Professional Documents
Culture Documents
OF TIMOTHY
LUCAS
In
re Fannie Mae
Securities
Litigation
CouP
District
of Columbia
MDL No
Consolidated Civil
Action
No
RJL
Submitted November
15 2010
Confidential
Qualifications
have years
until
Certified
Public
Accountant
CPA
and
For 14
my
May
of 2002
served
as Director
of Research
Technical
Activities
Accounting
Standards
Board
FASB
was
or
the
Board
The
FASB
is
designated the
to define
Generally
Accepted
Accounting
Principles the
in
United States
GAAP
staff
As Director
responsible
for supervising
FASBs
professional
research
which
comprised 50
to
CPAs PhDs
and
support
staff
also participated
in
the debates
and
procedures leading
in
In
particular derivatives
was
and
significantly
involved
the
Boards
of
technical
on
hedging
which
led to the
issuance
FASB
Derivative
Instruments
and Hedging
the
Activities
Statement
time
133
No
other
project
absorbed
also
as
much of
as
Boards time
or
my
period
19882002
is
served
Chairman accounting
of the Emerging
professionals
Issues
EITF
with the his
The EITF
group
of senior
who meet
regularly
FASB
Accountant
discuss
of the Securities
resolve financial
and
Exchange
Commission
that
arise in
SEC or
practice
designee
and
reporting
issues
the Director
of Research
to
Activities
at
the
FASB
was
to
Manager
there
from
1979
Sells
1986
the
FASB
in
1979
1972
an auditor
for Deloitte
Haskins
Big
1979
public
When
left
the firm
for overseeing
company
hold
audits
Bachelor of Arts
as
degree
in
Economics degree
list
and
all
degree
in
in
Accounting
as well
Master of Accounting
includes
Houston
years
Texas
list
My
of
or
all
resume which
cases
in
of
all
my
publications
over the
in
last
ten
and
litigation or
or
proceeding
last
which
is
served
an expert
Exhibit
report
testified
at
trial
by deposition
four
years
attached
as
Confidential
II
Assignment
have
been
retained
by
KPMG
in this
litigation
to address
certain
accounting
to
issues
pertaining relevant
of Statement 133
also
in
the time
2004
the
period
have
been
to
retained
to
identi
explain
certain
relevant
financial
and
respond
reports offer
to certain
opinions
expressed
by other experts
Berliner
in
this
matter
in this
the expert
of John
Barron and
Robert
submitted
In
this
report
some comments on
the contents
of those
reports
that
are related
to
Statement 133
In connection
with
my work my
on
this
have
called
on
the
knowledge
and
during
professional
My
my
opinions
are
based on
my
the
experience
expertise
in
financial
accounting
work
in
connection with
rate
preparation
my
report
have
in this
billed
KPMG
at
my
no
regular financial
hourly
of $650
the
am
of
independent
this
litigation
have
interest
in
outcome case
matter
my
fees are
in
no respect
contingent
upon
the
outcome
of
this
reserve
the right to
supplement
my
opinions that
based
on the opinions
expressed
by
plaintiffs
experts
and
any additional
information
might become
available
III
Snmmary Overview
of Opinions
In
my
opinion
as
to
implementation
the relevant
of Statement 133
was
reasonable
of
GAAP
regarding
in
specific
issues that
have
been
raised
Fannie
Maes
transactions
as described
below
and
have
found
that the
companys
approach
to applying
Statement 133
was
reasonable
appropriate
Fannie
Mae
identified as
13
transactions
that
were
most
significant
making
up
96% of
the
at
hedge
transactions
outstanding
of March
31 2004
based
on
notional
amounts
FMCIV-05 00700330
0390
Confidential
IV
Overview
of
GAAP
of accounting conventions
at
GAAP
accepted accountants
is
body
rules
and
define
accounting
follow
practice
particular financial
point
in
that
when
in
preparing
statements
related
footnotes.2
Financial
statements
prepared
accordance
with
GAAP
are
way
which
companies
report
their
financial
position
to current
and
prospective
investors
and
series
creditors
and
to other
such as regulators
to
set
issued
of Statements of Financial
characteristics that seeks
Accounting
to
Concepts
in
and
qualitative
it
achieve
GAAP
financial
statements
financial
Those
Concepts
is
Statements recognize
or
purpose
of
GAAP
and
statements
to
investors
creditors
of
company
That
intended
to
be useful
to
people
stock
who
are
making
economic
decisions
such as whether
to
buy
or
sell
companys
or to
extend
is
loan to the
company
financial
The Concepts
statements
that
there
cost to
preparing to
and that
both
accounting standards
cost benefit
implement them
should meet
practical
test.3
GAAP
has developed
the
from
its
number of sources
primarily
within
including
FASB
and
staff5 the
EITF
and
the
Accounting
AU
Section
411
The Meaning
effective
of Present
Principles
March
Financial
15
1992
AU
of
Fairly
in
Conformity
Accounting
Section
411
No
Objectives
See
FASB
Statement
of
Accounting Statement
Concepts
Financial
of Financial Reporting
by
Business
Enterprises and
FASB
Accounting
Concepts
No
Qualitative
Characteristics
of Accounting About
Information
at
FASB
under been
to
Facts
FASB 2007
to establish
available
at http//www.fasb.orglfacts/index.shtml
The
held
SEC
has
statutory the
authority Securities
financial
accounting
and
reporting
its
standards
companies
policy has
Exchange
private
Act of
1934
Throughout
to the
history that
however
the private
Commissions
to rely the
on
the
sector
in
extent
sector
demonstrates
ability
fulfill
responsibility
the
interest.
sellers including
The
standards
of
standard
Opinions
of
the
Accounting Procedure
Principles
Accounting by See
the
Research
of
the
AICPAs
that
at
Committee
on Accounting
include
have
been Guides
FASE
the
FASB
pronouncements 2007
are authoritative
Implementation
QAs
the
FASB
Facts
About
FASB
available
at http//www.fasb.org/facts/index.shtml
Since
organization
in
1973
Financial
Accounting
Standards
Board
FASB
has
been
the
designated
continued
on
next
page
Confidential
AcSEC
There
was
in
the relevant
time period
hierarchy
GAAP.6
10
GAAP
is
not frozen
or finished
it
continues
to
There
are
number of
because unclear which
areas
that
are subject
to
ongoing
efforts to
improve authoritative
given type
guidance
or
is
the existing
guidance
conflicting
address
of transaction
to
incomplete guidance
communicating
the transactions
the
applies
11
that
GAAP
is
not
an exact wide
science
Courts have
recognized
that
GAAP
is
term of Supreme
art
encompasses
for
range
of acceptable
that
procedures.7
is
The United
States
Court
GAAP
canonical
set
of rules that
will ensure
of identical transactions...
the choice
tolerate
range
of reasonable
leaving
among
altematives
to
management.. 12
both
Applying
GAAP
often
requires
significant the
professional
judgment
of
company
professionals
who
prepare
companys
financial
statements
professionals that
who
audit
them
in
GAAP
unambiguous
for
answers
the
questions
come up
preparing
financial
todays
is
corporations
and
it
who
prepares
the financial
statements
expected
to study
and
then
to exercise
professional
judgment
in
applying
them to the
from
previous
page
standards entities
sector
for establishing
of Those
financial standards
accounting are
that
govern
the preparation as
of
financial
officially
recognized
by and
the
Commission 2003
Policy
SEC
as
Financial and
the
Reporting American
Release
Institute
No
of
April
Statement Conduct
Certified
Public
Accountants
in
Professional
amended
1979
parentheticals
GAAP
Section
Hierarchy 411
in
AU
18
The
set
forth
in
the
authoritative to
auditing the
literature
in
particular into
its
in
completed
project
move
GAAP
Hierarchy
literature
Accounting
Standards
No
Accounting
In re
Issue
No
302
May 2008
675
n.22
Tool Thor
IKON Office Solutions Inc Sec Litig 277 F3d 658 Co Connr 439 U.S 522 544 1979
Power
Tool 439
Cir
2002
citing
Thor
Power
U.S
at
544
Confidential
companys
situations
specific
transactions
and
situations.9
As
the
companys may be
transactions
and
change
to
or as
accounting guidance
are
evolves
it
appropriate
for the
accountant
not
change
policies that
used to apply
GAAP
Such
change however
does
mean
at
in
previous
periods to
made wrong
those
that
It
is
inappropriate
just
because changes
in later
transactions
and
situations
change
policies
period
is
The
nature
of the accountants
test
such that
conformity with
GAAP
reasonableness
rather
than
an absolute
13
The
use
ofjudgrnent
is
an important
reporting reasonable
and
unavoidable
part
of
GAAP
Although
financial
statements
are basically to
results
of operations and
in
past
periods
GAAP
requires
the accountant
make
judgments
to interpret
estimates
information them
in
including
judgments
of how
GAAP
pronouncements of
practical
manner
Often new
interpretations
in
GAAP
for
subsequent
future
to the date
may
require
change
the
judgment
reports
the previous
financial
statements
wrong
They were
conformity with
GAAP
based
reasonably available
at
time
Derivatives
Hedging
and Hedge
Accounting
14
interest in
loan
contract
between
lender
and
borrower may
for
interest
provide
for the
payment
rate
of
various
ways
Some
contracts
provide
payments
at
fixed
e.g
5%
of
for the
life
of the contract
The popular
the contract
30-year
fixed-rate
mortgages
at
are
an example
this
contract
Alternatively
may provide
contract
for interest
rate that
floats
intervals
or
varies
with
specified
index
Under
such
the rate
is
reset
at
specified
See Remarks
by chairman
principles every
Arthur
Levitt
SEC
to
the
Numbers
straitjacket
Game New
Accountants
innovative
York
are
28
to
1998
Our
cannot
accounting
anticipate that
werent
meant
be
know
they
business
flexibility
structure to adapt
or every to
new and
transaction
develop
principles
allow
for
changing
circumstances.
