transcript fannie mae hearings

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UNITED STATES DISTRICT COURTFOR THE DISTRICT OF COLUMBIA

IN RE: FANNIE MAE SECURITIESLITIGATION

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Docket No. CV04-1639 (RJL)

June 5, 2012

11:00 a.m.

TRANSCRIPT OF MOTIONS HEARINGBEFORE THE HONORABLE RICHARD J. LEON

UNITED STATES DISTRICT JUDGE

APPEARANCES:

For the Class Plaintiffs: WILLIAM MARKOVITSJOSEPH DETERSMELANIE CORWINCHRISTOPHER STOCKPAUL DEMARCOWaite Schneider Bayless & Chesley1513 Fourth & Vine TowerOne West Fourth StreetCincinnati, Ohio 45202

DANIEL S. SOMMERSCohen Milstein Sellers & Toll,

PLLC1000 New York Avenue, NWWashington, DC 20005

For Fannie Mae: JEFFREY KILDUFFROBERT STERNO'Melveny & Myers, LLP1625 I Street, N.W.Washington, D.C. 20006

Case 1:04-cv-01639-RJL Document 1048 Filed 09/04/12 of 131

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For Franklin Raines: KEVIN DOWNEY, ESQ.ALEX ROMAINWilliams & Connolly, LLP725 12th Street, N.W.Washington, D.C. 20005

For Leanne Spencer: DAVID KRAKOFFCHRISTOPHER F. REGAN ESQ.ADAM MILLERBuckley Sandler, LLP1250 24th Street, N.W.Washington, D.C. 20037

For J. Timothy Howard: ERIC DELINSKYZuckerman, Spaeder, LLP1800 M Street, N.W.Suite 1000Washington, D.C. 20006

For KPMG: JOSEPH WARINSCOTT FINKGibson, Dunn & Crutcher, LLP1050 Connecticut Avenue, N.W.Washington, D.C. 20036

For FHFA: JOSEPH ARONICA, ESQ.Duane Morris, LLP505 9th Street, NWWashington, DC 20004

Also Present: Kevin LewisCarl ReedJessica ThornAdam GoldsteinEvan StolovSteve GeorgianJames GoldsmithSteve Carlin

Court Reporter: PATTY ARTRIP GELS, RMROfficial Court ReporterRoom 4700-A, U.S. CourthouseWashington, D.C. 20001(202) 962-0200


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Proceedings reported by machine shorthand, transcript producedby computer-aided transcription


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P R O C E E D I N G S

COURTROOM DEPUTY: Calling civil case 04-1639, In Re:

Fannie Mae Securities Litigation. Counsel, please approach the

podium and identify yourself for the record.

MR. MARKOVITS: Good morning, your Honor, Bill

Markovits on behalf of Lead Plaintiffs OPERS and STRS. With me

at counsel stable are Chris Stock also of the Waite Schneider

firm; Kevin Lewis, our technical consultant; Paul DeMarco from

Waite Schneider; Joe Deters from Waite Schneider; Melanie Corwin

from Waite Schneider and Dan Sommers Cohen Milstein.

THE COURT: Welcome, everyone.

MR. MARKOVITS: Thank you.

MR. KILDUFF: Good morning, your Honor, Jeff Kilduff

with O'Melveny & Myers for Defendant Fannie Mae. With me here

today is my partner Rob Stern who will be handling the first

argument opposing Plaintiffs' Motion for Summary Judgment and

sitting with us at counsel table here today is Vice President

Deputy Counsel Evan Stolov.

THE COURT: Welcome back.

MR. KILDUFF: Thank you.

MR. WARIN: Good morning, your Honor, Joseph Warin for

the Gibson, Dunn & Crutcher firm. I am with my partner Scott

Fink who will be handling the 133 Motion; our clients James

Goldsmith, Steve Carlin and Steve Georgian all in the law

department of KPMG are here present as well. Thank you.


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THE COURT: Welcome.

MR. DOWNEY: Good morning, your Honor, Kevin Downey

from Williams & Connolly for Defendant Frank Raines. Alex

Romain also of Williams & Connolly is here as well.

THE COURT: Welcome.

MR. DOWNEY: Thank you, your Honor.

MR. DELINSKY: Good morning, your Honor, Eric Delinsky

on behalf of Defendant J. Timothy Howard.

THE COURT: Good morning. Welcome back.

MR. DELINSKY: Good morning.

MR. KRAKOFF: Good morning, your Honor.

THE COURT: Mr. Krakoff.

MR. KRAKOFF: David Krakoff of Buckley Sandler with my

partner --

THE COURT: Like old times, Krakoff.

MR. KRAKOFF: Like old sometimes, yes. We got the video

and we got the Elmo.

THE COURT: Not quite as many lawyers over here.

MR. KRAKOFF: Yes, well, we need to fill in that table

over there, your Honor. I am with Chris Regan and Adam Miller

from Buckley Sandler on behalf of Leanne G. Spencer.

THE COURT: Welcome back.

MR. KRAKOFF: Thank you.

THE COURT: I knew you were out there somewhere, Joe.

MR. ARONICA: My usual perch. Good morning, Judge, Joe


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Aronica from Duane Morris on behalf of FHFA as conservative of

Fannie Mae.

THE COURT: Welcome back. Well, I guess everyone is

here, Mr. Markovits. Are you ready to get rolling?

MR. MARKOVITS: Yes, sir.

THE COURT: As you know, the parties agreed to do

45 minutes a side, but the moving party gets to put aside a

certain portion of that 45 minutes for rebuttal. So that's up

to you as to how much you want to use for that purpose. Usually

it is split 30/15 or something like that but there is

flexibility in the process so you go ahead. I don't have a

chess clock here.

MR. MARKOVITS: If I may your Honor, may I just reserve

any unused time?

THE COURT: Yes, you can reserve it.

MR. MARKOVITS: Thank you.

THE COURT: You can begin whenever you are ready.

MR. MARKOVITS: Thank you, your Honor. Good morning.

Bill Markovits on behalf of Lead Plaintiffs OPERS and STRS. May

it please the Court, over the next few days, you will be hearing

eight Motions for Summary Judgment.

THE COURT: That's a record for me.

MR. MARKOVITS: I think it is a record for me as well.

All but one of them, the Motion this morning relate to the

voluminous record developed in this case. Now, the Motion this


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morning, for the purposes of the Motion this morning, we haven't

ignored that record. We have acknowledged as Defendants in some

of their Motions do not that the voluminous record, all the

depositions, the millions of documents, the battling experts

generally create genuine issues of material fact that would

preclude Summary Judgment.

That's why Plaintiffs in this Motion have concentrated

and focused on a subset of the record which is the admissions of

Fannie Mae because in its restatement, in its malpractice

complaint against KPMG, in its Rudman Report, in the admissions

of its experts, and in the facts it cannot and does not dispute,

it has admitted all of the elements of liability for a

securities violation.

We have tried to avoid the he-said, she-said of the

record and concentrate on what Fannie Mae has admitted.

Now, Fannie Mae in its opposition has attempted to

avoid that particular battle ground. It wants to fight over the

entire record and ignore the admissions it has made, and let me

start off with a quick example. Slide three, Please.

This is from Fannie Mae's opposition at page 15.

Fannie Mae makes this argument. They say: But neither

Plaintiffs nor their expert have ever articulated with any

specificity what they contend was wrong about Fannie Mae's

application of FAS 133. Fannie Mae has instead been forced to

decipher Plaintiffs' theories from a series of cryptic


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allegations.

Well, first that's untrue. Both Plaintiffs and their

experts as well as the SEC and OFHEO and many others have

articulated exactly what they did wrong with respect to FAS 133;

and my colleague Mr. Stock will address that a little later this

afternoon.

THE COURT: Sure.

MR. MARKOVITS: But for the purposes of the Motion and

more importantly that's totally irrelevant. The question here

isn't what Plaintiffs say. The question is what Fannie Mae

says, what Fannie Mae admitted; and it has admitted that it

violated FAS 133. It admitted it in its restatement, in its

Rudman Report, in its malpractice complaints against KPMG.

Here is what they said in the malpractice complaint.

Slide four, please. This is Plaintiffs' Exhibit 4, the

malpractice complaint they filed against KPMG at paragraph 123

they say: KPMG materially breached its contractual duties by

approving of policies and practices relating to FAS 133 that

departed materially from the GAAP.

That's a binding admission. They are judicially

estopped from asserting otherwise at this point in time.

THE COURT: Now, let's go over this just quickly. The

various admissions that you are referring to, the restatement --

MR. MARKOVITS: Yes.

THE COURT: -- right, Rudman Report.


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MR. MARKOVITS: Yes.

THE COURT: The malpractice complaint.

MR. MARKOVITS: Correct.

THE COURT: That's three. What was the fourth one?

MR. MARKOVITS: Their own experts' admissions and the

statements of material fact.

THE COURT: Okay. Now, virtually all of these occurred

after this lawsuit was filed, right?

MR. MARKOVITS: Yes.

THE COURT: Rudman Report certainly did.

MR. MARKOVITS: Yes.

THE COURT: The malpractice complaint, their own

experts' statements. All of those -- the restatement, the

restatement postdated the filing of the suit as well did it not?

MR. MARKOVITS: Yes, it did.

THE COURT: So if I understand you correctly, you are

saying that notwithstanding this suit having been filed and

knowing the consequences potentially of engaging in or putting

out, I should say, statements that could be interpreted as

admissions, they did it nevertheless?

MR. MARKOVITS: That is correct, your Honor. And,

again, with respect to the malpractice complaint in particular,

that's a binding admission. They are judicially estopped from

contradicting. That's under the case we cited New Hampshire

versus Maine, the Supreme Court case.


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THE COURT: Um-hmm.

MR. MARKOVITS: Again, Fannie Mae however tries to

avoid that battleground and they try to ignore the admissions.

They want to change venue as it were and drag the Plaintiffs and

the Court into a dispute about facts they have already admitted.

Let me give a few other quick examples.

Slide five, please. In their opposition at page 14,

they raise three issues or they note three issues that were

raised in Plaintiffs' Motion with regard to FAS 133. One, the

documentation of hedging relationships; two, classification of

derivatives; three, assessment of effectiveness.

And then on slide six, please, they argue right after

that: However, Plaintiffs fail to present any meaningful

discussion of any these three requirements much less how Fannie

Mae allegedly violated them.

Again, the point isn't that Plaintiffs allege that

Fannie Mae violated them. The point is that Fannie Mae admitted

it violated these three requirements. Let's take a look at

their restatement. Slide seven.

With respect to documentation of hedging relationships,

they said in their restatement, which is Exhibit 7 at pages 74

to 75: In other instances hedging relationships were not

properly documented at the inception of the hedge.

Let's look at the classification of derivatives. They

say in their restatement: We incorrectly classified derivatives


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as cash flow or fair value hedges for accounting and reporting

purposes even though they did not qualify for hedge accounting

treatment pursuant to statement of financial accounting

standards number 133.

Again, that's an admission on their part.

The third, assessment of effectiveness. In the

restatement they say: The primary reasons for the loss of hedge

accounting treatment were the improper use of the short-cut

method as defined by FAS 133 and inadequate assessments of hedge

effectiveness and ineffectiveness measurement both at hedge

inception at each recording period thereafter.

