Following a review of Fannie Mae's accounting practices, the Securities and Exchange Commission said that the mortgage concern didn't comply with two major accounting rules and asked it to restate past earnings.

"Our review indicates that during the period under our review, from 2001 to mid-2004, Fannie Mae's accounting practices did not comply in material respects with the accounting requirements in Statement Nos. 91 and 133," a statement issued late Wednesday by SEC chief accountant Donald Nicolaisen said. The rules relate to accounting for deferred purchase price adjustments and for derivatives and hedging activities.

Nicolaisen said that he advised Fannie Mae -- formerly known as the Federal National Mortgage Association -- that it should restate its financial statements to eliminate the use of hedge accounting; evaluate the accounting under FAS 91 and restate its financial statements if the amounts required for correction are material; and re-evaluate the information prepared under generally accepted accounting principles and non-GAAP information that the company previously provided.

Fannie Mae had warned last month that if its accounting for some derivatives was deemed incorrect, it could have to restate earnings and report an after-tax loss of $9 billion on those transactions, and that if its accounting under FAS 91 was deemed noncompliant, it could report an after-tax loss of $26 million.

In a statement Thursday, Fannie Mae said that the SEC's determination "will have a negative impact on our minimum capital position, and we are committed to taking the steps necessary to comply with our minimum capital requirement." The company said that it will "take the steps necessary to comply fully with the SEC's determination."

Nicolaisen said that Fannie Mae "internally developed its own unique methodology to assess whether hedge accounting was appropriate." However, its methodology didn't qualify for hedge accounting because of "deficiencies in its application of Statement No. 133." Among other things, the SEC said that Fannie Mae's methodology of assessing, measuring and documenting hedge ineffectiveness was "inadequate and was not supported by the statement."

The SEC also said that Fannie Mae failed to record timely adjustments to the recorded amount of its loans based on changes in the estimated speed with which those loans would be prepaid, and 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 sought the SEC's guidance on the two rules following a report issued in September by its regulator, the Office of Federal Housing Enterprise Oversight, which accused it, among other things, of using accounting methods that didn't comply with GAAP in accounting for its derivatives transactions and hedging activities, employing improper "cookie jar" reserve in accounting for amortization of deferred price adjustments, and of deferring expenses to achieve bonus compensation targets.

Nicholaisen noted that it's "unusual" for the accounting staff 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 have received extraordinary public attention and resulted in the mortgage and capital markets experiencing uncertainty," he said, adding that the SEC made its staff views publicly available "in light of the public attention and uncertainties cited by Fannie Mae in its request, and other matters involving Fannie Mae that are publicly available."

The SEC said that it didn't consider the appropriateness of Fannie Mae's decisions to use financial or derivative instruments or to hedge its risks -- only whether the accounting it used to record those transactions complied with Statement Nos. 91 and 133.

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