Confidential
For example there are adjustable every year based on the then
rate
mortgages
referred
to as
ARMs
that
current
rate
on specified
U.S
Treasury securities
15
other
Derivatives
are contracts
that
provide
make payments
specified
or
transfer
assets to each
other
based on
underlying
variable
security
exchange one
party
rate
common
to
example
interest
an
interest
rate
swap
in
which and
agrees
stated
notional
amount
at
fixed
rate
the other
party
agrees
pay pay
interest
on the same
rate
amount
at
floating
rate
So
for
example
party
might agree
agrees to
to
fixed
of
3% on
the notional
amount
party
pay
interest
on
the
same amount
only as
is
at
the floating
rate
LIBOR
The
notional
amount under no
is
provided
in
the
contract
of periodic
the
payments
the contract
that
amount
not
paid
Typically
contract
requires
initial
payment of
from each
either party
and
interest
are
settled
net so depending
to the
on the
level
LIBOR
period
one
payment
other
16
there
Viewed
in
isolation
an
interest
rate
like
strange
instrument but
into
are practical
economic
for
uses
for
such contracts
rate
company might
debt outstanding case
enter
an
that
interest
rate
swap
example
driving fixed
if
it
had
floating
and
was worried
enter
rates
would
it
increase
up
its
interest
expense
In that
it
would
swap
where fixed
agreed to pay
If rates
rate
and
receive
floating
rate
often referred
to as
pay
swap
do
go
up
the
interest
on the debt
will increase
payments go
received
counterparty to
Of course
if
rates
down
the
company
that
have
make payments
have
interest
on the debt
otherwise
would
benefited
The company
if
has
itself
from an undesirable
outcome
increased
interest
interest
payments
if
rates
go
up
The
it
given
lower
payments
is
rates
decrease
decision
decision
to
hedge
the
hedge
particular
risk
exposure
an economic
quite
apart
from
LIBOR
published
or the
London
It
Interbank often
Offered as
Rate
is
market
interest
with
market
forces
and
is
daily
is
used
reference
for variable
Confidential
VIE
History of Statement
133
17
FASB
for Derivatives
and
Hedging
Activities
Statement
133
133
in
the
primary
after
GAAP
literature
for derivative
instruments
Statement
was
issued
1998
12
years
of development
effort
by the
FASB
and 1986
18
Increasing
innovation
the
including cited
new when
varieties
of derivatives
the decision
in
new
to
uses
for
them
was one of
agenda
highly
the reasons
FASB
it
made
add
to
its
broad
project
In the
990s
or
in
series
of
publicized
losses
of derivatives
for speculation
failed
hedges
cases
added
to the pressure
for the
FASB
to address
In
many
the losses
came
as
surprise
because
it
was
statements
that
the
company was
used to
limit
using risk
derivatives
derivatives
were
is
often
The
transaction
rate
swap
global
described
above
an example and
related
In
Statement 133
innovations
itself
the
Board
noted
Changes
in
financial
markets
financial
have
led to the
development
foreign
of new
derivatives
used to
manage Many
interest
rate
exchange
credit risks
believe
accounting standards
risk
have
not kept
pace
with those
believe
Derivatives
can
be useful
management
tools
and
some
that
inadequacy of
the
of
financial
reporting
may have
to
an
atmosphere
uncertainty
Concem
surrounding
about inadequate
large derivative
was heightened by
publicity
losses
at
few companies.2
19
The accounting
for certain
types
of derivatives
had
been had
previously to reason
addressed
in
the
GAAP
practice
many
transactions
the accountant
by analogy and
for the
was
diverse.13
Many
thought that
if
derivative
was
acquired
purpose
of
hedging For
interest
risk rate
the derivative
should be accounted
for as part
if
of the hedged
transaction
swaps
the
that
the
an outstanding
Statement
12
133 133
Issue
207 212
84-36
Interest
Rate
Swap
Transactions
and
FASB
Statement
80 Accounting
for Futures
Confidential
debt
it
would
be appropriate Under
that
to use
an accounting
if
approach
called
synthetic
rate
instrument
accounting.4
into
approach
in
the
company had
the
floating
debt
and
the
had
entered
pay-fixed
swap
as
the
example
if
above
were and
company would
treat
results
of the two
interest
instruments
as
they
one
synthetic changes
further
in
instrument
the
fair
It
record
expense
at
the fixed
rate
ignore
value
of the swap
This
that
is
called
hedge
accounting
and
is
discussed
below
developing
separate
accounting model
for
each
type
of derivative
broad
for
all
types
of
and
to define
accounting should
20
The Boards
Between
gestation
process
for
difficult
and
the
contentious
issued
1986
Board
six different
documents
three
defining
the issues
describing
accounting
for
approaches
formal
including
and
drafts with
opportunities the
comment
letters
companies
who
followed
process
that extensive
the
After
in
an
additional
step
in
the
Boards
on financial and
instruments
intended
to address
the
measurement measured of
this at
of derivatives
value
in
financial
instruments
fair
the
of financial
as the
position
pursued
to address
Certain
provisions
in
Board
continues
the
issues
its
broad project
21
with
The
process
of developing
the
and
hedging
did
not
end
the issuance
of the statement
FASB
anticipating
greater
than
normal volume
of complex
step
of establishing
group became
of expert practitioners
the Derivatives
Group which
positions
known
as the
DIG
That group
arose
included
be
in
to see
implementation
issues
as they
and
to
bring
Boards
14
Issue
84-36
Interest
Rate
Swap
Transactions
133
J2I6
Confidential
attention
periodically
to discuss
issues
and
recommend
referred
to
solutions
to the
Board
over 150
DIG
statements
of guidance
as
issues
were
published
22
The Board
also
received
requests
to
amend
the
new standard
The Board
first
amended
Statement 137
in
June 1999
to defer
the effective
date
in
amendments of
and 149
in
number of 2003
provisions
in
Statements
138
April
in
Throughout
this
period
for several
years
thereafter
SEC
staff
was
active
generating
comments
to registrants
and
in
frequent
public
comments
interpreting
the
standards
23
growing
The end
book
result
of
all
of
this
well
intentioned
activity
was
to
build
formidable and
difficult
of rules
Statement 133
implementation ended
became
significantly
challenge
their
Several
hundred
efforts
public
companies
when
implementation
were
deemed
inadequate
was
later
interpreted.16
Subsequent
the rules
to the relevant
time period
less difficult
SEC
and
the
FASB
have
those
moved
to
make
it
less
complex would
and
to
comply
additional
with.1
Absent
SEC 24
133
efforts
is
likely
there
have
been
numerous
restatements
In
June 2008
the
FASB
issued
an exposure
draft
proposing to amend
Statement
yet
again
The
stated
objectives
of that project
were to
Simpli accounting
Improve model and
the financial associated
for
hedging
activities
reporting
of hedging
useful
activities
to
make
the
accounting
disclosures
more
financial
statements
Resolve under
major practice
issues
related
to
hedge
arisen
from recognition
instruments
and
the
measurement accounting
for
anomalies hedged
between
items
the
accounting
for derivative
and
or transactions.8
See
e.g http//www.cfo.com/articIe.cfm/6874855/c
Nine Year Comparison
at at
2984409/ftarchives
21
see
also
Audit
Analytics
2009
2009
on March
SEC made
issued
an
announcement
Drafts
the
EITF
meeting and
FASB
Exposure
dated
June an
62008
see
infra
paragraph
51
and
the
See Accounting
for Hedging
Activities
Amendment
FA SB Statement
133
at
ii available
at
http//www.fasb.org/drafiled
hedgingamendment_st133.pdf
Con
fidentiat
25
the
In the
Background
and
Basis
for
Conclusions section
as
of the 2008
exposure
draft
Board
commented on
the reasons
follows
date
FASB
and
has been
asked to address
but not limited
on many
of hedge
accounting
including
issues related
to assessing
hedge
in
effectiveness the
ineffectiveness
As
result the
May 2007
for
Board
to
add
project
to
its
agenda decided
it
hedge
accounting
make
the
easier
preparers
of financial
reports
comply
and
the
financial
reporting
of hedging
activities
should be improved
to investors
make
other
hedge of
and transparent
and
users
26
applied changes
In
summary
the
Board
concluded
that
Statement 133 as
to
it
has
been
interpreted
and
is
complex and
the threshold
difficult
comply
with
include
for
hedge
accounting
from
of highly
to qualify
effective
for
qualitative
evaluation
of reasonably would