Those are all admissions they make in their restatement

and they made admissions in their malpractice claim. Whatever

positions other Defendants may take, Fannie Mae can't be heard

at this point in time in this Motion or any other Motion to take

the Motion position that they did not violate FAS 133.

The admissions as we talk about come from a number of

sources. The source Fannie Mae focuses on in its opposition is

the Rudman Report. They say that that's inadmissible hearsay,

can't be used for the purposes of Summary Judgment. It is in

fact admissible. It is not hearsay. It comes in as an adoptive

admission under Federal Rule of Evidence 801(d)(2)(b).

THE COURT: Was it adopted? That's the rub part.

That's the question.

MR. MARKOVITS: Well, that's the rub but if you look --


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we believe there can be no genuine dispute as to that issue. In

the fall of 2004 when disclosures of Fannie Mae's fraud were

occurring, they engaged special review committee which in turn

hired former Senator Rudman of the Paul Weiss law firm who used

the Huron Consulting Group for accounting, and they looked at

these accounting issues that had taken place during the class

period and they issued a report.

On February 23, 2006, Fannie Mae made the Rudman Report

publicly available and issued a statement which they then

attached to an 8K they filed the next day. Exhibit 8, please.

This statement was a Fannie Mae news release. It was on Fannie

Mae letterhead. It was put on the Fannie Mae website. And in

this release, slide ten, please, this is Plaintiffs' Exhibit 22,

in this release Fannie Mae's board chairman at the time Stephen

Ashley publicly announces that the board is releasing the Rudman

Report. Slide 11, please.

He then touts the comprehensiveness of the report

saying the board gave Paul Weiss unrestricted authority to take

this investigation wherever it led and leave no stone unturned.

THE COURT: Now, the investigation was not designed, as

I understand it, to determine whether or not there had been any

security fraud conduct on the part of the company or the people

running the company; isn't that right?

MR. MARKOVITS: That is correct, your Honor. We are not

alleging that the report makes a finding of any securities


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violation.

THE COURT: Right.

MR. MARKOVITS: It does make a finding, however of --

THE COURT: In fact, I think Senator Rudman stays clear

of that and clearly said that.

MR. MARKOVITS: He states clearly these are the

finding. Whatever the authorities wants to do with them, they

can. It is up to the authorities to decide what to do with them

and lawsuits that are sure to come. That's what he said.

Exhibit 1 to our reply is his testimony before Congress, but you

are right. He was clear that we are not looking into whether

there was securities violations and, to clarify because Fannie

Mae raises this in its opposition, they suggest, well, the

Rudman Report doesn't show securities violations.

We are not alleging it alone shows securities

violations. It shows elements of a security violation. It is

an admission that there were violations.

THE COURT: What's the practical consequence, from your

perspective anyway? I mean this is a securities fraud case that

you have brought on behalf of your clients. This is a

securities fraud case. You are claiming on the issue of whether

or not there were violations of FAS 133 you are entitled to

Summary Judgment based on this record.

What's the practical consequence from your perspective

of getting a ruling from this Court consistent with your wishes?


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Where does that take you with regard to the remainder of the

case?

MR. MARKOVITS: Where that takes us is liability will

be established as to Fannie Mae with the exception of the amount

of damages, but liability will be established because we believe

that through their admissions they have --

THE COURT: What, liability for securities fraud?

MR. MARKOVITS: Yes.

THE COURT: Well, now, isn't securities fraud, isn't

an element securities fraud the scienter requirement?

MR. MARKOVITS: Yes, an element of securities fraud is

scienter.

THE COURT: Your argument is that a one or more --

let's put it this way -- one or more violations of FAS 133

equals proof of some kind of securities fraud with all those

requirements including scienter?

MR. MARKOVITS: No, your Honor. What we are arguing is

that they have admitted the violations in multiple, in multiple

respects --

THE COURT: Right.

MR. MARKOVITS: -- through their Rudman Report, through

the restatement and most importantly through their malpractice

complaint against KPMG. With respect to scienter, we look

primarily to the Rudman Report which is an admission and it is

like now scienter is generally --


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THE COURT: But not an admission of scienter. By what

you just said a minute ago, you acknowledge and I think

accurately I might add, that Senator Rudman was not given the

mission and he didn't assume the mission, in fact he

specifically said that that wasn't what he was doing, to

determine whether or not there had been a violation of the

securities regulations.

MR. MARKOVITS: Because the Rudman Report doesn't

determine whether there is an efficient market, doesn't

determine where there is reliance or loss causation or economic

loss.

THE COURT: Or scienter?

MR. MARKOVITS: It does determine scienter, your Honor.

If I may be permitted --

THE COURT: Just start, you know, I want to give you a

chance to develop that argument in a second, but I want to start

with before you develop it point me, remind me where in his

report Senator Rudman says that he has determined that the

company and the people acting on behalf of the company had the

kind of scienter necessary for securities fraud.

MR. MARKOVITS: All right. I will point you to a

number of those points in the report.

THE COURT: Okay.

MR. MARKOVITS: If you go to slide 31, please, Kevin.

This is the Rudman Report Exhibit 21, the executive summary.


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THE COURT: Okay.

MR. MARKOVITS: Here is one of their findings and if

you recall the findings were embraced and accepted by Fannie

Mae. One of the findings is management accounting practices in

virtually all of the areas we reviewed were not consistent with

GAAP and in many instances management was aware of the

departures from GAAP.

THE COURT: Let me ask you to stop there a second.

MR. MARKOVITS: Yes.

THE COURT: You know, these phrases get thrown around

these briefs a lot and I want to make sure it is clear in my own

mind here. Can something be a violation, from your perspective,

can something be a violation of FAS 133, perhaps a minor one,

and still be consistent with GAAP or is it per se inconsistent

with GAAP to have any violation of FAS 133?

MR. MARKOVITS: Well, I will leave that to my

colleagues this afternoon to go into details of that.

THE COURT: Oh, but just give me your thinking on the

subject.

MR. MARKOVITS: I believe that in this case there were

clear and specific requirements as Senator Rudman and his group

found that were violated and so regardless of whether there may

have been other --

THE COURT: Violations of GAAP or 133?

MR. MARKOVITS: Violations of 133 and subsequently


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violations of GAAP. Okay. And --

THE COURT: But you are not saying under any and all

circumstances any violation of 133 is per se a violation of

GAAP?

MR. MARKOVITS: No, I am not making a claim that any

violation of 133 is per se. I am making a claim that these

violations were found to be violations of GAAP.

THE COURT: Okay.

MR. MARKOVITS: And slide 32, please, Kevin. Again

from the Rudman Report Exhibit 21, this is talking about FAS 133

and it concludes -- it makes a finding: Fannie Mae did not

engage in innocuous practical interpretations or modest

deviations from a strict reading of the standard.

If you go to slide 33, please. A little further on, it

says: The company's approach deviated from FAS 133 requirements

in numerous and important respects. Indeed, the record of our

review shows that the company's method of hedge accounting

conflicted with clear and specific provisions of FAS 133.

That's at page 102 to 103 of Exhibit 21.

Then if you would go to slide 34, please. Senator

Rudman's report makes conclusions of this nature throughout, but

I have just chosen this one.

THE COURT: Okay.

MR. MARKOVITS: In this excerpt which is at page 199,

it talks about what was the objective of these violations of FAS


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133 which is getting into scienter. What was the objective? And

they make a finding that the objective was to avoid both

volatility and to avoid the need to change their -- to make

complex changes to the company's business model. So avoid

volatility and avoid having to make changes to the company's

business model and it goes on to say, it makes a finding: In

order to achieve this result, the company adopted policies that

deviated from the requirements of FAS 133. These policies were

established with the knowledge and in some cases active

involvement of Howard, Leanne Spencer, Jonathan Boyles and

others.

THE COURT: So let me ask you to pause there a second.

From your reading of this report, is Senator Rudman saying that

that's what happened with the benefit of hindsight 20/20 or is

he saying or do you find that the company knew that before it

did it, i.e., violated FAS 133, they knew it before they did it

but they did it anyway?

Does he get into that distinction in his analysis of

the facts as he uncovered them?

MR. MARKOVITS: He does, your Honor. In fact, it is

clearly the latter that they knew it before they did it and they

did it anyway. He a number times, as I say and I believe this

excerpt to some extent shows, he is saying this is why they did

it. They wanted to avoid volatility. They wanted to void the

expensive changes to their accounting system so they knowingly


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implemented policies that violated clear and specific provisions

of FAS 133.

Now, you can't say -- Fannie Mae can't admit, and again

we say they adopted and therefore admitted the Rudman Report,

they can't admit that we didn't make practical interpretations

or innocuous practical interpretations. We violated clear and

specific provisions and this was done with the knowledge of the

senior management including Howard and Spencer but we don't have

scienter.

If they admit that they violated, clearly violated

clear and specific provisions of GAAP, that is scienter. That

establishes scienter. And they can't walk away from it at this

point.

THE COURT: Is that a legal question or a factual

question?

MR. MARKOVITS: Is what a legal question? I am sorry.

THE COURT: Well, has any Court held anywhere, this

Circuit or any other Circuit for that matter, let alone the

Supreme Court, that a conscious violation of FAS 133, an

admitted violation of FAS 133 per se constitutes scienter? Has

any Court anywhere ever said that? Second Circuit?

MR. MARKOVITS: Yes.

THE COURT: Any --

MR. MARKOVITS: Southern District of New York BISYS

case are 397 F. Supp. Second at 448 basically talks about if you


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have a knowing or reckless violation of GAAP, it creates the

strong inference of scienter. And there are courts that we

cited in our brief where Summary Judgment has been granted on

scienter. SEC versus Platform Wireless 617 F.3d 1072; Fraxil

versus Johnson 541 F. Supp. 2nd 1127, 1138. So it has been

done. Courts have found that --

THE COURT: That sounds like if the Court is saying

that it creates a strong inference of scienter, it sounds like

the Court is a saying in essence it is a factual issue that the

jury has to determine whether or not it in fact constitutes

scienter. It is not for a Court as a matter of law to say,

okay, that equals an admission. Therefore, we have scienter

established and that issue is now off the table for jury. If we

go to trial, that issue will not be on the table for the jury.

Scienter is established. Now we got to look and see about loss

causation. We have got to look at all these other issues.

MR. MARKOVITS: Actually the Courts we cited in our

brief have done that. There are Courts that will say, look, you

admitted, the Defendant here essentially admitted scienter. He

admitted that he knew what he was doing was wrong and based on

that admission scienter is off the table.

It is generally, you are right, it is absolutely

scienter is almost always a jury issue. It is a question of

fact for the jury, but there are cases and we believe this is

one where you have this admission that scienter is a given.


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And when you look at whether -- again, this is an

admission. I know there is the Rudman Report, there has been a

dispute about it, but for one, you can look at just the language

and --

THE COURT: In the Rudman Report?

MR. MARKOVITS: The language in the Rudman -- no, the

language in the statement of the chairman --

THE COURT: Okay.

MR. MARKOVITS: -- which was issued on February 23,

2006, slide 14, please, Kevin. And the important language is

where after saying that this is a comprehensive report and here

are some of the findings and the findings are disturbing, but

the board accepts and embraces the report, its findings and

recommendations.

