U.S. SECURITIES AND EXCHANGE COMMISSION

Litigation Release No. 19710 / May 23, 2006

Accounting and Auditing Enforcement Release No. 2433 / May 23, 2006

SEC v. Federal National Mortgage Association, Case No. 06-00959 (RBW) (U.S.D.C., D.D.C)

Fannie Mae to Pay $400 Million Penalty for Accounting Fraud

SEC and OFHEO Settle Action Against Fannie Mae

On May 23, 2006, the Commission filed a settled enforcement proceeding charging the Federal National Mortgage Association ("Fannie Mae"), a shareholder-owned government-sponsored enterprise, with fraudulent accounting in violation of the anti-fraud, books and records, internal controls and reporting provisions of the Securities Exchange Act of 1934 (the "Exchange Act") and the anti-fraud provisions of the Securities Act of 1933 (the "Securities Act"). In a related proceeding, the Office of Federal Housing Enterprise Oversight ("OFHEO") reached a settlement with Fannie Mae. As a result of its settlement with both OFHEO and the Commission, Fannie Mae will pay a total civil penalty of $400 million to the U.S. government.

The Commission filed a lawsuit in the United States District Court for the District of Columbia charging Fannie Mae with violations of Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; and violations of Sections 17(a)(2) and (3) of the Securities Act. Without admitting or denying the Commission's allegations, Fannie Mae consented to the entry of a final judgment in the Commission's federal lawsuit enjoining Fannie Mae from further violations.

In its federal court Complaint, the Commission charged that, between 1998 and 2004, Fannie Mae engaged in a financial fraud involving multiple violations of Generally Accepted Accounting Principles ("GAAP") in connection with the preparation of its annual and quarterly financial statements. These violations had the effect, among other things, of falsely portraying stable earnings growth and reduced income statement volatility, and - for year-ended 1998 - of maximizing bonuses and achieving forecasted earnings.

Specifically, in its Complaint the Commission alleged that Fannie Mae failed to comply with the accounting requirements of Statement of Accounting Standards ("SFAS") 91, which requires companies to recognize loan fees, premiums and discounts as an adjustment over the life of the applicable loans. In the fourth quarter of 1998, by not recording the full adjustment required by SFAS 91, Fannie Mae understated its expenses and overstated its income by a pre-tax amount of $199 million. Management's decision to book an amount significantly less than the adjustment amount required by SFAS 91 resulted in the company not only exceeding Wall Street expectations, but also hitting the earnings per share target necessary to trigger maximum bonuses. In the periods that followed, Fannie Mae made other departures from SFAS 91, including the implementation of a SFAS 91 Policy in 2000. Fannie Mae's SFAS 91 Policy used a "precision threshold" to determine the SFAS 91 adjustment amount the company would record. There is no support for the use of a threshold in SFAS 91. Implementation of the Policy led to misstatements of SFAS 91 amortization in all periods from the fourth quarter of 2000 through the second quarter of 2004. The Commission alleges that, on at least one occasion, Fannie Mae booked income when it was within its own Policy threshold, with the effect of meeting its earnings targets.

The Commission's Complaint also alleges that Fannie Mae failed to comply with the accounting requirements of SFAS 133, which governs the accounting for derivative instruments and hedging activities. Fannie Mae disregarded the requirements of SFAS 133 and qualified transactions for certain hedge accounting treatment based on erroneous interpretations and an unjustified reliance on materiality. By failing to comply with the requirements of SFAS 133, the company failed to qualify for hedge accounting. This failure led to the company issuing materially false and misleading financial statements for the periods covering the first quarter of 2001 through the second quarter of 2004. The vast majority of the anticipated restatement of at least an $11 billion reduction of previously reported net income is a result of Fannie Mae's improper hedge accounting.

In its Complaint, the Commission also alleged improper accounting practices involving the estimation and maintenance of the Loan Loss Reserve, the process of classifying the company's portfolio securities, the amortization of debt issuance costs, the consolidation of certain securitization transactions, the accounting for Dollar Rolls, and the valuation of aircraft asset-backed securities, among others. Several of the transactions, acts, practices, or courses of business alleged in the Commission's Complaint were directed and/or implemented with the knowledge or approval of Fannie Mae's senior management acting within their scope of authority.

In determining to accept Fannie Mae's settlement offer, the Commission considered the cooperation that Fannie Mae provided the Commission staff during its investigation. The Commission acknowledges the assistance of OFHEO in its investigation, which is continuing as to others.

SEC Complaint in this matter

http://www.sec.gov/litigation/litreleases/2006/lr19710.htm