effective
making
it
easier
hedge
after
accounting
the
initiation
The
of
proposal
also require
effectiveness
hedging
relationship
only
if
the
hedge
may no
risks
longer
be reasonably
all
effective
It
would
values
eliminate
of
specific
so that
generally
changes
in
the
fair
or the
part
of the hedge
It
would
also
eliminate
all
of the approaches
that
ineffectiveness
27
The
FASBs
as
effort to simplify
hedge
accounting
that
it still
has not
been
to
completed
effort
of of
this
has
announced
instruments
intends
pursue
this
as part
broader project
on financial
rather
than
as
separate draft
expedited
project
The Board
on
included
many of
the provisions
of the 2008
exposure
in
an exposure
draft issued
May 26 2010
Accounting
for Derivative
19
Id
A3
Confidential
10
VII
Overview
of Statement
133
28
FASB
tried
to take
principles-based
approach
as
to
The Board
standard
all
four
fundamental
decisions
to
serve
cornerstones
derivatives
were were
to
sheet
all
derivatives
to
value
only
items
of assets and
liabilities
special
hedge
With
all
derivatives
on balance and
losses
sheet
and
measured changed
at
fair
value
it
was
necessary the
to
account
as the values
losses
depends
on whether
designated
as and and
as
hedge
for
hedge
accounting
gains
losses
on the derivative
recognized
earnings
29
called
for
two
different
kinds
of hedging
strategies.2
These
is
are
hedges
in
and
In
some
liability
strategies
the objective
to
protect
against
losses
the
fair
of an asset or
for
of
100 shares
of
XYZ
stock currently
selling
$100
per
share could
protect
it
of the stock
That derivative
would
pay
the holder
the share
price
declined
The hedge
for
however
price
that
the investor
give 133
up
at
least
some of
the upside
potential
gains
went
fair
up
Statement
provides
for
hedge
strategy
For
value
hedge
in
gains
and
losses
the derivative
hedged on
asset or
liability
are
recognized on the
the
earnings other
If the
hedge
works
as
expected
value
the gains
one
Fannie
Mae made
its
fair
hedge
its
accounting transparent
securities
disclosing
cumulative
of
debt
from hedge
accounting.22
20
Statement Arguably
133 Statement
133 that relevant
21
provides
third strategy
for foreign
currency
hedges
but
is
not
here
22
2003
Form 10-K
at
146
Ill
Pa
Confidential
30
cash
In
other
strategies
the objective
is
to protect the
against
adverse
changes
in
an expected
rate
flow
with
Paragraphs
interest
15
and
16
above
gave
example
debt
is
payments
will
that
vary
with
market index
LIBOR
would
If the
company
concerned
in
that rates
go
up
it
derivative
that
effectively
lock
fixed
rate
Statement 133
cash flow
hedge
In
cash
shown
gains
in
section
of
sheet
called
other comprehensive
hedged
item affects
income
earnings
at
or
OCT
The
or losses
remain
in
OCI
until
the
which
out
of
the balance
sheet
and
included
in
earnings
as
well
If the
hedge
the
gains
and
losses
will offset
in
the
same
future
period
reflecting
economics
of the
effective
hedge
future
in
the
income
statement planned
is
cash
strategy rather
may
than
involve
forecasted
cash
flow such as
issuance
an
existing
asset
or
liability
Cash can
flow hedge
in
accounting
section
transparent
The
reader
statements
see
the
OCT
of the statement
of changes
in
equity cash
and
in
related
flow hedge
relationships.23
31
deferred
In
summary
if
the strategy
qualifies
for
hedge
affects
accounting eamings
gains
and
losses
are
and
recognized
when
the
hedged
item
for cash
item
flow hedges
fair
or
offset
by currently of hedging
recognizing
on the hedged
losses
for
value
hedges
The purpose
activities
is
economic
the
and
volatility
The FASB
to
reflect
economics
of effective
accounting
in
Statement 133
that
The purpose
not
reflect
accounting
underlying
to
avoid
volatility
of financial statements
cash
would
fair
economics
gains
Both and
accounting derivatives
and
in
value
hedge
period
accounting
as losses losses
work
gains
to
recognize
losses
the
same
and
on the related
derivatives
hedged would
transaction
Absent
earlier
hedge
than
accounting
losses
gains
and
on
hedging
be recognized
and
gains
on the hedged
23
2003
Form 10-K
at
80 table
31
124
12
Confidential
positions
generating
accounting
volatility
that
would
misrepresent
the
economics
of the
transaction
32
133
derivative
transaction
can qualify
for
for
hedge
accounting
is
under hedge
Statement
is
conditions
for qualifying
hedge
said to
accounting be effective
that
the
expected sometimes
derivative
be
highly
effective
item
hedge
is
if
the
losses
and
gains
on the hedged
are offset
by gains
and sometimes
losses on the
33
Statement 133
in
introduced
the idea
Ineffectiveness
is
easy to understand
fair
fair
value
hedge
change
amount
in
the
value
to the
in
the
fair
of the hedged
is
Assuming
For
one
cash
of those
gain
is
loss
the difference
ineffectiveness
flow hedges
eliminate or
however
reduce
including
involving
forecasted
transactions
the objective
is
to
variability
in
future
cash
flows
cash flows
If there
is
ineffectiveness
it
is
necessary
to convert
differences
in
those
future
into
an
amount
that
of gain or loss to
be recognized
than
After
Statement 133
was issued
gains
it
became
apparent
there
was more
cash
one
supportable
way
to
measure
or losses
from ineffectiveness
in
flow
hedge.24
VIII
Assumption of No
Ineffectivcness
34
in
Statement 133
sets forth
and
measuring ineffectiveness
Those
as Exhibit
The FASB
did
not
specify
recognizing
that
appropriateness
of
given
of assessing
can depend
on the nature
also
hedged would
the type
of hedging
in
instrument
used.2S
that
The FASB
be situations would
the entity
which
determining
critical
hedge
relationship
would
the
effective
be easy
If the
item
and
hedging
match
could assume
that the
be sufficiently
highly
effective
that
24
See
DIG
Issue
25
Statement
133
62
Confidential
13
measurement
these
of
in
effectiveness
was unnecessary
be
literally
in
relationships
would
not
perfect
ineffectiveness
be
zero enough
could
be
determined to be inconsequential
or small
to
ignore
35
qualify
While
for
number of
relationships with
that
would
an assumption of no
to
ANT
approach
no computation
to recognize
being
necessary
measure Board
ineffectiveness did
and which
no accounting
instruments
entry
made
any
ineffectiveness
the
not
specify
or relationships
would
qualify the
and
did
not
set
forth
list
of the
this
critical
terms
except
in
several
examples6 Thus
terms based on
accountant
who would
apply
approach
must assess
the
critical
of the relationship
36
Paragraph
case
68 of Statement 133
interest rate
is
special
case
of the
the
ANI
approach
did
set
In
the very
common
of hedging
the
risk with
swap
Board
out the
critical
accountant
of the responsibility
of assessing
the
economics
as the
of the
relationship
relationships
became known
among
practitioners
shortcut
method 37
It
is
clear
that
the
Board
intended
to provide
for
ANT
approaches
beyond
the
paragraph 68 shortcut
Disclosures
method
In
recent
About
Derivative
FASB
notes
that the
the shortcut
method
and other
methods
In
A65
the
commenting
states that
on
reasons
disclosure
of such
reflect
methods
negatively that
Board
entities
Those
Board
members
noted
that
this
disclosure
on
appropriately
method
as well
as other
methods
assume
zero
ineffectiveness
38
case
of paragraph which
the
68
to apply
an
ANT
approach
under an
the
identify
which
requires
of the economics
affecting
To
apply
26
Examples
are
found
in
paragraphs
65 155
and
161
of Statement
133
14
Confidential
AN
term
approach
in
it
may
also
match
means
for
each
critical
the context
39
change
The Board
in
if
in
the
sense
that
the
the derivative
penny
the
the
hedged
position
Further some terms may be impractical might mature on the same day two
transactions to as
to
match
item but Even
exactly
it
For example
difficult
derivative
hedged same
could be
to
arrange
all
for the
happen
at
the
instant
transaction
that
meets
the
criteria
for the
paragraph 68
is
shortcut method
Statement 133
will generally
have
some
ineffectiveness
but the
amount
minimal
like
and
all
measurement
that
or recognition.27
FASB
Statements
to immaterial
provides
the
provisions
of
this
not
be applied
items.28
40
have
For the
ANI
approach
it
should be sufficient
that
is
for the
critical
That
the potential to
to create
ineffectiveness
more than
than
inconsequential
match
create
be
difference
in
those