THE COURT: Now, you have to be candid here, now, Mr.

Markovits. You know that when he made this statement with this

lawsuit already pending and had been pending for awhile that he

is walking a fine line. You know, he didn't use the word

"adopt" obviously, obviously; and I am sure without knowing that

he had been counseled not to use the word "adopt." I think

that's probably a fair likelihood that that was the counsel he

got along the way.

Whether as a matter of law that quote you are just

pointing me to constitutes an adoption so that the whole report

comes in as an adoptive admission, well, again, that's a --


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MR. MARKOVITS: Well, your Honor, Fannie Mae admits

itself that under the case law particularly the Quesenbery

case --

THE COURT: Yes.

MR. MARKOVITS: -- you can have an adoptive admission

by either words, conduct or silence or so combination. Here

these words you couldn't have a stronger manifestation of

adoption. They didn't use the magic word adopt, but they

embraced and accepted. They didn't say, well, you know, we are

accepting the report; we don't dispute it. They didn't say we

are just not disputing the report or we embrace and accept it,

but we dispute it.

They just said we embrace and accept it. You can't get

stronger language than that. Then what do they do? Let's look

at the conduct. Under the case law, it says you look at the

conduct. Did they accept the report? They put the report on

their website. They gave it to the SEC. They gave it to the

DOJ. They gave it to OFHEO. They had Senator Rudman testify

about the report before Congress.

THE COURT: I understand.

MR. MARKOVITS: And --

THE COURT: What year was that again?

MR. MARKOVITS: That was in 2006.

THE COURT: '06. So for some strange reason you all

didn't bring this Summary Judgment Motion on this issue six


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years ago which would have taken a lot of discovery if you had

won it, would have saved a lot of time, money, effort and energy

on the discovery front.

If scienter was established by virtue of this adoption,

we could have short-cut the discovery proces by a heck of a lot

if you had won it back in '06 but you all for whatever reason

chose not to do that.

MR. MARKOVITS: That's correct, your Honor, and it

wasn't until the actual, the expert depositions which just took

place recently that we felt we had all of the elements of the

liability, even though you are correct that we could have sought

a partial Summary Judgment just on scienter at that point in

time. But we believe that we have all of the elements here and

that we have them through admissions. If you -- slide 23,

please, Kevin. If you look at the elements of Section 10b-5,

Rule 10b-5 violation material misrepresentations or omissions,

they have admitted to the misrepresentations or omissions. We

in our statement of material facts from 43 to 64 set out a

number of their public representations they made during the

class period about we GAAP and FAS 133 and 91, and they admit

they made those public representations. They admit that they

were false.

THE COURT: By the way, did Senator Rudman, remind if

you will, did Senator Rudman find in his investigation that

these violations, these numerous violations that occurred of FAS


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133, these were done over the objection of the outside

accounting firm that was providing advice to Fannie Mae?

MR. MARKOVITS: In some cases, yes. In some cases no.

It varied actually by the violation.

THE COURT: So they contravened the expressed advice of

their outside accounting firm in some instances?

MR. MARKOVITS: In some instances, yes, particularly

with some adjustments that were made where the accounting firm

recommended that they not be taken, they went ahead and took

them, but there was also the finding in the report that in many

cases the outside accounting firm KPMG were aware of the

violations as they were occurring so it is not sort of a black

or white answer to that. It is more of a gray area. It varies.

THE COURT: Are these characterizable drawing all

inferences favorable to the nonmoving party as differences of

opinion as to how to interpret and apply FAS 133 or were they in

Senator Rudman's, from Senator Rudman's perspective not even

capable of being characterized as differences of opinion between

themselves and their outside accounting firm on how to apply FAS

133? Rather, it was, to put it in the vernacular, surreptitious

actions that were being taken without the knowledge of their

accounting firm?

MR. MARKOVITS: Let me answer that by pointing back to

slide 32, Kevin, if I could. This is from the Rudman Report.

Again, this is talking about FAS 133 and he starts off here:


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Fannie Mae did not engage in innocuous practical interpretations

or modest deviations from a strict reading of the standard.

And then it goes on to explain why. And then again on

slide 33, he says: The approach conflicted with clear and

specific provisions of FAS 133.

So if you look at -- those are just a couple examples

but throughout the report it is clear that what he is saying and

what others have said, OFHEO and the SEC, again these were not

subject to interpretation type violations. These were knowing

violations of clear and specific provisions. Those were

findings that were made in the Rudman Report which we believe

was adopted by words conduct and silence by Fannie Mae.

With regard to whether or not the admissions were

material or the misrepresentations were material here, there

really can be no issue as to that because there was a

restatement. We cited in our brief some case law and accounting

guidance, slide 27 please, Kevin. These are two of the cases we

cited. One is SEC versus Kelly of Southern District of New York

from 2009 that in that case said where the fact there was a

statement quote, "belies any suggestion that any misstatement or

omission was not material." End quote.

And that actually -- case actually quoted an earlier

Southern District of Court, the BISYS case, which said pursuant

to generally accepted accounting principles previously issued

financial statements should be restated only to correct material


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accounting errors. So the case law is clear that where you have

a restatement, there is materiality.

Now, the response of Fannie Mae to that was to just

flat out ignore that line of cases. They did not respond to

that at all. The only argument they made was as to materiality,

quantitative materiality as to catchup adjustments under FAS 91;

and that argument of quantitative materiality fails in that all

the cases they cite if you look for the word "restatement" in

them, you won't find them.

They have cited no case where there has been a

restatement and yet a Court has found that a misrepresentation

or omission relating to that restatement was not material. They

have cited not one case.

And it is also ironic that they are bringing up that

quantitative materiality because in their malpractice complaint

against KPMG, one of the factors they faulted KPMG on was a

failure to consider qualitative materiality which again will be

I am sure delved into in further detail in later Motions, but

they simply ignore qualitative materiality. They talk about

quantitative materiality and they ignore that line of cases that

says if you have a restatement, you have materiality.

They admit the in connection with requirement. We

believe they admit the scienter requirement. On the fraud on

the market reliance or the reliance element, in order to have

fraud on the market -- slide 39 please -- the Stoneridge case


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beginning with the basic case and then the Stoneridge case in

the Supreme Court --

THE COURT: Let me ask you to hold on a second. Going

back to that admitting the scienter requirement --

MR. MARKOVITS: Yes.

THE COURT: -- you would agree, would you not, that if

I were to disagree with you on that, then I couldn't grant

Summary Judgment?

MR. MARKOVITS: Your Honor, yes and no.

THE COURT: It is all or none?

MR. MARKOVITS: No. In fact, could you pull up slide

55, please? They have recently changed Rule 56 to clarify

what's essentially always been the case but Rule 56 now reads

that you can get partial Summary Judgment as basically as to any

element. And so if you go down that list of elements for a

securities violation, if you were to find that we -- or that

they have admitted all the elements but scienter, you could

certainly grant Summary Judgment on all of the elements but

scienter.

With regard to reliance, there is a fraud on the market

presumption of reliance. If you have an efficient market and

public misrepresentations, we have already established they have

admitted there are public misrepresentations. As to an

efficient market, our expert Professor Jarrell, did an analysis

which came to the conclusion there was an efficient market which


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is fairly obvious actually in the case of Fannie Mae's common

stock.

None of the six experts including Fannie Mae's experts

disputed that analysis there was an efficient market and if you

look at the statement of material fact -- slide 40, please --

our statement of material fact number 79 begins with: Fannie

Mae's common stock was traded in an efficient market with regard

to publicly disclosed information.

And they say it is undisputed that Plaintiffs' expert

Professor Greg A. Jarrell determined Fannie Mae's common stock

was traded in an efficient market. They dispute that their

expert also calculated that. They say he just assumed it and

then they dispute that its options were traded in an efficient

market which we never even alleged, but they don't dispute that

the common stock was traded in an efficient market.

So we have admissions of an efficient market, public

misrepresentations. That gives you the reliance. That also

gives you economic loss which we have alleged here and, finally,

you have the issue of loss causation. And with regard to loss

causation, again they attempt to switch the battle here and talk

about -- they talk at length in their brief about what our

expert did with regard to loss causation. We recognize that

there are issues of fact in any expert testimony, but so what we

are focusing on is -- what we are focusing on is what their

expert did, what their expert admitted.


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They had hired Dr. Alan Kleidon who is an expert and he

performed an analysis which they say is an analysis of

artificial inflation or an analysis of alternative inflation or

alternative damages, but which in fact also establishes loss

causation. Let me just go through that quickly and explain how

that is an admission their part.

THE COURT: I just want to give you fair warning now,

you have used about, according to my calculation here, about

35 minutes of your 45 minutes.

MR. MARKOVITS: I understand, your Honor.

THE COURT: So if you want to have a little time for

rebuttal, just be mindful of that.

MR. MARKOVITS: Thank you, your Honor. I just want to

go through this last point which is Dr. Kleidon performed this

analysis and he applied a fundamental impact approach what he

called. He didn't look at the stock declines on corrective days

which is the typical approach for determining loss causation.

He looked at what would the economic impact be to Fannie Mae of

revelation of the fraud, and he concluded that that impact would

be the additional cost of capital compliance.

So slide 47, please, Kevin, this is Exhibit 31 from his

deposition. He says: But what I am saying is that there is a

methodology to assess the change in the stock price from the

capital compliance issue and that's what I am calculating.

If you go to slide 48, please, Kevin, he assumes fraud


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as did our loss causation expert and he says: All right, I am

going to assume fraud and I am going to calculate what the

artificial inflation due to fraud would be. And he calculates

it at 77 cents per share as of September 21, 2004. That's the

additional cost of capital compliance. So it is much less not

surprisingly than our expert calculated at that date, but I

think that was part of the purpose of his analysis was to

minimize damages and he did so. He said assume fraud. We have

artificial inflation of 77 cents.

Then if you look at slide 49, this is also from his

report, he says any inflation after October 6, 2004, must be

less than 77 cents because it is implausible that the market

believed after October 6, 2004 that there was no possibility

that Fannie Mae would restate.

So what he is saying is I am assuming fraud, I am

calculating 77 cents of as September 21, but due to the

disclosures that occurred after that, that fraud would

dissipate, that inflation would dissipate and when you have --

if you are assuming fraud when you have inflation that

dissipates because of disclosures, that's loss causation.

So he can't get around and Fannie Mae can't get around

that their own expert admitted loss causation. It differed on

the amount of damages, much smaller amount of damages, but

admitted loss causation. And again we believe, your Honor, that

all of the elements -- this is an unusual case -- you have these


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admissions in the Rudman Report, you have a malpractice

complaint which usually isn't -- while the case is -- securities

case is pending a malpractice complaint against one co-defendant

against another auditing codefendant, but we have those here

along with the admissions of the experts and we believe that we

are entitled to Summary Judgment or partial Summary Judgment

with respect to all of those elements. Thank you.

THE COURT: All right. We will take a five-minute

break so that Mr. Stern can get set up, and we will come back

and hear his argument and any rebuttal. You have got five

minutes left based on my clock. See you in a few minutes.

(Recess at 11:56 a.m.)

(Resumed at 12:02 p.m.)

THE COURT: All right, Mr. Stern.

