic that, when you use the word ‘‘derivative’’ and 

‘‘restatement’’ that it would be for the reasons that we are looking 

at with respect to Fannie Mae. 

Chairman BAKER. The gentleman’s time has expired. 

Mr. SCOTT. Thank you. 

Chairman BAKER. Mr. Fitzpatrick, do you have questions? 

Mr. FITZPATRICK. Thank you, Mr. Chairman. 

Mr. Nicolaisen, I appreciate your taking the time to speak to us 

today, and appreciate your candor. 

This is the second accounting scandal, I guess it is being called, 

affecting government-sponsored enterprises. 

Freddie Mac is not an organization that is registered with the 

SEC, but are you able to outline the differences between what happened at Freddie Mac versus what happened at Fannie Mae? 

Mr. NICOLAISEN. No, I have not followed the Freddie Mac issues 

closely, and I am not able to do that. 

24

Mr. FITZPATRICK. So you don’t have an opinion as to which might 

have been more severe? 

Mr. NICOLAISEN. No, I do not have an opinion. 

Mr. FITZPATRICK. Thank you, Mr. Chairman. 

Chairman BAKER. If the gentleman will yield, I think the distinguishing features between the two events is Freddie Mac, ironically, was underreporting its revenues to present a smooth picture 

of earnings, whereas in the case of Fannie Mae, it was an underreporting of risk, which lead to an overestimate of revenue. 

So the two were markedly different, at least in my judgment. 

I thank the gentleman for yielding. 

Mr. Baca, you are next. 

Mr. BACA. Thank you very much, Mr. Chairman. 

It has been reported that the SEC has been ranking with the 

regulators of OFHEO. How can we ensure that confidentiality is respected and that Fannie Mae has had an opportunity to address 

the issues that have come to light? This is question number one. 

And is there any incompatibilities between SEC enforcement 

missions and OFHEO’s mission as the ongoing regulators of Fannie 

Mae? 

Mr. NICOLAISEN. Let me try to respond to those. 

The SEC’s ongoing investigation is not something that I can talk 

about publicly, but it certainly is addressed at what our primary 

role is, which is to look to the financial reporting and fullness of 

disclosures of those companies who register securities with us. 

And in that context, our role is different than OFHEO’s role, 

which is as a safety and soundness regulator. We are interested in, 

did companies comply with GAAP reporting requirements. 

Mr. BACA. What is the status of pending civil and criminal investigations, and how could this affect the soundness of Fannie Mae? 

Mr. NICOLAISEN. Those are issues outside of my area of expertise; I would not know. 

Mr. BACA. If Fannie Mae’s accounting is currently the subject of 

a criminal investigation, are there any laws or regulations that we 

should be mindful of in holding this public hearing today, in terms 

of the areas we can cover, which is question number one. And how 

can we assure that the people’s right are protected is question 

number two. 

Are there any areas of questions you will not be answering today 

as a result of the confidentiality requirements? 

Mr. NICOLAISEN. Yes. As I said in my opening remarks, anything 

that relates to our ongoing investigation, which we want to maintain the integrity of, I would not be able to comment on it at this 

session. 

Mr. BACA. How can we assure that the people’s rights are protected? 

Mr. NICOLAISEN. I am not sure that I am the person to respond 

to that, either. I think, you know, it is an important question. It 

is probably an important question for you to ask. 

I am not sure I am the person to——

Mr. BACA. Maybe the question should be: Why are we here, and 

why are you here? 

Mr. NICOLAISEN. You know, I am here at your invitation and——

Mr. BACA. Right, thank you. Let me ask the next question. 

25

Now that the staff has responded for potential accounting irregularities at Fannie Mae’s have prepared or have been removed 

from the regulator’s employment, do you have any advice as to how 

the company, OFHEO and the Congress can assure that these sort 

of problems will not occur again? 

Mr. NICOLAISEN. I can’t respond to that, because it is forwardlooking. 

And I would say that the actions that I have read about that are 

in the public record are the actions that you would expect to take 

place: engagement of new audit firms, an agreement to restate, use 

of outside advisers and specialists to help them to do that. Those 

are the kinds of actions that I would expect would be appropriate. 