terms smaller
than
what
would
have
staff
the potential
to
ineffectiveness
that
is
more
inconsequential
The SEC
cited
this
approach
The example
was
foreign
where
but
the settlements
of the hedged
item
same month
on
different
days9
27
Paragraph assuming
discount
70 of Statement no
ineffectiveness
133
recognizes
this
Comparable
achieving
credit perfect
is
not
condition
for
even
though
the rate
fair
would
require or
that the
same
rate
be
used the
to
determine
discount
of
the
swap
and of
to
hedged
item
hedged
as well
To
justify
using the
same
the
risk related
fair
both
parties
to the
swap
debtor interest
on
hedged
are
interest-bearing
asset
in
value
hedge
have and
or the to
variable-rate
asset
on which because
easily
payments
is
hedged by
the
in
not
cash
flow of
hedge
interest
would
be
the
same
However
are not
complication
caused
interaction
is
rate risk
credit to
risk
which no
separable
in
comparable hedge of
creditworthiness rate
considered
necessary
condition
assume
ineffectiveness
interest
risk
DIG
all
Issue the
E-4 notes
applicable the
Statement
conditions
in
133
acknowledges 68
in
paragraph
70
that
hedging some
relationship
that
meets
of
paragraph
may
nevertheless
involve
notwithstanding of
28
supposed
assumption does
not
of no ineffectiveness such
ineffectiveness
Yet Statement
currently
in
the
shortcut
method which
following
recognize
earnings
Statement
133
56
Mr
Barron
in
29
51
takes
issue
with
the
use
of
the
terms
practical
applications
and one
next
ineffectiveness
Fannie
Maes
implementation of Statement
133
In
my
view on
of
continued 15
page
Confidential
41
effective
In
my
opinion
an
ANI
approach
is
an appropriate
way
to apply
133
in
cost
manner
IX
Fannie
Maes
Use of Derivatives
42
interest
understand
that
Fannie
extensive
use
of derivatives
in
managing
rate risk
At December
total
Fannie
Mae
held
approximately Fannie
1400
derivative
contracts
with
notional
amount
assets
of $324.7
billion.30
Maes
assets consisted
To
finance
these
assets
Fannie
Mae
had
liabilities
including notes
amount
notes
the discount
had
they
matured
at
market rates
so the
The
objective
was
to structure
the
flows
interest
expense
would
if
interest
earned
on
its
assets
locking discount
in
positive
spread
rise
For example
interest rates
went
rate
up
interest
on the rolling
assets
notes
would
result
on the fixed
mortgage spread
remained
constant
entered
The
could reduce
contracts the derivative
even
eliminate
the positive
Fannie
Mae
cash
into derivative
including
interest rate
swaps
so
that
the
combined
and
would were
have
stable
relationship
flows
assets
Hedging
to
activities
an important
relatively
part stable
of Fannie
Maes
business
model
was
as
intended
produce
consistent
profit
margins on
its
portfolio
interest
rates
and
mortgage
prepayments
varied
Fannie
Mae
Implementation
of Statement
133
43
would
understand
that
Fannie
Mae
to
recognized before
it
was
issued
that
it
be complex
effort
and
difficult
apply
to
its
business
Mae
undertook an
as well as
extensive
to
plan
for transition
working
with
its
auditor
regulators
continued the
from
previous
in
page
every
FASBs
objectives
is
Statement While
is
is
to
make
sure
practical
application ineffectiveness
is
possible
and
cost
in
of
the
implementation Statement
to
reasonable
the
words
inconsequential term
for
do
not
appear
133
in
my
view
that an
perfectly
acceptable
amounts was
of
ineffectiveness to denote
small
enough
be
not
recognized fhose
under
that
ANI
be
approach
inconsequential
intended
amounts
much
smaller
30
than
would
simply immaterial
See
at
4380
16
Confidential
employees Derivatives
from different
parts
of the organization
as
result
Accounting
Guidelines known
policies for
the
DAG
was The
sizeable
book
companys
applying
Statement
133
DAG
included
diagrams describing
outline
pictorially the
as well
as
an
form description
of the transaction
accounting.32
44
The volume
of transactions
the
fact
the
number of hedging
guidance
strategies to
the
of and of
that additional
continued
emerge Fannie
DIG
SEC
volume
combined
to
make implementation
computerized
for
Mae
of
Because
the
of transactions Fannie
that
was an
essential
part
implementation
software available
Mae
discovered
that
was no
readily
available
off the
shelf
would
meet
its
needs.33
45
define
As
part
of
its
extensive
effort to
implement
qualify
Mae
decided
to
series
of relationships Fannie
that
would
assumption of no
the transactions
ineffectiveness
Under and
this
approach
as
Mae
would where
generally
limit
they
entered
into
designated
it
would no
was
very highly
effective
would because
be
the
ineffectiveness
critical
item
Mae
would
not enter
some
been
transactions
that otherwise
have have an
economically
for
attractive
that
would
have
economic
but
hedges
not
qualified
hedge
accounting under
Statement 133
would
have
qualified
ANI
approach
46
of the
not
occasional
transactions
that
fell
outside
the
parameters
did
AN
guidelines
because the
for the
critical
Since
these
transactions
qualify
DNQ
assumption of no
although
they
did
qualify
for
hedge
accounting
ineffectiveness
was
calculated
using
long-haul
and
recorded
The
See
32
at
4381-82
at
4385-89 KPMG-CIV-00285352
also
at
See See
8667-801
5767-927
tr
at
4229
see
Jonathan
Boyles
civil
276-77
September
16 2009
Statement
65
Confidential
17
fact
that
ineffectiveness
amounts
for these
DNQ
transactions
were
also
inconsequential
amounts
to
de facto periodic
reconfirmation
of the reasonableness
of the
implementation.35
47 swap
the
Fannie
Mae
also
made
extensive
use
of options
and
swaptions
an
option
to acquire
as
hedging
value
instruments of these
As
permitted as the
Mae
designated
intrinsic
instruments
derivative
the
time value
was
in
not
part as
of the hedging
relationship
and changes
the
time value
were
recognized
earnings
they occurred
48
Tn
my
and
opinion
Fannie
Maes
approach of
to
implementation
in
was
reasonable
appropriate
application
GAAP
the relevant
XI
Issues
Raised
by Fannie
Mae
Implementation
49
Fannie
The
following
sections
discuss
certain
issues that
have
been
raised
specific
to
Maes
hedge
transactions
Was
it
reasonable
in
its
under
GAAP
in
for
Fannie on
the
Mae
basis
as
it
described
letters to the
SEC36
assume no
ineffectiveness
of item
analysis
that
showed
that
minimal
variances
between
to
the
terms
of the hedged
instrument would be
expected
produce
inconsequential
amounts of
50
way
to
As noted above
in
my
opinion
an ANI
approach
is
reasonable
and
appropriate
and
is
specifically
provided for
in
paragraph which
apply an critical
derivative
ANI
approach
under
identify the
based on
an understanding
the
affecting
hedged
and the
To
apply
ANI
approach
it
also
necessary
to
determine what
match
KPMO-CIV-00108327 5519-28
36 31
at
8414-15
8642 8489-95
8397 KPMG-CIV-00285352
00126701
at
5442-43
5720
see
also
e.g KPMG-CIV-00009996
to
FMCIV-03
00700330
to
FMCIV-05
00394376
in
4425 FMCI
has
V-OS
to
0407
65
as
Mr
all
Barton
that
his
report
chosen produce
the
interpret
paragraph
narrowly exactly
as
paragraph
with
68
requiring reading
that
terms
could
possibly could to
ineffectiveness use
Even
such
criteria
of
to
paragraph
65 one
be
support
of
an
ANI
for transactions
that
met
calculated this
limit ineffectiveness
inconsequential
amounts
based
language
all
provisions
of
Statement
need
not
applied
to immaterial
items which
appears
FASB
Statements
18
Confidential
means
for
each
to
critical
term
in
the context
The
critical
terms would
item
be deemed
that
match
when
the difference
and
of the hedging
is
instrument
are small
enough
its
that
ineffectiveness
inconsequential
That
the
approach
Fannie
Mae SEC
used
in
adoption
of Statement 133
5L
As
noted
above
the
staff
endorsed
very
similar application
of an ANI
approach
The minutes of
the
report
An SEC
applied
staff
member
situations
in
which
registrants
have
the
the item
critical
terms match
method
when
the
and
hedged been
do not exactly
registrants
match
would
provisions
of paragraph 65 have
satisfied
generally the
be expected
to
conclusion that
Evaluate and
the
support
reasonableness item to
quantitative
confirm
relationship
was
effective
was de minimis
basis to assert that the
confirm
was
reasonable effective
terms
matched
that
the relationship
was
highly
and
that
any
ineffectiveness
was
de minimis
continued application
of hedge hedging
within the