MR. STERN: Thank you, your Honor. If I may, your

Honor, I would like to hand up -- if I may approach?

THE COURT: Oh, sure.

MR. STERN: Ready, Patty? Your Honor, Mr. Markovits

argued for 40 minutes and he didn't cite a single piece of

deposition testimony or a single document from this case. I

understand his theory about admissions, but Mr. Markovits

doesn't contend that the Rudman Report is a judicial admission

and it is not rebuttable. He doesn't contend that that the

restatement is a judicial admission that's not rebuttable.

THE COURT: Did this he depose Mr. Ashley?


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MR. STERN: Interestingly we are going to get to that,

your Honor, because the Lead Plaintiffs notwithstanding the fact

that they took 150 depositions in this case never noticed Mr.

Ashley's deposition. It is interesting.

THE COURT: Did they depose anyone who was a Board

member at the time of that statement Ashley made to determine

whether or not the board considered that statement to be an

adoption on their part of the findings for the purposes of this

litigation which was extant?

MR. STERN: There was one member of the board who was

deposed in the context of this litigation who was a Board member

at the time of the OFHEO report. That was Tom Garrity. He was

not asked the question because I believe he was no longer a

member of the board at the time of the Rudman Report. I may be

wrong about that.

In any event, what I do know is he was not asked that

question and he was not asked what Mr. Ashley meant.

There were other members of the board deposed in the

context of the ERISA litigation. There was a prior member of

the board deposed in the shareholder derivative case, none of

whom, noon of whom were asked about Mr. Ashley's statement but

as your Honor is aware and we will get to it later we have a

declaration, we submitted a declaration from Mr. Ashley. But

before I get to that --

THE COURT: Hold on a second. Just to close the


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circle, it is your position as I understand it that if for that

statement by Ashley to constitute an adoption, the adoption for

the purposes of its admission in this litigation, the adoption

had to be a decision of the board, not of Mr. Ashley

unilaterally?

MR. STERN: That's not my position. That's Mr.

Ashley's position and that's Fannie Mae's position and it is the

position of the Board of Directors of Fannie Mae, your Honor.

THE COURT: Right. So Fannie Mae's position in this

litigation is Ashley could not unilaterally adopt it for

purposes of the Rules of Evidence and for its admission in this

case, that would have to be a board decision?

MR. STERN: Absolutely.

THE COURT: And there would have have to have been a

board vote on it?

MR. STERN: Absolutely.

THE COURT: And there was no board vote?

MR. STERN: That's right.

THE COURT: Okay. Go ahead.

MR. STERN: Before I get admissibility of the Paul

Weiss report, and I understand Mr. Markovits spent a long time

on that, I first want to focus on the record in this case.

THE COURT: Right.

MR. STERN: Because these things are not judicial

admissions and they can be rebutted and in fact they have been


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rebutted by the 67 million pages of documents that were produced

in this case, by the 150 witnesses who have been deposed over

180 days.

The transcripts total tens of thousands of pages and

three quarters of a million lines of testimony. We debated

bringing the transcripts here. There would be stacks my height

and in their opening brief the Lead Plaintiffs and their

statement of undisputed facts in support of it cited one line,

one line of testimony in their moving papers.

In all fairness they do cite three lines of expert

testimony from Fannie Mae's expert Alan Kleidon out of more than

a quarter of a million lines of expert testimony in their

opening brief but that's it.

And one interesting thing about the Lead Plaintiffs'

reliance on the Paul Weiss report as your Honor already noted

they could have filed this Motion six years ago, right? The Paul

Weiss report is dated February 23, 2006. They could have filed

it on February 24, 2006, but they didn't. Instead, they chose

to notice or subpoena more than 150 witnesses presumably we know

why. Because they thought when those people raised their right

hand and swore the oath, they would confirm the findings or the

opinions in the Rudman Report.

But an interesting thing happened. In the context of

this adversarial proceeding with the protections that are

afforded to the Defendants under due process and the Federal


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Rules of Evidence, every single witness past, present, former

employee of Fannie Mae who was involved in the development of

these accounting policies every single on testified that they

believed the accounting policies complied with GAAP. Every

single one and several of them testified they still believe they

comply with GAAP notwithstanding what the chief accountant of

the SEC testified or opined.

THE COURT: I want to be clear on this. Mr. Markovits

pointed to what he characterized as admissions in the statement

that Mr. Ashley made in connection with the Rudman Report

accepting the Rudman Report, maybe not adopting although he says

adopting it but that the Rudman Report noted numerous violations

of FAS 133. That's what he said. Numerous.

And you are contending that a fair review of the

depositions that have been taken place in this case indicate

that notwithstanding that, the people who are engaged in these

violations of FAS 133 all said that their actions were

consistent with GAAP?

MR. STERN: Your Honor, if I may. Mr. Markovits spent

a lot of time on whether there was a violation of GAAP or not.

THE COURT: Right.

MR. STERN: Right. That goes to this. That goes to

whether there was a material misrepresentation or omission made

by the Defendant, but it is clear and the cases are plentiful

that a violation of GAAP, an accounting error and accounting


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restatement is not securities fraud. In fact, in your Honor's

decision in the Evergreen case, your Honor noted that if an

accounting error by itself even a large one were sufficient to

qualify as fraud, it would eviscerate the entire scienter

requirement and let's be clear.

This accounting error or the accounting errors that Mr.

Markovits contends Fannie Mae made with respect to FAS 133 are

just that. They are an accounting treatment that Fannie Mae

determined subsequently and in consultation with the chief

accountant of the SEC to reverse. It doesn't speak anything to

what the people involved in making those judgments at the time

knew, thought, intended and meant.

And let's be clear. The factual record, and you are

going to hear from several of the witnesses in this case, shows

they all believed it was GAAP at the time. You asked Mr.

Markovits whether it was over the objection of KPMG. The

development of that policy was with the expertise in

consultation with KPMG. And as you will see later, the policy

itself was shown to the Federal Government. Fannie Mae turned

the policy over to its primary regulator OFHEO and it gave a

copy of the policy to the Government Accounting Office. This

simply is not the stuff of fraud.

But not surprisingly given that factual record Mr.

Markovits and the Plaintiffs are running pretty far and pretty

fast from the record in favor of rhetoric and hyperbole. What I


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want to do and what I would like to spend the balance of my

doing is showing what the facts developed in case establish.

Mr. Markovits said over and over FAS 133, large

restatement equals fraud. In fact, he said I think it was

presumptively fraud or something like that. But --

THE COURT: You disagree on that?

MR. STERN: Vehemently, your Honor.

THE COURT: To say the least. Now, I asked him and I

will ask you the same question: Were you able to find any cases

anywhere where a Court said just because you got a violation of

FAS 133 doesn't necessarily mean that that constitutes some kind

of scienter or some kind of securities fraud?

MR. STERN: We are not aware of a case specifically

that dealt with 133 but the cases are plentiful that says an

accounting error, a violation of GAAP without more is not

securities fraud.

THE COURT: Fine. So a violation of GAAP, maybe not FAS

133, but at least GAAP violations don't necessarily equal

securities fraud?

MR. STERN: Right. But the GAAP violation, just to

stay with the elements of the claim, the GAAP violation only

goes to whether the financial statements of a company were

materially misstated. It doesn't speak to whether the

accounting treatment, right, the accounting judgments made were

made with scienter.


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Let's be clear. The Supreme Court in Merck says

scienter is an important and essential element of the claim.

THE COURT: Yes.

MR. STERN: The Supreme Court says scienter is intent,

it is intent. It is not negligence. It is not recklessness.

You heard Mr. Markovits say -- spend an awful lot of time

talking about the complaint against KPMG. That's a negligence

based standard. It is a malpractice case. It is not an

intentional standard.

THE COURT: But for scienter you could have a situation

with extreme recklessness, could you not?

MR. STERN: The D.C. Circuit in Steadman has held,

right, that the intent, the intent requirement could be

satisfied by extreme recklessness, but let's be clear. It has

to be such a departure from the standards of ordinary care that

were so obvious that the actor must have been aware of it.

That's more than just recklessness. It is intent.

In this case, it would mean that the internal and

external accounts at Fannie Mae would have had to do something

to ensure that the accounting was -- would have had to do

nothing to even try to comply with GAAP and it would it would

mean that senior management with Mr. Raines and Mr. Howard who

weren't accountants would have had to know that the accountants

were doing nothing to comply with GAAP and they do nothing about

it. As you will see, those aren't the facts here.


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THE COURT: Well, did the facts uncover any situations

where a memo was written by KPMG to the senior management

Mr. Raines, Howard and Spencer, whatever saying, you know, you

can't do this and, if you do this, you will not only be in

violation of GAAP but it could even be fraud?

MR. STERN: No.

THE COURT: There is nothing of that kind that was

uncovered?

MR. STERN: No, absolutely not.

THE COURT: All right.

MR. STERN: So, your Honor, what do the Plaintiffs do

when they are confronted with a voluminous factual record in

this case that is the antithesis of scienter? They basically

pull out the Rudman Report, right, they dust it off, they make

some changes and they file it against Fannie Mae as their

Summary Judgment Motion. That's what they have done here.

But more than six years of discovery and evidence has

taken place, and I am about to show your Honor what that record

shows. So let's talk about the actual evidence in this case.


MR. STERN: First, let's talk about this case really

is -- Mr. Markovits spent a lot all time on it -- this case

really is all about FAS 133 because as your Honor will see this

is a bar chart of Fannie Mae's restatement. Okay. These are

aggregated up during the course of the restatement period. What


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you see here is Fannie Mae's misapplication of FAS 133 reduced

income over the restatement period by $9.8 billion. We will

explain why that number is what it is. All the other accounting

errors that he mentioned combined increased Fannie Mae's income

by $3.6 billion resulting in a total net restatement the

reduction of $6.2 billion that you have heard talked about over

these eight years.

So the case really is all about Fannie Mae's

accounting for 133. It is Fannie Mae's accounting for 133 that

drives the restatement.

All you need to know about FAS 133 are two things. It

concerned accounting for financial instruments known as

derivatives that Fannie Mae used to manage risks from changes in

interest rates and, second, it is the one of if not the most

complicated and misunderstood accounting pronouncements ever.

THE COURT: It is kind of like the accounting

equivalent of the rule against perpetuity.

MR. STERN: It is exactly like that, your Honor.

THE COURT: You know, I remember when I was in law

school they used to say, well, you know, we are going to try to

teach you about this, but the truth of the matter is no one

really understands it.

MR. STERN: The good news is you probably don't need to

know it for purposes of what you do today so it is all good.

Let me elaborate briefly on this because it is important to


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understand why it is not $9.8 billion and it is important to

understand why it is not fraudulent.

As the Court is aware, Fannie Mae is an enormous

financial institution and it has a unique Government mission.

It is basically in the business of buying mortgages from lenders

and mortgage originators. In fact, during the class period

covering this litigation, Fannie Mae was the largest, the

largest provider of liquidity in the residential mortgage market

in the country with a balance sheet in excess of a trillion

dollars, a trillion dollar balance sheet.

But let's be clear. Fannie Mae doesn't originate or

lend the mortgage directly to the homeowner. It buys it from a

secondary market from the bank or financial institution that

does and then Fannie Mae gives that banking financial some money

and that financial institution can turn around and lend more

mortgages. Fannie Mae funds all of this by issuing debt to Wall

Street or the capital markets and it makes money on the spread.