Mr. BACA. Is it your opinion that Fannie Mae will be able to continue to carry out its core mission? 

Mr. NICOLAISEN. I would not have a view on that. 

Mr. BACA. No opinion at all? 

Mr. NICOLAISEN. No. 

Mr. BACA. No view? 

Mr. NICOLAISEN. No. 

Mr. BACA. Okay. 

Given that these accounting rules apply to any member of the 

company, do you think it would be appropriate to investigate other 

companies that have applied this accounting standard, to ensure 

that their books are in order? 

Mr. NICOLAISEN. We would not comment on our ongoing investigations of other registrants or anything that is not publicly——

Mr. BACA. But don’t we want a fair process to hold other companies accountable for same thing that we are asking Fannie Mae to 

be accountable—we should be holding other companies accountable 

as well, to assure services are provided that follow the regulations 

that are in order? 

Mr. NICOLAISEN. I think it is fair to say that we always look for 

a level playing field. 

Mr. BACA. And that we should not discriminate against one or 

the other for any reason? 

That is why the accounting should be done; the same standards 

should be done. There should be a due process that should be in 

place, and that everybody should be held accountable, not just one, 

and not just for whatever reason, political or otherwise. 

Mr. NICOLAISEN. Certainly that is ideally correct. We do know 

that there are instances of enforcement in other areas, whether it 

is traffic ticket or otherwise, where not everybody who is violating 

the law is necessarily subjected to the same punishment as the one 

who happens to have been caught. 

Mr. BACA. And that is not fair when we enforce it on one and 

not on another. We should enforce it on all companies. 

Mr. NICOLAISEN. We try to enforce it on all. That is why the financial industry is structured the way it is. I can’t—you know, this 

is within your purview as to how that occurs. 

But I would refer back to various pieces of legislation that are 

intended to require companies to report, auditors to be involved, 

boards of directors to have their roles in the activities of corporate 

America. There are a lot of things that are in place today. 

Chairman BAKER. The gentleman’s time is expired. 

26

Mr. BACA. Thank you very much, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

Mr. Shays? 

Mr. SHAYS. Thank you. 

Basically, you are sitting in the same place where Mr. Raines 

spoke very defiantly, very angrily, saying that Fannie Mae had 

done nothing wrong and OFHEO was just off-base and that the 

SEC would vindicate him and Fannie Mae. 

Is there anything that you have done in your report that vindicates Fannie Mae or Mr. Raines? Or, in fact, did you reinforce the 

OFHEO report? 

Mr. NICOLAISEN. Well, again I dealt that with just the two accounting issues. And with respect to those two accounting issues 

my view and the view of my staff was that Fannie Mae did not 

comply with GAAP. That is a view that was expressed by OFHEO. 

OFHEO expressed a lot of other views in their report to which 

I have no comment and certainly was way beyond any——

Mr. SHAYS. But basically your investigation reinforced the fact 

that Fannie Mae had overstated earnings by approximately $9 billion? 

Mr. NICOLAISEN. No. I want to be careful here as well. I have not 

expressed a view as to the amount of any restatement. That needs 

to be dealt with by the registrant, Fannie Mae, and their auditors. 

They need to work through those numbers. 

I have simply said that, as I read the accounting literature as I 

have seen it applied as using my experiences, that Fannie Mae did 

not comply with the literature. And that requires restatement. The 

amount of that restatement has yet to be determined. 

Fannie Mae, in its public disclosures, did say that the amount 

could be as much as $9 billion net of tax. 

Mr. SHAYS. But the bottom line is it wasn’t that they understated 

their income, they overstated their income. Is that correct? 

Mr. NICOLAISEN. That is correct. 

Mr. SHAYS. And in the process of overstating income, investors 

believed that Fannie is a better investment than the reality. 

Mr. NICOLAISEN. Yes, I——

Mr. SHAYS. I am not asking you to comment. But it is the reality. 

Fannie and Freddie are not, by law, under the 1933 and 1934 

Acts, which basically requires them to register with the SEC. Tell 

me under what basis you were able to do this investigation. 

Mr. NICOLAISEN. Well, Fannie did come to the commission as a 

voluntary registrant under the 1934 Act. There is various levels of 

detail that you may or may not be interested in that, but basically 

they have volunteered to register with the commission. 

