[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]




 
                       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


                     U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2005
22-157 PDF

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North          HAROLD E. FORD, Jr., Tennessee
    Carolina                         RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
VITO FOSSELLA, New York              STEVE ISRAEL, New York
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio              JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
TOM FEENEY, Florida                  STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida           ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   AL GREEN, Texas
KATHERINE HARRIS, Florida            EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona                  MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania            DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico            GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas               
TOM PRICE, Georgia                   BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK, 
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina

                 Robert U. Foster, III, Staff Director
  Subcommittee on Capital Markets, Insurance and Government Sponsored 
                              Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair         PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma             MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois         HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
SUE W. KELLY, New York               JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio                  STEVE ISRAEL, New York
VITO FOSSELLA, New York,             WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois               CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio              STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina   BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
TOM FEENEY, Florida                  NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania            MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida            ARTUR DAVIS, Alabama
JEB HENSARLING, Texas                MELISSA L. BEAN, Illinois
RICK RENZI, Arizona                  DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky                BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK, 
    Pennsylvania
MICHAEL G. OXLEY, Ohio



                            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. Ruben.........................................    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


                       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.
    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.
    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 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.
    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.
    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 
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.
    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.
    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.
    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 
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.
    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.
    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.
    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 non-GAAP 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 understanding 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 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.
    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 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 
report 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 
Sarbanes-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 
quasi-public 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?
    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.
    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.
    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.
    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.
    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 
forward-looking.
    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.
    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.
    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 
Sarbanes-Oxley, 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. 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 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.
    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?
    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.''
    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.
    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.]


                            A P P E N D I X



                            February 9, 2005

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