If the income that it receives from mortgages is greater than

its borrowing costs, it makes money; but as you can imagine, as

you can imagine, there is a significant risk if interest rates

move because most of the mortgages Fannie Mae holds are 30-year

fixed mortgages and if interest rates rise and then all of a

sudden Fannie Mae's borrowing costs are higher than the income

it is receiving on the mortgage it is holding.

So it goes out in the market and it buys insurance, a


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form of insurance, if you will.

And the insurance it buys are financial instruments

known as derivatives, and it is the accounting for these

derivatives that FAS 133 applies to. Derivatives. As I

mentioned, Fannie Mae's balance sheet is a trillion dollars so

during the class period, Fannie Mae had to enter into 30,000

derivative transactions to protect against the risk of changes

in interest rates.

So as your Honor can imagine, if one applies an

accounting standard or policy consistently 30,000 times and the

policy is subsequently determined to be a mistake or did not

comply with GAAP, the resulting number is big. And it is not

big because of it was fraud and it is not big because you

intentionally got it wrong. It is big because of consistency in

the compounding effect.

So the size of Fannie Mae's restatement speaks nothing

of intent or fraud. It actually speaks of consistency. And

while you are going to hear a lot more about the propriety of

Fannie Mae's accounting under 133 later today from Mr. Fink,

there are four undisputed facts that defeat Mr. Markovits'

Motion and actually support Defendants' Motion for Summary

Judgment on 133.

The first of those is that Fannie Mae spent five years

and millions of dollars developing its FAS 133 policy before

the standard ever became effective. The standard became


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effective in 2001 and in 1996 Fannie Mae put together a team to

do that. Second --

THE COURT: When you say developing now, are you

talking about a group of internal accountants/economists who

came up with the way to do this; or are we talking about also

working with outside accounting firms like KPMG?

MR. STERN: We will get to this. I am going to come

back, but we are talking about internally accountants, computer

systems people, internal auditors, lawyers, executives,

externally KPMG and the auditors, including KPMG's specialists

in accounting for derivatives. And also as I mentioned earlier,

OFHEO and the GAO. Prior to the implementation of the policy as

you will see later Fannie Mae gave its 133 policy to the Federal

Government. That's fact one.

Fact two, every fact witness testified that Fannie Mae

made a good faith attempt to implement the standard and you are

going to hear later from Mr. Fink that now the SEC thinks Fannie

Mae's implementation of 133 is reasonable and right.

THE COURT: In hindsight?

MR. STERN: In hindsight. Third, as I mentioned,

Fannie Mae was transparent to everybody with its 133 accounting

and the development of the policy internally its auditor and

its Government regulator.

THE COURT: So there weren't in the discovery process,

at least from your perspective, there weren't any memos that


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were unturned or e-mails that were unturned in which it was

demonstrated that accountants or officials within Fannie Mae

were trying to surreptitiously avoid applying the FAS 133 policy

that they had developed?

MR. STERN: No. And, in fact, your Honor, I am going

to --

THE COURT: No smoking gun, so to speak?

MR. STERN: No smoking gun, no smoke filled backroom,

none of it. It was all out in the light of day. In fact, your

Honor, I am going to go show you that the quote we saw from the

Rudman Report about known departures from GAAP, I am going to

show you the one memo that came from too so we can talk about

that.

THE COURT: Okay.

MR. STERN: And finally, Plaintiffs own experts concede

that once Fannie Mae adopted and implemented 133, it followed

its own policy during the entire class period. This is not a

situation where Fannie Mae wrote a policy and then went off

script. You will see from Plaintiffs own experts they conceded

Fannie Mae followed the policy it wrote.

And let's take each of these in turn now. First,

Plaintiffs' experts concede that Fannie Mae spent years

implementing FAS 133. On the left, we have an excerpt from the

expert report of John Barron. That's Plaintiffs' FAS 133

expert. As you can see, Mr. Barron says: Fannie Mae's


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preparation for the implementation of FAS 133 began

approximately five years prior to the effective date of the

standard. And when Plaintiffs' audit expert Robert Berliner was

deposed, he was asked question: Now you would agree that KPMG's

pre-implementation work on Fannie Mae's FAS 133

implementation --

THE COURT: Go slower.

MR. STERN: I am sorry, Patty. Now, you would agree

that Fannie Mae's pre-implementation work on Fannie Mae's FAS

133 implementation span a number of years, correct? Answer:

Yes.

As your Honor asked how that implementation and policy

was developed, I mentioned it was an interdisciplinary team of

internal and external accountants, economists, computer systems

people, lawyers, businessmen, KPMG. This is the product of it.

This is Fannie Mae's FAS 133 policy. May I approach?

THE COURT: Um-hum.

MR. STERN: Now, I am not asking you to read it, your

Honor, and I am certainly --

THE COURT: I hope not.

MR. STERN: -- and I am certainly not asking you to

understand it because after 6 or 8 years, whatever we have been

at it, I couldn't testify that I do, but I would like you to

flip through it and what you are going to see is this policy

documents the transactions, 65 transactions that Fannie Mae


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regularly uses to run its business. It provides diagrams about

how the cash flows are going to work and it provides the

purported or proposed accounting for each of those transactions.

This is called the Derivatives Accounting Guidelines

and it is colloquially referred to sometimes as the DAG within

and outside of Fannie Mae.

THE COURT: So this is the policy that would be used as

it relates to each of those 30,000 derivative transactions?

MR. STERN: Kinds, buckets, broad buckets. Right? So

not each individual transaction but the kind of business

transactions in which Fannie Mae engages, this is the proposed

accounting treatment for all of them. And there is no dispute

that this is the policy. Plaintiffs will concede it.

There is also no dispute to the second fact that

everything KPMG witnessed who was involved in the development of

this policy testified -- who was deposed in case has testified

they believed at the time it complied with GAAP and many of them

still believe it. But don't take my word for it. Watch and

listen to Jonathan Boyles. He was a Senior Vice President for

financial standards and the head of Fannie Mae's accounting

policy, developing the accounting policy.

Your Honor would note he is not a Defendant in this

case and at the time he was deposed he was not even employed by

Fannie Mae any longer.

In advance, I will tell your Honor that in the interest


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of brevity we have made cuts to the video, but the transcripts

are in the record.

(Whereupon, the videotape was played.)

MR. STERN: Your Honor, Mr. Boyles is such an expert in

accounting for derivatives that when the FASB, the Financial

Accounting Standards Board, has a question with respect to how

accounting for derivatives could have an impact on companies,

they would call him and they would ask him questions; and

that's -- Mr. Boyles was the internal expert at Fannie Mae on

the development of this policy. He was chairman and head of the

implementation group and you just heard from him. He believed

the accounting policy complied with GAAP.

But it was not just Mr. Boyles. Let's be clear. You

will see here I have attached a memo dated January 31, 2001,

where Fannie Mae, Mr. Boyles, circulates this internally to all

those distributees at the bottom of the memo and you will see --

I will pull them out for you. These are the ones who were

deposed in this case, 16 of them. Not a single one of them has

testified they believed this policy violated GAAP, not one.

And then see the 17th entry there KPMG, that's not a

single person, right. As you can imagine a couple people from

KPMG were deposed in this case.

THE COURT: I would think.

MR. STERN: And they all said they believed the policy

complied with GAAP. In fact, after the OFHEO report was issued


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in September 2004, you might recall that Fannie Mae took the

issue to the chairman, the chief accountant of the SEC. KPMG

signed a letter with Fannie Mae explaining why after OFHEO's

criticisms they believed the accounting complied with GAAP.

THE COURT: Now, how does this square with the Rudman

Report?

MR. STERN: How does what square with the Rudman?

THE COURT: The point you are going over here.

MR. STERN: It summarily defeats any inference of

scienter that you could -- I mentioned, your Honor, before the

Rudman Report and the restatement addressed whether there was a

misrepresentation and whether there was a reliance upon that

misrepresentation. As Mr. Markovits -- as you asked Mr.

Markovits whether the Rudman speaks to scienter, and he showed

you a couple of conclusions that I think you noted were at best

ambiguous with respect to whether there was scienter --

THE COURT: I think he said, I am trying to do this

from memory now, I think Mr. Markovits said that Senator Rudman

in his report pointed out and then, of course, the company

accepted this when Ashley did his statement that the violations

of FAS 133 were also violations of GAAP.

MR. STERN: That's true, but there were not violations

that were made with the intent to deceive. The scienter

requirement is with the intent to deceive.

THE COURT: Right.


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MR. STERN: So an innocent mistake of GAAP, an innocent

error of GAAP is not securities fraud. Your Honor noted that in

the Evergreen decision.

THE COURT: I know.

MR. STERN: And the cases are plentiful. So the key

issue here with respect to 133 is there is no evidence, no

evidence of any intent to deceive. When you asked me about

smoking gun document, right, and I replied not only is there no

smoking gun document, there is no smoke filled backroom, no --

there is no evidence of any intent to deceive because to my next

point you don't deceive in the light of day.

And not only did Fannie Mae develop this policy, it

shared the policy with its primary Federal regulator, OFHEO.

Again, don't take my word for it. Listen to what Ms. Kvartunas,

OFHEO's market risk examination manager in charge of reviewing

Fannie Mae's FAS 133 at the time testified to under oath.


MR. STERN: It wasn't just OFHEO. As Mr. Boyles

testified, Fannie Mae gave a copy of the DAG to the Government

Accounting Office as well.


MR. STERN: Your Honor, given your accounting policy to

the Federal Government before you employ it or implement it is

just not the stuff of fraud.

Now, I will return as I mentioned, Mr. Markovits


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directed you to an excerpt from the Rudman Report where the

Rudman Report concluded there had been a known departure from

GAAP and there was a colloquy whether that is scienter or not.

After all the years of discovery, this is the reference to the

known departure from GAAP. But look at the what memo says in

context from Mr. Boyles, March 13, 2004. While this has been a

known departure from strict compliance with GAAP, we allowed the

treatment because, from an economic taken point, the analysis

showed it produced an inconsequential difference. In approving

this policy we stated in our hedge guidelines that we would test

the hypothesis that ineffectiveness was immaterial. Our tests

of hedges in 2001 and 2002 confirmed our belief.

So what Mr. Boyles is saying here at the time is while

it might be a known departure, it is immaterial. And he was

asked, as you can imagine, he was asked about this document in

discovery. Here is what he said.

(Whereupon, the videotape was played.) A.

MR. STERN: That's the reference from behind tab 31.

That memo and that's the testimony that shows there is no

scienter there. There is no attempt to hide anything.

Mr. Markovits also showed you behind tab 33 an excerpt

from the Rudman Report that referenced Mr. Howard and Ms.

Spencer; but if you look at the sentence carefully, all it says

is that the policies were developed with their input, with their

knowledge. No where in there are you going to find a reference


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that they believed the policies weren't GAAP, knew the policies

weren't GAAP, intended to violate GAAP. Paul Weiss doesn't go

there because it is just not true.