Mr. SHAYS. Right. But can I qualify the word ‘‘voluntary’’? They 

were going to be required by law to be under the 1933 and 1934 

Act in order to take the wind out of the sail of that they voluntarily 

agreed, which was, in my judgment, the height of arrogance. You 

know, everything they seem to do, is—they do it at their decision, 

when they want. 

And what I am asking you is whether they ‘‘voluntarily agreed’’ 

or whether they were forced to, they are now not totally, but mostly, under the 1934 Act. 

27

My question to you is what gave you the right to do this investigation? If they had not been under the 1934 Act would you still 

have been able to do this investigation? 

Mr. NICOLAISEN. If they had not registered with us, I don’t believe we would have been involved in this type of review. 

Mr. SHAYS. I just want to say this, Mr. Chairman. What is stunning about this investigation, the extraordinary arrogance of both 

our GSEs. They have fought for years to not be under the Act. And 

when we had Enron and WorldCom and we looked at SarbanesOxley, it became eminently clear that these guys, these two companies, were basically exempt, pretty much, from Sarbanes-Oxley. 

And what is so stunning is they are so large and so big. 

So if in fact they weren’t under the 1934 Act, whether it was 

‘‘voluntary’’ or ‘‘forced to,’’ we might not know this information 

today. Isn’t that correct? 

Mr. NICOLAISEN. I can’t speculate. 

Mr. SHAYS. Let me say this: It is unlikely that you would have 

been able to do your investigation. Is that correct? 

Mr. NICOLAISEN. Well, if they were not registered with us, we 

would not have conducted the type of review that are completed in 

December. 

Mr. SHAYS. I would like to say to the other members of the committee that have fought tooth and nail Fannie and Freddie from 

being under the 1933 and 1934 Acts, this is the best lesson to this 

committee and to members of the need for Fannie Mae and Freddie 

Mac to play by the same rules that everyone else does and be 

under the same rules and requirements as anyone else is. 

And I am grateful that you looked into this. But if you had not, 

the world would still be thinking that OFHEO was just on this, 

somehow, vendetta. And you gave credibility to what OFHEO had 

done. And frankly, they have been a very weak overseer. 

So I am happy you have done what you have done. I just know 

there is more to be done. 

I hope the arrogance of the GSEs is dealt with by this committee 

once and for all. 

Chairman BAKER. The gentleman’s time has expired. 

Ms. Wasserman Schultz? 

Ms. WASSERMAN SCHULTZ. Thank you, Mr. Chairman. 

I guess I would like to ask a naive question for a freshman, and 

the question would be of you. Would that be appropriate? 

Chairman BAKER. I am sorry, I was trying to figure out my——

Ms. WASSERMAN SCHULTZ. This might be a naive question for a 

freshman since I am not familiar with the procedure, but it would 

be okay to ask you a question? 

Chairman BAKER. Certainly. Yes, whatever you like. 

Ms. WASSERMAN SCHULTZ. Okay, thank you. 

I have felt some frustration during this meeting that most of the 

questions that have been asked of Mr. Nicolaisen he is not able to 

answer. 

And I have—I spent 12 years in the legislature and I am accustomed to being able to question people who come before committees 

and get substantive answers and feel, when I leave a committee 

meeting, that I should come away with more than I arrived with. 

28

And I am not going to leave this committee meeting feeling that 

way. 

So I guess my question of you is: Are there plans by the chairman or perhaps the full committee chairman to bring someone before the subcommittee that can answer the substantive questions 

that we have been asking? 

Chairman BAKER. I appreciate the gentlelady’s question and it is 

not a naive or simple question. 

The answer is: Most of your colleagues would tell you we have 

had far too many hearings on this topic already. 

However, going forward I can assure you, as the legal processes 

permit the committee to receive the information which has been requested, either by correspondence or by another appearance of SEC 

representatives, we certainly will. 

And going forward, as we work our way through the regulatory 

reform process, many of the issues raised that I feel, and I think 

Mr. Kanjorski feels, should be addressed—even though Nicolaisen 

is not in a legal posture today to make comment, I assure you the 

committee will proceed to address in any event. 

But certainly the information will be forthcoming as the lawyers 

let us talk. 