The example
hedged
item
cited
was
foreign
currency occurred
where
the settlements
of the
same
month
but not
on the same
day
52
In
addition
similar
2001
publication
distributed
by another
dates
Big
accounting
rate
firm
describes
approach
applied
to the repricing
of an
interest
swap
company may
ineffective not exactly
believe
that
its
interest
rate
risk
hedge
design
is
marginally the
perhaps
dates
hedged
item
do
match
However
that say could
the incur
maximum
amount
of ineffectiveness
reasonable clearly
market
If
this
interest
rates
remain within
is
range
between
4% and 8%
as
worst case
policy
ineffectiveness that
immaterial
no earnings
certain
market conditions
remain within
38
5-O7mtg_minutes.pdf
footnote
omitted
see
also
Deloitte
Up
Vol 14
Issue
dated
March
19 2007
available
at
http//www.deloitte.com/view/en
US/us
Communications/Saa7e33d39Ofbl
1OVgnVCM
00000ba42fOOaRCRD.htm
19
Confidential
range
the
This policy
would
not
that
the
provisions
of
Statement need
be applied
items.39 approach
53
2007
Another
Big
this
was widely
practiced
in
publication
Many
registrants for
have
the effectiveness
of hedging
possibility
only those
may have
reasonable
of
more
than
de minimis amount
Other sources
of
rise
ineffectiveness
i.e
believed
those
that
remote chance
evaluated aspects
of giving
to In
significant practice
amount
entities
of ineffectiveness
that
many
relationship
i.e
to
the
critical
terms need
to be quantitatively
assessed
documented
qualif5i in
of hedge
the
accounting under
item
FAS 133
For
example many
within the
practice the
that
if
hedged
settle
same month
matched
for
relationship
sufficiently
purposes
Therefore assessment
formally
no quantitative of those
assessment
was performed
de minimis sources
of ineffectiveness
may
not
have
been
documented
Our
historical
perspective that
has
been
that
if
there
were
any sources
of variability
in
hedging
relationship
an assumption of no
acceptable
if
ineffectiveness
under
paragraph 65
have
been
of high effectiveness
and
that
be de minimis.40 approach
in
its
54
Fannie
Mae
described
letter
to
the
SEC
in
the following
terms
Although
FAS
an assessment
to
of effectiveness
it
methodology
assessment and hedged
relationships
of hedge
effectiveness
based on matching
consideration
counterparty
the
method have
of assessing
we concluded
that also
hedge
would
as the
no or inconsequential
ineffectiveness relationship
We
concluded
key matching
were
FMCIV-03
Derivative
03091796
Instruments
at
1934
Ernst
Young
Activities
LLP
Financial
Reporting
Analysis
Developments of
Accounting 133 as
for
and Hedging
at
Comprehensive emphasis
in
FASB Statement
Amended and
40
Interpreted
4.36
Dec
2001
original
FMCIV-1 0-11169603
instruments
at
70007-08
Activities
at
PricewaterhouseCoopers 393-94
LLP
Guide
to
Accounting
for
Derivative
and
Hedging
2007
Confidential
20
maintained on
periodic
there
was no need
to
measure
ineffectiveness
on
individual
transactions
basis.4
55
were
In
summary
Fannie
Maes
application
of an
ANI
approach
that
using
critical
terms that
matched
within
defined
limits calculated
to assure
unrecognized and
ineffectiveness
was
inconsequential
was
reasonable
and
appropriate
was
consistent
of Statement 133
that other
knowledgeable
accountants
adopted
Was
no
it
reasonable
under
on
GAAP
in the
relevant
Mae
to
assume
ineffectiveness
hedges
of discount
rates
notes such
reset
DAG
transaction number
as
when
the dates of
1-
days
of
its
56
notes
strategies
was
hedge
of the rollover on
discount
are short
term notes
Fannie
Mae
in
issues
regular wilt be
basis
Wednesday
then-current
week
rates
Because
the notes
issued
the future
priced
the discount
note
program
issuances
is
effectively cash
floating
rate
source
The
interest
payments of
its
on the thture
have
flow risk
To
to
better
the characteristics
assets
to lock in
flows
It
have
funding of the
source
with
fixed
interest
cash
could
with
combination would be
discount
note
program
and
derivative
such as
swap.42
The swap
pay-fixed-
receive-floating
instrument
Mae
estimated
would
match
the
life
of some of
fixed
rate
assets
years
57
Fannie
Mae
applied
an
ANI
approach
with
to these
hedges
Because 90
the
discount
notes
and
fixed maturities
e.g
days
while available
been
issued
week
occur
it
was
not practicable
have
the
maturities
of the notes
if
and
the reset
on the
same
day
Fannie
Mae
determined that
the dates
were
within
1-
days
the resulting
FMCI V-OS
42
00394376
at
4391
at
KPMG-CJV-00108327
at
5436 5772-73
21
Confidential
ineffectiveness
would
date
be inconsequential
That
is
one
of the
critical
reset/maturity
match.43
58
Mae
did
quantitative
assessment
prior to
of
ineffectiveness
adoption
that they
reconfirmed subsequent
and updated
analysis
assessment
in
2003
Those
analyses
concluded
and
has confirmed45
that the
amount
of ineffectiveness
was
inconsequential
59
previous
This
is
an example
of the general
cited
in
application that
of an
ANT
approach
described
in
the
question
The guidance
discussion
from Ernst
the
Young
of dates
in
2001
are
and
from the
close
SEC
and
PricewaterhouseCoopers
matched.46 In
in
2007
the
uses
example
to
that
my
opinion
approach
the discount
note
hedging of
program
including
the use
of the ANT
approach
match
Was
no
it
as
1-
reasonable
and
appropriate
application
of Statement 133
reasonable
GAAP
in
the
relevant
time period
for
Fannie
Mae
to
assume
the
ineffectiveness
termouts
DAG
transactions
number
2-4 13 and
20
when
fair
valne of the
initial
swap
at
60
Term-outs are
variation
on the discount
discount
note
hedge hedge
Sometimes
because of
notes
note
the
medium-term
the
fixed-rate
note
into
so that
combined
cash
swap
are the
same
as
discount
flows of
all
three
instruments
are the
original
fixed rate
KPMG-CIV-00108327 5501-04
See
45
at
8410-T3
8472-74
8489-95
8624 KPMG-CIV-00285352
at
5437-38
55 19-28
5642
at
4393
Grant
46
51-53
22
Con fidentia
61
hedge of swap
possible
criticism
of the application
the term-out
of an
ANT
approach
to
is
that
if
one believes
not
requires
redesignation
value
of that swap
would
be zero
at
the
time of redesignation
62
at
requires
that
the
swap have
fair
value
of zero of
this
designation
and 65
auditors
have
such
taken
very
literal
rules-based
view
requirement
rule
is
Paragraph
to
includes
no
requirement
In
my
opinion
the
same
rigid
not required
qua1if
for the
ANI
approach
65
especially
for cash
Because
paragraph 68 provides
for very
mechanical
defined
of hedge
accounting
the
specifically
transaction
happens
to
be
frequently
encountered
is
Board
defined
very specific
qualiing
tests
Because Board
the
ANT
approach
attempt to
potentially
applicable
to
that the
did
not
describe
specifically
except
some examples
the
approach
is different.47
63
note
that
the
termout transactions
are similar to
and
It
in
fact
in
paragraphs 159-161
fair
of Statement 133
would
at
also
that
the
value
of the
the
first
swap would
not
be zero
the date
second
swap
was added
derivatives
Nevertheless
are effective
at
Board
Together
the
interest
the cash
offsetting
payments
in
note income
Changes and
in
fair
values
of the two
to earnings affect
are
recognized
other
are reclassified
when as
the
hedged
forecasted
transactions
variable
interest
payments
earnings
required
by paragraph
No
ineffectiveness
64
included
Mr Barron
in
makes
reference
page 40
that
to
an amendment of example
to the
that
was
deleted
Statement 138
He
notes
reference
shortcut
method
was
Mr
not
Baron
recognizes
pages
9-1
and
35
12
that
Statement
133
incorporates that
both
the
shortcut
method
did
1168 and
the
matched
terms method
133
1165
rests
His primary on
the idea
Fannie
Maes
not the
accounting
comply
with or
Statement
page
accounting
could extends
quali
matched
the
terms
ANI
approach matched
there
is
In reaching
that
conclusion
he
incorrectly
shortcut
method
to the
terms approach no
requirement
As
under
described paragraph
above 65
for
the
two
are
initial
more
fair
he
appreciates
In particular
zero
or for
terms
48
to
exactly 133
match
Mr
Berliner
makes original
similar
argument
page
3-10
Statement
11161
parentheticals
in
23
Confidential
and
concludes
that
the intent
an assumption of no
undeleted portion values
ineffectiveness
He does above
in
not
make
reference
to the
remaining
In
my
opinion
the
language
in
fair
are recognized
other
comprehensive
income..