Finally, the last point I would like to make is that

all the transparency in the development of the policy Lead

Plaintiffs experts concede that Fannie Mae then followed it they

didn't disregard it. During his deposition FAS -- Plaintiffs'

FAS 133 expert John Barron Answer: I believe Fannie Mae

implemented and followed their policies. Plaintiffs' auditing

expert Robert Berliner. Question: And you would agree with

Mr. Barron that Fannie Mae complied with its own

interpretations? The question was had asked in the connection

of 133. Answer: Yes.

So there was no dispute, your Honor. Fannie Mae spent

years and millions of dollars implementing a policy. It got the

best and brightest assembled they could, they served the policy

with the Federal Government and they followed it. This is

simply not the stuff of fraud. One doesn't commit fraud in

broad daylight. One certainly doesn't go to the Federal

Government and say here how I am going to commit fraud and then

do it.

THE COURT: So what's the relationship between that

reality as you see it and the fact that they had to do the

restatement they had to do for $6 billion? None?

MR. STERN: I will get -- let me say it this way, your


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Honor. For a company like Fannie Mae, accounting isn't two plus

two equals four. It is much more akin to what we do as lawyers

applying Generally Accepted Accounting Principles, right,

principles to concrete business transactions and determining how

those principles should be applied.

And so to use an analogy -- before I use the analogy,

let me just -- there is no dispute that different accountants

operating in good faith can look at the same transaction and

reach different conclusions with respect to how those principles

should be applied and, to draw an analogy, it wouldn't be that

much different from how judges could look at an issue and reach

different conclusions.

So, for instance, if I came to your Honor in a criminal

trial and filed a Motion in limine to excluded evidence under

404(b), that Motion might be granted. If I walked next door to

Judge Walton and I filed the same Motion in Judge Walton's

courtroom, it might be denied. For it to be scienter, it would

have to be that one of you was right and the other was so insane

that no reasonable Judge could make that ruling because that is

what the extreme recklessness standard is. It not negligence.

It is not two different judges disagreeing. It is one has to be

so beyond the pale that no reasonable Judge could reach this

conclusion.

And the answer how you reconcile these two realities

with respect to the restatement of FAS 133 on the one hand and


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the other absence of any evidence of scienter on the other is

that Don Nicolaisen as Chief Head Accountant of the SEC when he

was there said Fannie Mae's interpretation didn't comply with

GAAP. So Fannie Mae changed the interpretation.

Now, you are going to hear later today from Don

Micolaisen and what he meant by that but let's be clear. It is

just a difference of judgment. It is just as you asked Mr.

Markovits, it is two accountants reaching a difference of

opinion as to how you apply that standard.

Mr. Markovits also noted that Fannie Mae used its 133

accounting to smooth earnings. That's what he said the purpose

was. This chart the red dotted line is Fannie Mae's GAAP

earnings during the class period. You will notice that the

spike up in the third quarter of '01 pretty dramatic, almost a

dollar and it spikes back down; and then the second quarter of

'03 it spikes and then it spikes back down. If Fannie Mae was

using its FAS 133 accounting to smooth its earnings, pretty

unsuccessful at doing it.

The blue line that we superimposed is an assumed three

percent growth quarter of a quarter or 12 percent year over year

which is what Plaintiffs allege Fannie Mae was smoothing too.

THE COURT: Now, Plaintiffs' allegation though that it

was being used for smoothing purposes is based on whose

testimony?

MR. STERN: It is based on a document early on prior to


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the implementation where Fannie Mae said in disclosing it to its

accountants, Government, everybody else that its implementation

was designed to achieve predictable earnings and to eliminate

unnecessary volatility because let's be clear. There is no

debate about the economics of these derivative transactions.

You are not going to hear Mr. Markovits tell you that they

didn't in fact work economically the way insurance was supposed

to and mitigate the risk of the economics.

You are going to hear Mr. Fink tell you later today

that the economics of those transactions were in fact reflected

on the financial statements during the relevant period. You are

going to hear all of that. So this is not about whether these

derivatives economically worked. The only question is how they

get recorded on the financial statements at any point in time.

THE COURT: So there was no one in their deposition, no

former senior official in the company or board member testified,

if I understand you correctly, yes, we did this to smooth out

earnings?

MR. STERN: No. In fact, I am going to let you hear

from the senior executives at the and. The only other, if I

might, your Honor, the only other accounting error that we

talked about and that could even cause Plaintiffs' loss because

it was corrected during the class period is FAS 91 that you have

heard a little bit about that early on. All of the other

accounting errors that Mr. Markovits mentioned weren't corrected


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until the restatement 6 years later after the class period and

Plaintiffs don't even allege that somehow they could have caused

any of the injury.

So if I might just briefly a little bit of background

on FAS 91. As I mentioned earlier, Fannie Mae is in the

business of buying mortgages and often when Fannie Mae buys a

mortgage it does so at a price that's a little bit above or a

little bit below the face of the mortgage so hypothetically if a

mortgage were a $100,000 mortgage, 30-year fixed at five percent

and interest rates moved down to four and half or up to five and

a half, Fannie Mae may pay a little bit more or a little bit

less depending upon whether that mortgage is more or less

valuable today as a result of interest rates.

And all you need to know about FAS 91 is it is the

accounting policy that requires Fannie Mae to book the

additional little premium or discount that it pays for that

mortgage when it acquires it, and the accounting policy requires

Fannie Mae to book that over the expected life of the mortgage,

however it estimates that. And as you can imagine, estimating

the expected life of a mortgage is not an easy task because

although the vast majority of mortgages Fannie Mae purchased

were 30-year fixed mortgages, few mortgages go 30 years.

So, for example, if you assume your Honor has a 30-year

fixed mortgage, there is a chance that in a year or 2, 3, 4

interests rates my fall and you may choose to refinance.


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Alternatively you could decide to retire to Cape Cod, Bermuda,

the Cayman Islands.

THE COURT: Not on a Judge's salary. That's for sure.

MR. STERN: Either way your mortgage isn't going

30 years. It is going to pre-pay. As you can imagine,

estimating the expected life of one mortgage is hard. Fannie

Mae has to estimate the expected life of all the mortgages it

buys, tons and tons of them.

And so the result understandably requires a lot of

management judgment and is necessarily even imprecise, but

Fannie Mae employed computer systems and a special model and a

whole bunch of complicated rate paths to estimate that scenario

to come up with the best estimate it could, but the estimate is

still that, it is an estimate.

And so Fannie Mae with the concurrence of KPMG decided

that whatever number the computer system spit out within a

reasonable small range plus or minus one percent, that estimate

would be reasonable. It is referred to in the documents as the

precision threshold. And as you can imagine, the precision

threshold was driven largely because of the imprecise nature of

the accounting required and the nature of Fannie Mae's business.

It is Fannie Mae's use of this precision threshold that

the Plaintiffs claim violates GAAP and supports the securities

fraud violation, but like 133 Plaintiffs can't base a securities

fraud claim on our misapplication of 91 either because as with


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FAS 133, the employees at Fannie Mae who are involved in the

development of that policy have testified under oath they

believe it complied with GAAP at the time.

Plaintiffs' experts have conceded that the application

of FAS 91 requires extensive judgment. As you can imagine, you

are making estimates. Third, Plaintiffs' experts agree that the

precision threshold, the outer boundaries of that precision

threshold were immaterial to Fannie Mae's financial statements

plus or minus one percent was immaterial; and you will see that.

Finally, Fannie Mae's application of FAS 91 in the

fourth quarter of 1998 to the extent relevant is obviously

barred by the statute of repose.

THE COURT: I would ask you to back up to number three.

MR. STERN: Sure.

THE COURT: When you say that the Plaintiffs' experts

say that it was immaterial to the financial statements, were

they opining that, if I understand this correctly, were they

opining that plus or minus one percent wouldn't be enough if

known publicly to the stock purchasing public to make a

difference as to whether to buy or sell Fannie Mae shares?

MR. STERN: Yes.

THE COURT: That's basically what they were saying?

MR. STERN: The quantitative -- if you converted the

plus or minus one percent, and I will get to that in a second,

into dollars during the class period, it would be roughly


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$100 million. I understand that sounds like a really large

number, okay, but as I mentioned earlier, Fannie Mae had a

trillion dollar balance sheet and in the years during the class

period was earning billions of dollars.

So while $100 million may seem like a lot, that would

be roughly the precision threshold. What you are going to hear

is Plaintiffs' experts say $135 million is immaterial. So if

$135 million is immaterial, then $100 million is immaterial.

THE COURT: Okay.

MR. STERN: Your Honor, I started with the notion that

the people involved in the development of Fannie Mae's approach

to FAS 91 believed in good faith it complied with GAAP. This is

Ms. Pennewell. Janet Pennewell was the Senior Vice President of

Financial Reporting and Planning. She was the senior executive

at Fannie Mae charged with the development of Fannie Mae's FAS

91 approach and the implementation on the books. Here is what

Ms. Pennewell said during her deposition.


MR. STERN: Second, I mentioned to your Honor that it

is undisputed that the implementation requires extensive

management judgment. Plaintiffs' FAS 91 expert Ms. Fierstein

testified that $135 million was immaterial. I am sorry. When

she was asked if there was a prescription for this, she

testified there is not. As did Mr. Berliner. Extensive

management judgment they both said.


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And, finally, as I mentioned to you when they were

asked whether the precision threshold was material, they both

testified that $135 million was immaterial. So if $135 million

is immaterial, $100 million can't be.

Lastly, your Honor, I would like to return to where I

started, the Paul Weiss report. Mr. Markovits spent a lot of

time, you asked about it and, as I mentioned to you, they

deposed 150 witnesses and they never deposed Mr. Ashley to ask

him what he meant by the statement. That speaks volumes. But

his declaration speaks even louder because in his declaration he

said I did not adopt for myself or the board the factual

findings set forth in the report.

He goes on to make the point that you made which is it

would have required full board approval. And he also says that

the board specifically directed Fannie Mae to contest liability

in this case when the lawsuits were first filed, after Paul

Weiss was hired, throughout Paul Weiss's investigation and after

the report was issued.

It is simply not an adoptive admission. But even if it

is, as I mentioned before, it is more than rebutted by all the

evidence I just showed you. And I would like to close by

letting your Honor hear from just a couple more of the senior

executives at Fannie Mae because the Plaintiffs allege that this

is a financial fraud, that Fannie Mae intentionally

misrepresented its financials to the public. It knowingly


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misapplied GAAP.

I am going to let you hear from all the senior

executives what they meant and what they believed at the time.

You are going to hear from Mr. Boyles again who is in charge of

the development of the accounting policy. You are going to

hear from Ms. Pennewell who is in charge of implementing the

policies. You are going to hear from Ms. Spencer who was the

controller. You are going to hear from Mr. Howard the CFO, and

you are going to hear from Ms. Kappler, the General Counsel who

is head of the disclosure committee and who was in charge of

ensuring that the processes used to develop the disclosures were

robust. You are going to hear from Mr. Rajappa the head of

internal audit and lastly you are going to hear from Mr. Serock.

Mr. --

THE COURT: How long is all that going to take?

MR. STERN: 2 minutes, 3 minutes. I think it is three

minutes and 6 seconds.

THE COURT: You had me worried there.

MR. STERN: No chance. No chance.

THE COURT: I will give Markovits two extra minutes.