Ms. WASSERMAN SCHULTZ. Thank you. 

And I guess the questions that I might want to ask, because I 

am at the end here, I have realized that most of them you will not 

be able to answer. So I would just as soon save them for when we 

have someone who comes before the committee who can. 

Chairman BAKER. I thank the gentlelady. 

I have Mr. Matheson next. 

Mr. MATHESON. Thank you, Mr. Chairman. 

I think, following up on Mr. Kanjorski’s line of questioning at the 

start of this hearing, FAS 133, as I understand it—and you may 

need to help confirm this for me—was a rule that was put in place 

to help provide some guidance both in the hedge transactions 

and—its attempt also was to try to levelize or normalize earnings. 

Is that a fair statement, that that was one of the goals behind 

that rule? 

Mr. NICOLAISEN. No. 

Actually, the standard itself had its origins back in the early 90s 

when the use of derivative instruments had gained quite a bit of 

momentum. They were used extensively. 

The amount of accounting literature available to reference for 

that was very limited, so people had various interpretations. That 

was the primary reason for the FASB’s effort. 

In its deliberations, the FASB had concluded that letting the volatility that does exist in the capital market transactions show up 

in the financial statement was an appropriate answer. 

Many people were concerned that if you had transactions that 

were essentially viewed as a single transaction—they typically are 

viewed together—that that left accounting with an income statement mismatch. And that is where hedging really is used and has 

been requested by many who had responded to the FASB’s project 

on derivative accounting. 

And hedge accounting does allow, under very specific circumstances and tight rules, the offset, if you will, of gains and 

29

losses so that when you have items that are matched they are reflected in the same accounting period. 

Mr. MATHESON. You have been asked about the degree of interpretation that could be applied to 133, and I have heard your answers on that. And I—the question I would follow up with is—and 

this follows up on Mr. Kanjorski’s concern of what is going on with 

other companies in this country as well—is 133 adequate? 

Even though, you know, it can be interpreted in a clear way, is 

it adequate in its form for this emerging use of, and expanding use, 

of derivatives in financial transactions? 

Does it merit review to see if it ought to be revisited to provide, 

not necessarily even greater clarity, but should it be revised to better reflect capital markets in 2005? 

Mr. NICOLAISEN. It is certainly one of the statements amongst 

others that should be reviewed periodically to make sure that they 

are meeting the expectations and the objectives that were originally intended for them. 

I want to be careful, though, and say that the standard, as it exists today, is being enforced. 

We do expect registrants to follow those rules and to be compliant in preparing their statements, which they purport to be GAAP 

financial statements. 

Mr. MATHESON. Okay. Thanks, Mr. Chairman. 

I yield back. 

Chairman BAKER. I thank the gentleman. 

Mr. Davis? 

Mr. DAVIS OF KENTUCKY. Thank you, Mr. Chairman. 

In Kentucky, we are working closely with Fannie Mae to expand 

home ownership opportunities for first-time owners, planning workshops, reaching out into the community. 

And in that vein, it is especially important that these people who 

are often entering the financial market for the first time in their 

lives have trust and confidence in our institutions. I think this is 

especially critical with government-sponsored enterprises, where 

good faith is quite important. 

With that, as the committee considers GSE, legislative reform 

proposals will be on the table in the coming months led by the 

chairman, are there any provisions that you would specifically recommend that we include to avoid these types of what might be an 

understatement or misstatements in the future by GSEs? 

And in effect, what would you do to simplify and mistake-proof 

the process? 

Mr. NICOLAISEN. Well, you have a tough undertaking and a very 

important one. 

I have not given the type of consideration to that issue to be in 

a position to advise you as to what direction you should head. 

I do believe that the application of GAAP financial accounting is 

important. And I also believe that companies who register their securities with the SEC follow GAAP—that that is a hallmark of importance. 

Mr. DAVIS OF KENTUCKY. I will take that one step further. 

In my other life as a consultant, I liked to ask folks their biggest 

area of pain to get below the symptoms down to the root cause. 

30

You, in effect, do that as chief accounting officer for the SEC. 

What would you say regarding GSEs is the biggest, and specifically 

Fannie Mae, is the biggest area of pain you are experiencing or 

identify other than having to testify before a subcommittee here? 