contained
in
the
amended
example
technical
clearly correction
describes
an
ANI
approach
to
to delete
the reference
should
have
been
an example
of
paragraph 65
ANI
approach
along
65
developed
be thought
believe
that
in
the relevant
policies
were should
at
reasonable
people could
continuing
different
on
whether
term-out
of as
single
relationship
new hedge
relationship
the
time
redesignation the
understand
was known
discount
at
was
put
could
occur
The
basic
note
hedge
put
in
discount
notes
issued
periodically as part
after
the
hedge
is
place
note
might have
out
viewed
process
the cash
Since
was never
of
rate
hedge
that
relationship
flows
achieved
the desired
fixed
was
the
objective
of the strategy
that there
with
or
without hedge
the
term-out one
might reasonably
redesignation
have
is
reached
the conclusion
is
single
relationship
and no
necessary
66
fact
Even
that
if
the
termout
is
considered
new hedge
relationship use
and
redesignation
the
swap
that
has
non-zero
fair
value
of an ANI approach
in
understand
Fannie
Mae
did
in
addition
to relying
on the guidance
to
the
example
in
paragraphs 159-161
resulting
also
quantitative value
assessment
fair
of swap
when
the term-out
was
inconsequential.49
67
helpful
The
but
term-out
transactions
are
complex
The example
in
paragraphs 159-161
is
it
all
the details
of application
instruments
of 133 to these
did achieve
transactions
It
appears
combination
of these
the objective
of
FMs
See
at
4387
FMCIV-0S-00700330
at
0332 0390-96
24
Confidential
cash
flow hedge
reasonable
In
my
opinion
the
approach
to
accounting
for term-outs
described
above
was
and
appropriate
application
of Statement 133
Was
no
it
reasonable
under when
at
GAAP ia
the relevant
in
for
Fannie
Mac
to
assume
the
ineffectiveness
using swaptions
varions
strategies
even
though
fair
DAG
transactions
10
11 67 and 68
convert
it
71
is
swaption
to
an instrument
specified
that
gives
the holder
the right
but
to
swap with
terms
at
future
date
sided
As
with
other
option
instruments
the
buyer pays
premium
at
origination
and
has
one
protection
Statement 133
item
clearly value
hedge
strategy or
can
designate certain
as the
hedged
In
changes
in
or
cash
flows above
it
below
level
such
strategy
will
always be
but
the
money when
expire
is
exercised
In
if
it
was
use
out
of the money
it
would
for
be
exercised
would
worthless and
my
opinion
of an
AN
approach
such
strategies
was
reasonable
appropriate
application
of Statement 133.50
Was
no
it
reasonable
under when
GAAP
in
for
Fannie
Mae
to
assume
ineffectiveness
using dnration
term
in
hedges
of anticipated
debt issuances
69
assets
Anticipatory
debt
hedges
to acquire
were
Fannie
Mae
planned
to
to
issue debt
to
fund
the
it
was committed
short
the future
up
30
days
Because
assets
Fannie
rate
Mae was
committed
than
to acquire
had
fixed rate
and
the currently
available
funding
was lower
to
the rate
on the assets
spread
Fannie
Mae
entered
into derivative
transactions
lock-in
the positive
life
of the assets.5
70
Fannie
Mae
applied
an
ANI
approach
to
hedges
In
its
duration
matching approach
Fannie
Mae
defined
Mr
Barrons
report
pages
the
45-47
non-zero
as
objects
fair
to these
at
transactions date
and
notes
that
it
is
the not
same
agree
issue
as the
termout
should
transactions
value
the
ot exercise
As noted
it
do
that this
necessarily
be viewed
new
relationship
or that
even
if
is that
precludes
application
of
the
8402-05
8423-42
8616-21
KPMG-CIV-00285352
at
5429-32
25
Confidential
duration
and
notional
amount
to
Duration
in
is
direct
measure
of the sensitivity
of the value
of
value
fixed-rate
instrument
changes
interest
rates
average same
present
of have
all
Two
in
duration
will
the
sensitivity
changes
with the
interest
rates
and
thus will
be more
effective
two
instruments
same
an
final
maturity
Duration
value
is
more
change
sophisticated with
exacting
measure
rates
of how
much
instruments was
fair
will
change
interest
The same
duration
matching hedge
the business
decision
of selecting
an economically
that the use
appropriate
relationship
for the
accounting amount
is
understand
of duration
and
principal/notional
standard
approach
in
finance
economics.52
71
Fannie
Mae
defined
certain
ranges
of duration
that
as
matching
closely did
enough
to ensure
inconsequential
ineffectiveness
understand
Fannie
Mae
initially
quantitative
assessment
periodically
of duration assessment
differences
within
the selected
ranges
and
that they
for selected
transactions.53
72
As noted above
It
the
FASB
did
not
try
to define
the
critical
terms for an
ANI
to
approach
understand
is
necessary
who would
and
apply an
ANI
approach
the
economics
of the instruments
to identify
the
critical
terms and
In
how
precisely use
they
must match
to ensure with
ineffectiveness
my
opinion
of an ANI
appropriate
approach
term defined
in
terms of duration
is
reasonable
and
application
of Statement 133
Was
it
reasonable
under
GAAP
in the
relevant
time period
in target dollar
for
Fannie between
Mae
the
use hedged
de
based
on
changes
yield
instrument as of hedges
part of
offset
approach
to assessing
and
ineffectiveness
of anticipated
debt
did
73
Maes
approach
when
situation
hedge
not qualify
assumption of no ineffectiveness
ANI
If
such
arose the
52
understand
that
if
the
products
match
also
closely
and See
the
durations
match
closely
then
mathematically
the
principal/notional
amounts
must
at
be close V-OS
Expert
Report of Dwight
at
Grant
See
FMCIV-05 00394376
4400 FMCI
00700330
0372-88
26
Confidential
DAG
with
provided
that
Fannie
Mae
would
assess
effectiveness
using the
de minimis test
is
Under
to
approach
item
change
the
the
fair
value
of the
derivative
compared
ratio
is
the
change
in
the
hedged
and
hedge
is
deemed
highly
effective
if
the
between
in
80-125%
both values
in
This method
are
fail
on many
occasions
when
the
changes
the
small
markets were
essentially
unchanged
even
changes and
$1000000
If the dollar
hedge
offset
might be method
$l
is
and
-$0.50
for
ratio
of
50% or
$1
$O.50
DIG E-8
when
to
be used which
so that
was
clearly
contemplated
see
it
provision
numerical
call
results outside
of the 80-125
range
the absolute
is
de minimis do not
into
question
the expectation
of high
effectiveness.54
74
use
am
of
aware
of
test
2003
SEC
of
staff
interpreted
is
to proscribe
the
de minimis do
as part
dollar
method
because that
viewed
as
two
be
methods.55
not agree
of Statement 133
as discussed
believe
it
would
an inappropriate
it
amendment
use
above
it
would
make
impractical
to ever
the dollar
method
75
In
my
opinion
Fannie
Maes
use of
de minimis
reasonable
test
as part
of
dollar offset
approach
to assessing
ineffectiveness
was
and appropriate
application
of
Statement 133
Was
Fannie
Maes
approach
to
hedge documentation
documentation
relevant
which
viewed
the
DAG
and the
of
computerized
the
interpretation
requirements
in the
76
As
spelled
out
in
EITF
topic
D-102
documentation
of
hedge
should
include
identification
of
The hedging
instrument
derivative
54
Mr
as
Barron of
page
47
and
Mr
Berliner
page
3-18
such
that
both
assert
that
Fannie
Maes
that
use did
of
not
de minimis
use
test
part
the
dollar
offset
method
of
assessing
effectiveness
test is
an
ANI
method and
was 133
inappropriate clearly
As noted above
the use
of
the
dollar
offset
contemplated
National
of
method SEC
Developments
James AICPA
Conference
1211
on
Current
Dec
11 2003
available
at
http//www.sec.govfnews/speech/spch
O3jmj.htm
27
Confidential
item
or transaction
and
prospectively
to assess
effectiveness
ineffectiveness
level
of precise
as
detail
of that documentation
auditors
was something
worked
increased to
that
attention
accountants
implement
first
Statement 133