MR. STERN: Mr. Serock, the engagement partner of KPMG,

he was guy when the financial statements got issued and KPMG

issues a clean audit opinion saying they fairly present, he is

the guy who has to sign that, who has to sign off on that. You

are going to hear from him as well.


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MR. STERN: Thank you, your Honor. I have nothing

further.

THE COURT: Thank you, sir. Mr. Markovits, you can

have seven minutes.

MR. MARKOVITS: Thank you, your Honor. Your Honor, if

a securities case could be dismissed because the participants in

the knowing violations claim they knew nothing of the

violations, we would have no securities cases. It hardly is

shocking that all of these people testified that they knew

nothing of -- or were not aware of any violations of GAAP. That

is directly contrary to what Fannie Mae admitted in its Rudman

Report. Let's go back to its admissions.

In Rudman, in the malpractice complaint, the

restatement it is not just FAS 133. It is 30 critical

accounting policies, thousands of internal control violations.

That's what they have admitted to, and now they are trying to

walk away from that and claim that never happened, we never

admitted to it. This wasn't a frolicking detour on the part of

Mr. Ashley. He didn't go off and issue this statement without

an authority. This was a statement by Fannie Mae that was

published on their website that said that the board, not Mr.

Ashley, embraced and adopted the Rudman Report. Again, they

said not one negative word.


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THE COURT: Did they say adopt?

MR. MARKOVITS: They said accepted and embraced. They

did not say the magic word adopt, but that doesn't matter; and

it doesn't matter whether as a corporation they would have had

to have a formal resolution.

The case law says we look at words, conduct and

silence.

THE COURT: Hold on a second there. Mr. Stern just put

up on the Elmo there, I don't know if it was a quote so I will

just say he had something up there, you probably recall seeing

it as well in which he pointed out that the board specifically

directed management to contest the security fraud suit of this

case. Okay. He represented that that that was a board decision

to contest it.

Now, I think you would have to agree that a decision to

contest the security frauds suit here would be inconsistent with

an adoption of a report which you contend on its face would

constitute evidence of scienter. Would it not?

MR. MARKOVITS: Not at all, your Honor.

THE COURT: Isn't that inconsistent?

MR. MARKOVITS: I don't see that inconsistency because

it is clear that if you look at Senator Rudman's before Congress

that what they were saying, that what he was saying to Congress

and what Fannie Mae was saying is we made all these mistakes,

the bad people are gone including Mr. Boyles, by the way, who


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testified. He was let go because the Rudman Report found that

he had knowingly violated clear and specific GAAP provisions.

Bad people are gone. We are moving forward. That's the message

they sent.

They could contest the securities complaint because of

loss causation, damages, reliance, whatever else; but the Rudman

Report which they embraced and accepted and therefore adopted

clearly said that they were both these misrepresentations and

that they were made knowingly.

Let me turn quickly to a few of them that dealt with

FAS 91. Slide 36, please. Exhibit 21, management was well

aware of the requirements of FAS 91 as it developed the policy.

A little lower down: Management considered the prospective

treatment of catchup notwithstanding its awareness that it did

not conform with GAAP.

Slide 37. Finally we conclude -- this is a finding --

that Spencer and Howard concealed the true purpose of the

amortization policy and the manner which it was implemented from

the board. That shows both scienter, and it shows a lack of

transparency. Let's look at this question of transparency for a

second. Slide 51.

Rudman who is hired --

THE COURT: Let me have you back up there. What was

the amortization.

MR. MARKOVITS: That's FAS 91.


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THE COURT: Okay.

MR. MARKOVITS: I am sorry, your Honor. Slide 51,

Rudman Report Exhibit 21: The information that management

provided to the board of directors with respect to accounting,

financial reporting, and internal audit issues generally was

incomplete and at times misleading. And slide 52. Based on our

interviews and the documentary record it would be incorrect to

assume that the FASB had a significant appreciation of the facts

behind the company's accounting policies surrounding FAS 133.

The evidence will show that there wasn't this

transparency that they claimed. The evidence will show that

although FAS 133 may be complicated in some respects, there were

clear violations of clear and specific provisions which OFHEO

found, which the SEC found, and which Fannie Mae's own

investigators found; and they found it with regard to FAS 133,

FAS 91, and these dozens of other critical accounting policies.

These were all material violations and let me just

touch --

THE COURT: Well, now he is making that finding,

Senator Rudman, he is making that finding in hindsight, right?

MR. MARKOVITS: Yes. Right.

THE COURT: He is not finding -- he did not unearth,

for example, documents or e-mails that showed Fannie Mae

officials, if I understand you correctly, Fannie Mae officials

consciously saying we are going to do this, this, this and this


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even though it violates GAAP?

MR. MARKOVITS: In fact, he did, your Honor, and it is

a very long report. If you look at the report, he cites to a

number of instances. We mainly cited his findings or conclusion

based on those instances that are cited in the report. The

report is attached as an exhibit to our Motion, but there are a

number of cases in the report where he does specifically find

that.

THE COURT: So it is your understanding of the report,

your recollection of the report that there are specific

documents that are referenced in the report in which it is

indicated, whether they be e-mails or memos or whatever, an

intentional conscious decision by Fannie Mae executives,

accountants, whatever, to violate GAAP?

MR. MARKOVITS: Yes, your Honor, absolutely. And

that's how he makes his findings --

THE COURT: Knowing that it is a violation of GAAP?

MR. MARKOVITS: Knowing that it is a violation of GAAP,

yes.

THE COURT: And were there any where they were

countermanding advice from KPMG not to do it and they just

countermanded it in violation of GAAP? Did you find any of

those?

MR. MARKOVITS: Yes. There are a few, and I believe my

colleague Mr. Stock will be discussing them later at a later


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point. Let me point to slide 36 because this gets directly to

your issue you just raised.


MR. MARKOVITS: Management considered the prospective

treatment of catchup notwithstanding its awareness that it did

not conform with GAAP. All right. That's the amortization

policy. They are saying they are well aware of the

requirements of FAS 91 and they intentionally violated the

requirement in this case. And that's how he reaches his

conclusions as to the intent behind their violations.

He looks at the evidence and he had findings, and they

admitted and adopted those findings. They did not contest those

findings. Again, when this report came out, did you see

anywhere, have they produced any evidence that anywhere they

contested any of the findings or conclusions of Senator Rudman

in the report, the report that he spent two years that they paid

$62 million for where he interviewed 240 fact witnesses more

than double the number of fact witnesses who are interviewed or

who were deposed in this case and closer to the time period with

the full cooperation of the company?

All of those factors point to the Rudman Report being a

reliable piece of evidence; but apart from that, it is an

admission on the part of Fannie Mae. And they have to rebut --

it is rebuttable, unlike the malpractice complaint, it is a

rebuttable admission but where it says Spencer and Howard


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concealed the true purposes of the amortization policy and the

manner in which it was implemented from the board, they produced

no evidence rebutting that.

THE COURT: Well, I mean it is your Motion. So I mean

you have got to convince the Court that this was adopted by the

board and I mean obviously the burden is on you in that regard.

MR. MARKOVITS: Absolutely.

THE COURT: Not on them. So you have got to convince

the Court that this was in fact adopted and that, of course, is

a legal question --

MR. MARKOVITS: That is a legal question.

THE COURT: -- as to whether or not it was adopted and

would therefore usable in any future trial that may occur.

MR. MARKOVITS: Correct. I would just point out a case

that sort of resonates in that regard. There is the

Wright-Simmons case versus City of Oklahoma, 155 F.3d 1264. And

there is an investigative report and a city manager took the

investigative report and said this is the information I have, it

seems to be substantiated; and on that basis a Court of Appeals

affirmed that in fact that was an adoptive admission. This is

the information I have. It seems to be substantiated.

Well, the words and conduct we have here are much

stronger than in that case, and what we have here were clear

violations as found by Rudman and as reflected in the record.

We will get to the record evidence later. What we are pointing


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out here was we have admissions by Fannie Mae. They are

unrebutted that entitle us to Summary Judgement, partial Summary

Judgement as to the elements. One last point --

THE COURT: You want Summary Judgment, ideally you want

Summary Judgement as to liability.

MR. MARKOVITS: As to liability. So all of the

elements of liability.

THE COURT: That's pretty --

MR. MARKOVITS: It is unusual but again this is an

unusual case.

THE COURT: To say the least.

MR. MARKOVITS: This is an unusual case where we do

have the Rudman Report, we have the malpractice complaint which

is a binding judicial admission, and we have the admissions that

they did both in their statements of material fact and their

experts.

As to our experts, supposedly agreeing that the

precision threshold was immaterial, in fact they said the

contrary. They said it was qualitatively material and that is

why it is was in fact in the restatement because there is this

issue of qualitative materiality which again Fannie Mae wants to

ignore here; but they sued KPMG on the basis of, KPMG, you

forgot about qualitative materiality. They appear to forget

about it here today as well.



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MR. MARKOVITS: Thank you, your Honor.

THE COURT: All right. We will take a break and

reconvene the next round of arguments at 2:30 p.m. See you

then.

(Recess at 1:05 p.m.)

(Resumed at 2.45 p.m.)

THE COURT: Mr. Warin.

MR. WARIN: Good afternoon, your Honor. I would like to

reintroduce my partner Scott Fink who will be arguing the Motion

this afternoon. At counsel table with him is Steve Georgian who

is a Certified Public Accountant, has been engaged as partner on

many significant engagements for KPMG over the many years but

who is attached to the law department, is actually assigned to

the law department in assisting Mr. Fink in the FAS 133

argument, your Honor.

Mr. Fink has been working on this matters for years

with us. He has been invisible to the Court, but I can assure

you that he has been deeply and intimately involved as we

thought when we induced him to come over and work on it a short

case, your Honor. Thank you.

THE COURT: So he got the short straw is what you are

trying to say. All right.

MR. FINK: Good afternoon, your Honor.

THE COURT: Welcome.

MR. FINK: May it please the Court, Scott Fink Gibson,


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Dunn & Crutcher representing KPMG in this matter. But I am

speaking now in support of Defendants' Joint Motion for Summary

Judgment on the issue of scienter as to Fannie Mae's accounting

for derivatives under FAS 133, the famous 133 that you have

heard so much about.

Your Honor, I think that the fraud claim here as to FAS

133 is unlike any you are likely ever to see. Let me tell you

why I say that. There were no fake transactions here. No

phoney revenues were recognized. The Plaintiffs don't even

allege that. There were no hidden liabilities. The liabilities

were right there in the financial statements, and Fannie Mae was

not speculating in derivatives unlike some of what you have read

about in the newspapers. Fannie Mae was not making bets on the

movements of markets. They were not doing that. They were

hedging.

Another reason that the fraud claim is so unusual here

we think is that the Plaintiffs agree that the hedge accounting

policies of Fannie Mae accurately portrayed the economics of the

business. That's very unusual, and they have to concede that

because everybody agrees that Fannie Mae was in fact hedging its

risks as opposed to speculating.

So it is not surprising, your Honor, that the

Plaintiffs own experts have testified and agreed that Fannie Mae

sought to disclose quote the "true economics" of Fannie Mae's

business. That's not disputed.


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In fact, this is how the Plaintiffs summarize what we

think is truly an extraordinary claim if we could have the first

slide. Fannie Mae with KPMG's guidance and approval designed

and implemented a hedge accounting policy that violated FAS 133.