Mr. NICOLAISEN. I actually have limited my involvement to only 

Fannie Mae. So I am not in a position to describe the other GSEs 

or what is in common with them. 

Mr. DAVIS OF KENTUCKY. I yield my time back. 

Chairman BAKER. I thank the gentleman. 

Mr. Meeks? 

Mr. MEEKS. Thank you, Mr. Chairman. 

I just have a few questions. There are just a couple of things that 

I guess maybe I am not grasping; I don’t understand. 

And I think that reading some of your testimony and listening 

to some of the answers to questions, it seems as if you said that 

the interpretations of FASB, et cetera, is basically clear cut, that 

there is not a lot of room for misinterpretation. 

So my first question would be—this goes back to 2001. And this 

issue did not come up, or OFHEO apparently in looking at the 

books from 2001, and 2002, 2000, didn’t see anything, didn’t say 

anything that there was a violation. 

So I was wondering, did they previously interpret the rules differently? Or what should they have been looking for so that if, in 

fact, there was an error, that they would have discovered it earlier? 

Mr. NICOLAISEN. I am not familiar with the process that they 

apply then or now. 

The two issues that they did raise, that Fannie Mae chose to ask 

me to address, were issues that in my view and the consideration 

of my staff were pretty clearly not in compliance with GAAP. 

Mr. MEEKS. Again, and I—then maybe—and this is probably my 

last question—because here is my confusion also. 

We have independent auditors that are looking at a similar situation, in this case KPMG, and based upon those audits they obviously must have felt something was different or they interpreted—

because they basically believed that Fannie Mae was implementing 

FASB 91 and 133 correctly. 

But yet, from your testimony, you are saying that there is no 

room or there was no room—and I don’t understand it. 

Has anyone had conversations with KPMG to find out how did 

they do their audit and any question with regard to them, because 

they signed off on the audits and said it was being implemented 

properly? 

Mr. NICOLAISEN. Right. 

On the knowledge, again, that we do have an ongoing investigation, it is fair I think to conclude that in that ongoing investigation 

that we look first to the preparer of the financial statements, in 

this case Fannie Mae, what was their process, what did they do, 

what happened, what went wrong. Those are all things that I am 

not prepared to testify to today. That is an ongoing investigation. 

Secondarily, and perhaps related to it, on a parallel track, where 

was the auditor, what was the role, what type of audit was being 

conducted? 

31

I think you should assume that we will have a thorough investigation, that we will continue our efforts, and that we will be prepared to comment on those at an appropriate time. 

But at the moment, I can’t tell you what went wrong in 2001. 

Mr. MEEKS. Well, I just asked the question because it seems to 

me, even with the prior major accounting scandals that we have 

had, we saw that it was the accounting firms who were checking 

off on them. We then showed that there had to be some kind of collaboration between the two. 

I don’t know in this scenario because, generally, if you sit on the 

board of directors of any organization, you want to have an independent auditor that comes in to review the books. And you may 

ask them for their questions and their interpretations. And oftentimes you will accept that and say that, ‘‘Okay, we are moving’’—

if you are sitting on the board. That is what you are utilizing to 

use prudent judgment; you accept what their standards are; you 

move forward in that direction. 

And so, I am just curious to find out because there is a lot of—

I think Mr. Scott indicated, you know, what a lot of us—what is 

on the minds of a lot of American people, and clearly based upon 

some of the questions that was asked, there is a lot of individuals’ 

reputations on the line, at stake here, and I think that just before—I would just like to understand the essence of it. 

And I guess we can’t get at it here, as my colleague Wasserman 

Schultz said, there is—understand, an ongoing investigation. But 

you are here, and so therefore those questions need to be asked so 

that we can make a judgment in totality as to everything that is 

going on as opposed to looking at half a picture. You know, it is 

like giving a case to a jury before the other side has a chance to 

put on his or her case. 

Mr. NICOLAISEN. Those are good questions. They are appropriate 

questions. And I can assure you they are questions that we have 

as well and that our enforcement division will be looking at the 

areas of which you have expressed concern. 

Chairman BAKER. The gentleman’s time has expired. 

Mr. Israel? 