In
general expectations
for
over the
years
of implementation
77
into the
understand that
some of
the
hedge
documentation
Fannie
Mae
relied
computer
as part
133
and
as noted
the interpretation
increasingly
the years
after
no
all
documentation
my
opinion
the
approach
Mae
Did Fannie
the
Maes
shortcut method
affect the
in the
original
version
of
DAG
when
referring
an
ANI
approach
substance
of compliance
with
Statement
133
has
78
come
to
be associated
in
only with
interest
rate
swap
transactions
paragraphs 68-70
Early
the
life
of Statement 133
at
Fannie
Mae
and
elsewhere
that
observed
outlined
by practitioners
in
One
could
also describe
the
method
paragraph 65 as
79
refer to
In
my
opinion
the
fact
that
the
in
the
first
edition
DAG
to
ANT
approaches
is
not
substantive
The
DAG
includes
an
of the hedging
Fannie
Mae
On
80
Volatility
It
has
been
suggested to
that
one
of Fannie
Maes
objectives
in
its
implementation
of
Statement 133
was
reduce
the
volatility
of reported
with
earnings
Mr
Barron notes
page
15
28
that
disagreed
certain
provisions
of Statement 133
Confidential
and
that
one
of managements
true
objectives
in
implementing
new
GAAP
standards
was
to
reflect
the
economics
He
follows
that with
the observation
that
the
true economics
complying
objective
with
GAAP
is
unacceptable
strategy
note
that
eliminating
volatility
is
the business
of any hedging
represent the
and
that
eliminating
accounting
is
volatility
that
economics
of
business
transaction
accounting
all
In the
development
to
fair
FASB
derivatives
value
and
losses
to earnings
show
volatility
not representative
of the actual
economics accounting
years to
when
the derivative
is
part
of an effective
hedge
and
would
for the
investment of significant
the extent
efforts
develop
accounting
To
Fannie
Maes
economically
financial
hedge
better
more
representationally
reporting
than
the application
of Statement 133
has
without
hedge
accounting were
an
understand
subsequent
that
analysis
shown
not
that
Fannie
Maes
hedges of
economically approach
effective
and
the ineffectiveness
recognized due
to the use
ANT
was
minor.56
November
2010
Timothy
Lucas
Date
56
Grant
earnings
As
noted
above occurred
Fannie As
Mae
result
recognized the
changes
in
the
time
value
of were
options
and swaptions
in
as they
earnings
Fannie
Mae
reported
quite
volatile
29
Confidential
Exhibit
Resume
Timothy
Lucas
3863
Attley
Drive
980 7759
Louisville
E-mail
TN
37777
865
Tim@LucasFR.com
Experience
LUCAS
May
Generally Accepted
corporate as well
2002
to
Date
Independent Engagements
past
Accounting
Principles
GAAP
with both
with
management on
as appropriate legal counsel
accounting
might require
restatement
involved various
for prospective
in
Other engagements
consulting roles
in
working
civil
with
an expert
and
criminal
SEC
Neenah Member
Paper Inc
of the Board and Chairman of the Audit Committee of
this
2004
to
Date
NYSE Company
1988
to
Standards
Board
FASB
EITF
the Director position
2002
and Technical
Issues
Activities
Chairman Emerging
As
the leader
full
Task Force
staff
of the
FASBs technical
Members
health
was on
the
in
same
level as the
seven
time Board
including
That
care
role involved
active
participation
all
major
FASB
projects
retiree
costs income
taxes
impairment
derivatives professionals timely those regular basis
of assets and
stock
compensation
as
financial the
hedging-
Also served
six
of
EITF
Board
group
of top accounting
issues
that
met
times
year to
and and
in
resolve
financial
reporting also
on
in
of the
SEC
FASB
Members
participated with
meetings speeches
the
FASBs
communications
Institute
program
major conferences
the staff
all Institute
by the American
of
CPAs
and
Financial
Executives International
quarterly issues
and
numerous
activities
with the
SEC
and
with
FASB
Responsible for
aspects
of administration
staff
recruiting evaluation
training
assignments
etc
for the
FASB
technical
Previous Experience
Gordon
and
to to
to
FASB
Deloitte Jesse
Manager
leading audit
projects
on Pensions and
1-laskins
Sells
manager
staff training
Jones Graduate
School
of Business
Rice
University Center
to to
LT.j.g Education
U.S Navy
Finance
BA
30
Economics
Master of Accounting
Jones Graduate
University
Publications
have
authored
in the
preceding
ten
years
from formal
updates
The FASB
Accounting
are created
publishes
range of technical
pieces
documents
to regular
on process
agenda
for that
All
of those from
as Director not
of Research
was
responsible
process
1988
through
May
of 2002
Most do
identi
an author
or any
administrative in the
proceeding
in
which
have
served an expert
report
or by deposition
In
Court Testimony
No
CR-04-0201
MJJ
Costa Brava
Fairfax
Partnership Circuit
III
L.P
Goodman
Company LLP
County
Court
Virginia
Case
No
CL
2005-7931
Alan Schein
Circuit
and
Results
Technologies
Inc
Emst
Judicial
Circuit
Broward
Case
No
CACE
03
Adeiphia Communications
Corporation
et
al
Motorola
06-01
Inc
et
al
U.S
Bankruptcy
Court Adversary
Case
No
558-reg
Securities
Litigation
Court of the State of California County of Los Angeles Judicial Council Coordination Proceeding Nos 4322 4325 and Court of
Common
Pleas Franklin
No
O3cvhO7
7932
Schering-Plough
Corporation
District
of
New
Jersey 5-48-19846
Action
No 05-257515K
Corp
Bank of America
Arbitration
ABN AMRO
Bank
N.V
Securities
And Exchange
Commission
Bartek and
Microtune
Inc
Douglas
Nancy
Richardson
Action
No
3-O8CV1 105-B
311
Confidential
Alstom
SA
Securities
Litigation
Southern
District
of
New York
Action
No
03-CV-6595VM
Served
In
an expert
to
addition
in
reports
above
in
the
last
four
years
have
served
expert
reports
are
covered
by confidentiality
agreements
32
Confidential
Section
Assessment
of Hedge
Effectiveness
Hedge
Effectiveness
Requirements
of This Statement
62
that
an entity define
the
at
the time
it
designates
in
hedging
offsetting
It
relationship
method
value
it
will
use to assess
cash flows
hedges
achieving
changes
requires assess
at
in
or offsetting
being hedged
also to
that
method
period
inception to
and
in
on an ongoing
achieving
expects
the
hedging
part
relationship the
be highly
offset
and
of
hedge
If the entity
it
an improved
the existing
method hedging
and wants
apply and
that
method
the relationship for either
prospectively
must discontinue
designate
anew
using
the
improved hedge of
single
method
assessing
whether
expected method
to
be highly
effective
measuring hedge
ineffectiveness
The
appropriateness
given
of assessing
hedge
effectiveness
can depend
and
the type
of hedging hedges
in
instrument similar
used
Ordinarily however
different
effectiveness
for similar
manner use of
methods
hedges should
be justified
63
In
defining
in
how hedge
assessment
effectiveness
all
will
be assessed
whether
it
that
hedging
part
but does
not
require an
exclude
all
or
of the hedging
of hedge of hedge
as follows contract
is
assessed
in
the
options
intrinsic
value
the
change
in
of the contract
would
from the
assessment
of hedge
effectiveness
If the effectiveness
of
that
hedge
is
its
with
intrinsic
an option
value
contract
is
assessed
based on changes
the
in
the
options
the
minimum value
value
plus
the effect
of discounting
change
in
volatility
of the contract
would
be excluded
of hedge
of
hedge
to
with
forward or fUtures
in
contract
is in
assessed
fair
based on of the
or futures
changes
contract
in
fair
value to the
attributable
changes
spot prices
the
change
the
value
related
changes
in
the difference
between of hedge
price would In
be excluded
each
the
excluded
that
component
would
be included method
currently
in
earnings together
ineffectiveness
any
in
ineffectiveness
results
of assessing should
is
As noted
that
paragraph
62
the effectiveness
