Fannie Mae Earnings Management Case: The Entries That Hit the Bonus Target

Fannie Mae agreed to a $400 million penalty jointly negotiated by the Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight to resolve allegations of earnings management that smoothed results and met bonus targets. The securities regulator alleged that senior management directed employees to record less expense than the calculation required, then made additional adjustments that helped trigger maximum bonuses. For someone inside accounting or financial reporting, that allegation points to a revealing comparison: the calculated adjustment against the amount management allowed into the books.

This page follows those entries, the accounting policies behind them and the money returned to investors. Our page on accounting restatements follows the broader connection between a public correction and the decisions that produced the original number.

What Was the Fannie Mae Earnings Management Case?

The case concerned allegedly misleading financial statements that presented stable results while accounting choices suppressed earnings volatility. The Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight announced their joint resolution. The announcement identified the company as Federal National Mortgage Association and covered misstatements from at least 1998 through 2004.

The agency’s account tied the alleged smoothing to loan fees, premiums and discounts, and to the accounting for derivatives used as hedges. Both could change reported income when the underlying assumptions or values changed. The Securities and Exchange Commission alleged that Fannie Mae knew its accounting departed from the rules but failed to assess how much the departures mattered. Its account contrasts the steady earnings shown to investors with the adjustments made inside accounting.

How Did Accounting Choices Reach the Earnings Target?

The Securities and Exchange Commission alleged that management selected how much expense to recognize and made additional income adjustments to reach the bonus target. In that account, the gap between the year-end calculation and the booked amount affected both reported earnings and management pay.

The Expense Calculation Lost to the Bonus Target

At the end of 1998, the Securities and Exchange Commission alleged, senior management directed employees to record only $240 million in amortization expense. The agency alleged that leaving out the rest overstated income and understated expense by a pre-tax $199 million.

The Securities and Exchange Commission complaint alleges additional adjustments that helped offset the expense management did record. According to the complaint, accelerating a tax-credit accounting change into 1998 recognized two years’ worth of credits at once, adding net after-tax income of $108 million. The company had planned as late as November to make the change the following year, the complaint said. The agency alleged that moving it forward helped reach the bonus target.

The complaint alleged another adjustment just before the books closed: reversing aged credit items from a suspense account into income. According to the complaint, credits held since at least 1994 became $3.9 million of miscellaneous income in the adjustment for 1998, the year those entries helped trigger maximum bonuses.

The Securities and Exchange Commission alleged that these decisions let Fannie Mae exceed Wall Street expectations and reach the earnings-per-share target for maximum bonuses. For an employee working on the close, the timing matters: when the original expense was calculated, who reduced it, and why an old balance became income just then. In the agency’s account, we see what the bonus rewarded: the entries.

A Threshold That Kept Adjustments Out

Fannie Mae’s alleged smoothing also operated through a written accounting policy. The complaint said the company developed that policy after failing to record the full catch-up amount at year-end 1998. The agency explained that loan fees, premiums and discounts should be recognized over the loans’ lives. When borrowers repay sooner than expected, or expected prepayments change, the accounting needs a catch-up adjustment. That connects reported income to changing expectations about the loans.

The complaint alleged that Fannie Mae instead used a company-defined precision threshold. The policy set the threshold at 1% of net interest income or 2% of guaranty fees for the period. It recorded no catch-up adjustment when the calculated amount fell within that threshold and recorded only the excess when the amount went beyond it. The agency alleged that the accounting standard provided no support for this approach.

For a loan-accounting employee, the useful comparison is the complete calculation against the posted entry and the policy used to bridge them. A threshold can explain why a correctly calculated adjustment never fully reaches earnings. In the complaint’s allegation, putting the practice in writing gave the smoothing a policy to point to.

Hedge Accounting Without Measuring the Mismatch

The Securities and Exchange Commission also alleged that Fannie Mae used special hedge-accounting treatment without meeting its requirements. A debt instrument and an offsetting derivative can respond differently to interest-rate changes. The complaint explained that the difference generally had to be measured and recorded in income. Narrow exceptions, including the shortcut method, allowed qualifying transactions to skip that measurement.

The complaint put the operational problem and management’s preference beside each other:

The agency alleged that Fannie Mae used the shortcut by misreading the rules and treating the departures as too small to matter. According to its account, the company therefore failed to measure and record the difference between changes in the derivative’s value and changes in the hedged item’s value. For someone working on those accounts, the derivative terms, valuation support and accounting approval explain what the reported earnings left out.

Which Records Show Earnings Management Like Fannie Mae’s?

In an earnings-management matter like Fannie Mae’s, the useful evidence connects the underlying transaction, the calculated adjustment, the booked amount and the decision that separated them. The reporting chain runs from transaction records through accounting entries, estimates, the close, financial statements, disclosure review and officer certifications. Different employees can know different parts of the same decision.

We examine loan-fee schedules and prepayment assumptions against the entries they produced. For hedge accounting, we compare the instruments and valuation work with the treatment approved for them. For a late income adjustment, the account history and dated approval can explain why a balance changed in that reporting period. The compensation calculation then shows what the reported result meant for the bonus target.

The records behind the reported number also show who reviewed it. Close files, report versions, auditor communications and audit-committee materials can connect a questioned entry to the response inside the company. We work with the person who understands that history to connect the accounting judgment to what investors were told.

What Did the SEC and the Housing Regulator Resolve?

The Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight jointly negotiated the corporate penalty. Fannie Mae agreed to a permanent court order barring violations of securities-law requirements for honest reporting, accurate books and accounting controls. The securities regulator’s account placed responsibility on management’s emphasis on stable earnings and the company’s insufficient accounting resources.

How Large Was Fannie Mae’s Expected Restatement?

In the announcement, Fannie Mae expected to revise its annual statements for 2002 and 2003 and its first two quarterly statements for 2004. At that point, the company estimated that the restatement would reduce previously reported net income by at least $11 billion. For an accounting employee, the restatement work connects the public correction to the earlier entries and periods that needed changing.

What Did the Fannie Mae Fair Fund Pay Investors?

The Securities and Exchange Commission announced on October 19, 2007 that it was mailing checks totaling $356,128,500 to individual investors, pension plans and other victims. The same announcement identified $350 million as the SEC portion of the jointly negotiated penalty, paid to settle the agency’s charges. The earlier proposed distribution notice identified potential recipients as purchasers of Fannie Mae common or Class N preferred stock from January 14, 1999 through December 22, 2004.

What Can an Accounting Insider Change?

An accounting insider can explain how a target became an entry and why a review failed to change it. The 2019 working paper Do Corporate Whistleblower Laws Deter Accounting Fraud?, hosted by MIT Sloan, studied companies exposed to state False Claims Acts through state pension-fund ownership. It found a 5% to 9% reduction in its measures of accounting-fraud probability after exposure to those laws.

For someone considering reporting similar securities fraud, we assess the accounting evidence and the whistleblower opportunity together. An SEC whistleblower can earn 10% to 30% of sanctions collected in a qualifying action exceeding $1 million. Where the conduct involves a false claim on government money, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. Your knowledge of the entries and decisions is where our conversation starts.

You Know Why the Entry Changed

If you know why an expense disappeared, a hedge qualified or an old balance became income at the close, talk with our whistleblower experts. We build your case around those decisions and bring in securities fraud whistleblower lawyers who understand financial reporting. We stay with you as experts and advocates throughout the case.