Mr. ISRAEL. Thank you, Mr. Chairman. 

Virtually every question that I have of Mr. Nicolaisen, Mr. 

Nicolaisen can’t answer. So I just want to share something with 

him briefly. 

And I am going to ask unanimous consent to insert this in the 

record. 

It is a letter to the editor that appeared in Barron’s on December 

13th. And the letter—I will just read one paragraph very quickly—

‘‘As I read the press, Fannie Mae thought that it had applied 133 

quickly’’. So did Fannie Mae’s auditor, KPMG. So did Ernst and 

Young, Fannie Mae’s consulting accountant. 

‘‘But Fannie Mae’s regulator disagrees. Its consultant, Deloitte & 

Touche agrees with the regulator and disagrees with Fannie Mae 

and KPMG and E&Y. Now the mess has offloaded for arbitration 

to the SEC’s chief accountant, who says that it may take months 

to make a decision because of the complexity of 133. This is no way 

to run a railroad.’’

32

The author of that letter to the editor is Walter Schuetze, the 

former chief accountant of the SEC. 

My question to you, Mr. Nicolaisen, is: Is your predecessor right 

or wrong? 

Mr. NICOLAISEN. My predecessor has a right to his opinion. He 

expresses it often. I certainly appreciate it when he does. 

We don’t always agree on everything, but he certainly has the 

right to express his opinion. 

Mr. ISRAEL. You are not necessarily agreeing or disagreeing? 

Mr. NICOLAISEN. I am not agreeing or disagreeing with what he 

has expressed there. 

I think what I would read, knowing Walter Schuetze very well, 

I think he expressed a degree of frustration that is probably not 

uncommon. 

Mr. ISRAEL. Well, this letter and your statement reflects that 

there is a diversity of opinion, and certainly a lot of complexity to 

this. 

And I know that this subcommittee has always been very bipartisan. And I know that as we delve into this, we will have hearings 

that reflect that diversity and even includes the opinions of the 

GSEs on this matter. 

Mr. Chairman, I would ask unanimous consent to include this in 

the record, and I yield back. 

Chairman BAKER. Without objection. I thank the gentleman for 

yielding back. 

Mr. Nicolaisen, just in a wrap up, it would seem to me if I were 

in my vehicle headed home this afternoon, not caring what the 

speed limit is, maybe not even knowing what the speed limit is, I 

pick up my cell phone and call a Virginia state policeman and say, 

‘‘I am on 395. I don’t know how fast I am driving. Would you put 

a guy out there with a radar gun please?’’

He pulls you over and says, ‘‘Sir, I regret to inform you you have 

been speeding. And I noticed your vehicle is smoking a little excessively. I am going to look under the hood. I see your environmental 

control mechanisms are not properly engaged. I am going to have 

to write you several citations for this conduct. And it looks like the 

stuff was intentionally organized this way so you could either drive 

faster or get better fuel mileage.’’

Now, standing there before the policeman after I made the cell 

phone call, would my first line of defense be to say, ‘‘Look, there 

goes one driving faster than me’’? That probably wouldn’t work. 

Could I say, ‘‘Well, there is something wrong with this car. Maybe 

I should have known it, but I have asked for your expert opinion’’? 

There is something wrong with this vehicle. And now I am responsible for fixing the vehicle from compliance with the law. And 

in the meantime, since I called you up, you decide to open up my 

trunk and see what is there, too. Could be a bad day for you. 

My point is that despite the protestations to the contrary, it does 

not appear that this was a casual exercise on the enterprises’ part. 

They came to your good offices, asked for your professional opinion, 

and accordingly you gave it to them. 

One may not like the opinion, but it is professional, arm’s length, 

and done in the appropriate fashion, and I commend you for your 

work. 

33

And I know going forward the committee will have additional 

hearings and we await the results of your further inquiry and hope 

you will not find it necessary for the committee to ask, but hope 

you will inform us as you deem appropriate. 

I thank you for your time here and your participation was most 

helpful. 

Our meeting stands adjourned. 

Mr. NICOLAISEN. Thank you very much. 

[Whereupon, at 11:53 a.m., the subcommittee was adjourned.] 

(35)

A P P E N D I X

February 9, 2005

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