similarly assessing
includes
whether
component components
derivative
effectiveness
No
other
on the designated
instrument
may be excluded
the effectiveness
of hedge
effectiveness
64
consider the
In
assessing the
of
cash
will
need
to
time value
of money
is
if
significant important
the the
circumstances hedging
of cash
time value
of money
especially
instrument
33
Confidential
settlements
An
example
of
situation futures
in
which
reflect
the
time value
of
money
is
tailing
strategy
with
contracts contracts
When
used
in
using
tailing
strategy earnings
an entity adjusts
amount
of futures
hedge
so that
or expense
do
not
distort
from reinvestment
the results
or finding
of daily settlement
offset
gains
of expected of
the futures
tailing
strategy
has been
value
used
the
an
the
time value
money
by comparing instrument
the present
of
hedged
cash
flow with
the results
of the hedging
65
If the
Whether
there
hedging
will
relationship
qualifies
as highly
in
effective earnings
sometimes
during the
will
be easy to
assess and
critical
be no
ineffectiveness
to recognize
instrument
and
asset or
as
could
flows
fair
or
hedged
or cash
forecasted
are the
same
changes
value
at
to the risk
being hedged
inception
entity will if
at
may
be
forecasted
purchase
commodity with
to
effective
ineffectiveness
be recognized
earnings
for
purchase
quantity
of the same
commodity
the
location value
hedged
forecasted
at
is
zero
is
Either the
the
change
the discount
or
excluded
from
assessment
in
of effectiveness
cash flows
and
included
earnings
is
pursuant
to
paragraph 63 or the
for the
change
expected
on the forecasted
transaction
commodity
66
Assessing hedge
effectiveness
and
part
can be more
would
resuJt
circumstances
difference transaction
instrument instrument
in
and and
the
hedged
gui
Id
item
or
hedged
such
as
Deutsche
that
markbased
those bases
Dutch
erbased
hedged
item
to the extent
in
do not move
critical
instrument maturities
hedged
or delivery
as differences
notional
amounts
quantity location
dates
Ineffectiveness attributable to also
would
in
result the
if
part
of the change
in
the
fair
value
of
derivative
is
change
counterpartys
creditworthiness
67
both
at
hedge
inception
that
test
specified
in
paragraphs
the
20b
and
28b
that is
at
and
hedge
to be highly
effective
achieving
offsetting
criteria
flows
If the
also
to
qualify
for
hedge
accounting
to assess
hedge
qualifies
for
hedge
test
the entity
would
continue
whether
the
the
hedge
would
measure
at
any ineffectiveness
if
during
hedge
period
the
hedge
to
fails
the
test
the entity
in fair
hedge
the
be highly
ceases to qualify
in
achieving
changes
values
flows
hedge
in
hedge
accounting
The
discussions
of measuring hedge
ineffectiveness
the
examples
the
34
Confidential
remainder of hedge
this
section
at
of Appendix
assume
that the
hedge
satisfied
all
of the
criteria
for
accounting
inception
Assuming No 68
Ineffectiveness
in
Hedge
with
an
Interest
Rate Swap
An
assumption of no an interest-bearing
simplifies the
ineffectiveness financial
is
especially
important
interest
in
hedging
relationship
it
involving
instrument necessary
and
to
an
rate
swap because
entries
significantly
computations
in
make
of
the accounting
interest
An
entity
may assume
no
ineffectiveness asset or
liability
hedging
relationship
rate
an
in
interest-bearing following
list
and
an interest
swap
if all
of the applicable
conditions
the
are
met
to
Conditions
applicable notional
both
fair
value
hedges
and cash
The
asset or
amount
of the swap
matches
the principal
liability
The
fair
value
of the swap
for
at
its
inception
is
zero
interest
The formula
each
is
computing
under the
rate the
swap
is
the
same
for rate
net settlement
That
index
is the fixed
the
same throughout
constant
term and
the variable
and
includes
same
is
adjustment or no adjustment
The Any
typical
interest-bearing other
asset or
liability
not
prepayable
instruments or
interest
terms
in
the interest-bearing
financial the
rate
swaps
are
of those
instruments
to fair
and
assumption of no
ineffectiveness
Conditions
applicable expiration
value
The
liability
date
of the swap
matches
the maturity
date
of the interest-bearing
asset or
There
is
the variable
interest
rate
of the swap
rate in
The
enough
three
to
interval
of the variable
interest
the
swap
is
frequent
justify an
assumption
or
the variable
payment
or receipt
is at
to six
months
less
to
Conditions
All the
applicable
interest
receipts as
payments
on the variable-rate
interest
asset or
liability
during
the
term of
swap
are designated as
hedged and no
payments
beyond
the
designated
hedged
is
There
asset or
interest
no
has
is
floor or
interest
rate
of the swap
liability rate
floor or
cap
In that
case
the
swap
must have
floor or
cap
on the variable
that
comparable
to the floor or
asset or liability
if
For
rate
this is
purpose
swaps
variable
LIBOR
LIBOR
percent
10
percent
would
be comparable
cap
on the asset
those rate
The The
repricing
match
of the variable-rate
is
index
on which
rate
the variable
is
based matches
on which
the asset or
liabilitys variable
based
69
The
fixed as
rate
on
hedged
item
need
not exactly
match
rate
on
swap
asset or
designated
liability
fair
value
on an interest-bearing
designated as cash rates
need
fair
to
on The
swap
fixed
flow hedge on
swaps
35
value
from
net settlements
and
variable
swap can be
Confidential
changed
without
affecting
if
both
are
changed
by the same
fixed rate
amount That
percent plus
is
swap same
and
with
payment
based on and
fair
LIBOR
as
and
receipt with
based on payment
of
value
swap
based on
LIBOR
based on
fixed rate
of
percent
70
even
to
Comparable though
actually
fair
at
inception
is
not
condition require
for
assuming same
no
ineffectiveness rate
perfect
offset
would
the
that the or
discount transaction
be used
justify
determine the
the
of the swap
and
of
hedged
to both value
item
hedged
To
using debtor
same
discount
rate
parties to the
swap
as well
as to the asset
on the hedged
the interest
interest-bearing are
in
cash
fair
hedge
or the variable-rate
on
which
payments
hedged
is
in
have
to
be the same
risk
However
risk
because
are not to
caused
by the interaction
creditworthiness
interest
rate
and
credit
which
separable comparable
in
not considered
necessary
condition
assume
no ineffectiveness
hedge
of
interest
rate
risk
36
Confidential
In the
forming
my
also
opinions
in this
matter
have
reviewed
number of documents
in
including
SEC
filings
of Fannie
Mae
and
that
and
documents
produced
by the parties
the course
of
discovery documents
in
have and
read
considered relied
relevant for
authoritative
accounting literature
facts
The
are
listed
materials
upon
that
an understanding of the
in
of this case
included
the footnotes
of
this
report
and
those
reviewed
the course
of
my work
the
following
various
Fannie
other
Mae
accounting policy
memoranda and
documents
KPMG
workpapers
cited
in this
various
Fannie
Mae
and
KPMG
as specifically
report
the
2001
and
2003 and
versions
of Fannie
Maes
Derivatives
Accounting
Guidelines
in
Fannie
Fall
Maes
KPMGs
submissions to the
SEC
Office
of Chief Accountant
2004
submitted
the reports
in this
matter
and marked
in
the regulatory
and
civil
including
exhibits
connection
SEC
Feb
2005 Feb
2006 2004
2006
16-17
Boyles Boyles
OFHEO
SEC
testimony
testimony Boyles
May 2009
2006
Jonathan
24 2004 Dec Apr 11-132005 Mar 14-16 civil litigation transcript Sept
Aug
Kimberly
Katarina
Stone Skladony
SEC
testimony
Nov
29-30 2005
OFHEO
testimony
Aug
26 2004
Mona
Patel
OFHEO
SEC
Sept
2004
13
Mary Trzeciak
Ursula Schaefer Donald
Paul Sinclair
Oct
2005
SEC SEC
Salfi
SEC
testimony
Oct
2005
27 2005
Mall Johnson
SEC
testimony
Sept
Confidential