Why? In the service of the company's mission to portray the

economics business realities underlying those transactions.

So that's the fraud that Fannie Mae told everybody what

was really happening in their business? We are not aware, your

Honor, of any case holding that financial statement is false and

misleading and fraudulently so when it accurately reflects the

economics of the business. And certainly the Plaintiffs have

not cited any such case.

The fraud claim, your Honor, here is unlike any you

will ever see we believe for at least two other reasons. First,

as Mr. Stern explained to you and I won't spend too much time on

this, the Defendants methodically wrote the plans that the

Plaintiffs say were fraudulent into a playbook transaction by

transaction with words and pictures. They then took that

playbook and they handed it over to their primary regulator and

the GAO, arms of the Federal Government, to their outside

auditor and they widely distributed it within the company. They

actually put it online within the company. So why distribution

of something that the Plaintiffs say the Defendants thought was

a fraud? That is as far from the behavior of somebody attempting

to commit a fraud as I can possibly imagine.


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Secondly, your Honor, as you know all too well, that in

2004, the SEC chief accountant disagreed with Fannie Mae's

accounting for 133. No issue. He disagreed.

THE COURT: Did he disagree with the policy or did he

disagree with the application of the policy?

MR. FINK: He disagreed with Fannie Mae's

interpretation of 133. This is all about interpretation and he

disagreed with the interpretation. That's what I am here to

talk mostly about.

THE COURT: Interpretation and application?

MR. FINK: Well, the application followed directly from

the interpretation. Again, as Mr. Stern pointed out, there is

no real allegation here that they didn't do what they said they

were going to do. They put it into a book, they programmed it

into their computers and they did it; and he showed you the

concession from the expert that -- I think from two of the

experts -- that they followed those policies. So it is really a

question of how did Fannie Mae interpret it and was that

interpretation appropriate or not?

So in 2004 the SEC chief accountant said he disagreed;

but in 2007, the SEC examining this same issue reversed course

and accepted the same approach under FAS 133 that had been used

by Fannie Mae during the class period. Plaintiffs own expert

when asked about this said, well, the SEC changed its mind.

They changed their mind. And it wasn't just the SEC that agreed


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with this approach that Fannie Mae and others had been using

historically. Lots of other professionals out in the field were

doing this at the same time. They also had interpreted it the

same way Fannie Mae did.

Now, we think that this uncontroverted evidence

entitles the Defendants to Summary Judgment on the issue of

scienter.

THE COURT: What's the consequence of that?

MR. FINK: The consequence, your Honor, is very

significant. We believe it would effectively end the case.

There is no question that FAS 133 is the biggest issue in the

case and we think the Plaintiffs would be completely and totally

unable to show damages or loss causation were 133 to be removed

from the case.

Now, they might argue to the contrary and, if your

Honor were to grant this Motion, presumably we would then have

to have some discussion, perhaps some briefing about exactly

what is the impact of your having dismissed the 133 claim; but

make no mistake we think it would be effectively a case ender

and I am not going to make any bones about that that's what we

think.

Now, we can fight all day and people have been fighting

for all these years about who was right or wrong about the

accounting. That's not the issue here. The issue here as I

think was discussed in the first Motion is scienter. That's the


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issue, not who was right or who was wrong.

They cannot fight with us that reasonable professionals

agreed with Fannie Mae's interpretation. They cannot fight

that. We have put in the evidence, and I am going to go through

the evidence for you today. Scienter is not the Latin word for

you got the accounting wrong. That's not what it means. It

means fraudulent intent. That is actual intent to defraud

investors or -- let's put up Steadman, you are going to see

Steadman a lot so let's put it up -- or something that is so

extremely reckless that may also satisfy the intent requirement.

So it has to be actual intent and extreme recklessness may also

satisfy the intent requirement. What does it require? Extreme

departure, extreme.

The danger of misleading buyers had to be either known

to the Defendant or so obvious that effectively they were aware

of it. Again, intent.

So Fannie Mae's interpretation and that's what I said

it I was, it is an interpretation --

THE COURT: Well, I am going to conflate the two.

MR. FINK: Okay.

THE COURT: You are interpreting and applying it --

MR. FINK: Interpreting and applying it.

THE COURT: -- because you appreciate, I am sure, that

there are situations where there may be an interpretation but

the application never ever occurs.


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MR. FINK: Right.

THE COURT: Here it is both. It is being interpreted

and applied.

MR. FINK: The way they actually applied it according

to the way they interpreted it, I am fine with that.


MR. FINK: So for Fannie Mae's application and

interpretation to be fraudulent, they would have to prove one of

two things; that they actually knew the policy was wrong and it

would materially mislead investors and I think there is just no

evidence of that whatsoever, or that the interpretation and

application, I will put that in, was so clearly and obviously

wrong, so utterly lacking in support that no respectable and

intelligent accountant could have conceivably interpreted it

that way. If there was a clear rule that says you can't do this

and they just did it, maybe that would work. That's not this

case.

THE COURT: Well, now, when you say -- well, you are

implying objectively wrong, right? FAS 133 and this policy that

is an application of FAS 133, right, has certain objectively

certain components to it, right?

MR. FINK: It has language that people have been

fighting over what those words mean for the last decade.

That's what this is about. It is interpreting what do the

actual words mean in FAS 133, and that's why this saga has gone


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on as long as it has including, as I mentioned, the SEC changing

its view as to whether the words meant what Fannie Mae thought

they meant or what the SEC originally thought they meant. I am

going to go through that for you.


MR. FINK: But that's my goal here is to talk

about --

THE COURT: But I want to make sure it is clear at

least in my mind that the challenged conduct that the Plaintiffs

are criticizing and raising doubts about and relying upon

actually, scienter, the impression I have is that it is conduct

not of mere interpretation of what the words in FAS 133 mean,

but disregarding of what FAS 133 requires a company to do so it

is not really a question, if I understand their position, they

are not saying it is a different interpretation of what 133

stands for. It is the utter disregard of what is 133 requires

and because it is an utter disregard, well, then they are not

willing to comply with the agreed upon standard that the

accounting profession would require under these circumstances

for derivatives. I think that's the distinction they are

trying.

MR. FINK: Right. You have correctly stated their

position --

THE COURT: And you disagree --


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MR. FINK: -- and my job is to explain to you why they

are just completely wrong.

THE COURT: Right.

MR. FINK: So wrong that we are entitled to Summary

Judgement.

THE COURT: Why is it is a matter of interpretation as

opposed to matter of utter disregard.

MR. FINK: That's right.

THE COURT: Rudman, Senator Rudman, what's your read on

what Senator Rudman concluded? Was he saying it was an utter

disregard or what was --

MR. FINK: I am sorry.

THE COURT: -- or was he is saying it was a

misinterpretation?

MR. FINK: I think he says many things including

potentially that it was a disregard of clear rules, but what I

am here to tell you and explain to you is as this has gone on

for all these years, it is quite obvious to everybody in the

profession now that the rules weren't clear or there would have

been no reason for the SEC to go back and examine it again and

come out with a different conclusion.

The SEC literally came out with a different reading of

the same words. FAS 133 did not change from 2001 to 2004 to

2007. The SEC came in and the SEC changed its interpretation,

and their expert admitted that the SEC changed its


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interpretation.

If the same words are susceptible to different

meanings, then it is an interpretation issue. It is not an

issue that's black and white and that is exactly our point.

THE COURT: Okay.

MR. FINK: That's what happened here and that's what I

am going to hopefully persuade you of as I go through my

argument.

THE COURT: Okay. Go ahead.

MR. FINK: Now, I am not going to spend a lot time on

the transparency issue. It is well briefed I think in our

briefs but the key point is, as I mentioned, Fannie Mae wrote

the fraud, this supposed fraud into a playbook. Here is the

playbook. It is 475 pages long and they handed it to the

regulator. They handed it to the GAO. They gave it to KPMG.

They widely distributed it within the company.

We just don't think that's the kind of behavior that's

consistent with fraud. We think that's as a matter of law

essentially in this case. The cases we cited in our brief are

instances in which perhaps they made a disclosure to regulator

or the auditor or maybe within the company. There is no case

like this where it was so widely distributed and yet a Judge let

the case go to trial on the issue of scienter. There is just no

case like that. The Plaintiffs have not cited any case like

that.


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THE COURT: Were there cases that you found where the

Judge granted Summary Judgment on the scienter issue?

MR. FINK: There were cases where based on this

transparency issue and based on the fact that the policy was a

matter of interpretation as opposed to being clear the Court

either dismissed or granted Summary Judgment. I will give you

one or two examples.

THE COURT: Yes.

MR. FINK: There is a Tenth Circuit case that we have

cited. I always trip over the pronounce. Dronsejko -- I even

wrote it down here so I wouldn't say it wrong -- Dronsejko

versus Grant Thornton, and there was an issue in that case as to

whether an accounting rule was sufficiently clear that if the

Defendant disregarded it, it was scienter. And the Court looked

at the rule, looked to see how clear it was, looked to see that

people interpreted it differently and said even if the Defendant

got it wrong, and it was a case where the SEC said you got it

wrong, the Tenth Circuit said that's not good enough. It has to

be obviously wrong. It has to be clearly wrong. The

interpretation just has to be ridiculous or you are not acting

with scienter.


MR. FINK: So that's one case and I think there are a

couple of other cases. The Worlds of Wonder case talks about

the policy needing to be obviously wrong citing SEC versus


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PriceWaterhouse.


MR. FINK: So let me move on to this extreme

recklessness issue. We have covered some of it. It is

undisputed that other people in the profession were

interpreting, were reading the words of FAS 133 the same way

that Fannie Mae was. And the SEC -- and, as I said, the most

stark evidence of this, the most stark evidence the fact that

there are people reading it differently is, of course, the SEC

in 2007 reading the same language differently than it had

previously read it. And as I mentioned, the SEC was

interpreting the exact same language. We can take this down.

If the SEC is interpreting the same language

differently than it did four years earlier, it had to at least

be a reasonable interpretation. We are not going to say that

the SEC in 2007 adopted a ridiculous interpretation so we are

going to only look at the one that the SEC came out with in

2004. So it had to be at least a reasonable interpretation, and

it can't be fraudulent in this case for Fannie Mae to have come

to that reading of FAS 133 before the SEC was willing to accept

it. They were looking at the same words. They just disagreed

about what the words meant.

THE COURT: Was it known in the markets, if you know,

or if the record develops this, I don't know if the record did

develop it or not, does the record indicate or do you know if it


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doesn't whether or not the people in the marketplace who are

looked to for guidance on evaluating the health of Fannie Mae

for the purposes of purchasing stock or selling stock, whether

or not those kind of people, the analysts I think guess they

are, were sufficiently knowledgeable back then of FAS 133 as it

applied to derivative transactions and the complexity of

applying and interpreting it? Were they witting of all that back

then?

MR. FINK: That's have very question, your Honor, and

it is part of presentation so I will just jump ahead and answer

the question. When the restatement occurred and when Fannie Mae

had to change its accounting, of course it was a significant

event.

THE COURT: Sure.

MR. FINK: The analysts commented on it. The analysts

said you know what? We know because of all the disclosures about

derivatives and there are all kinds of disclosures, we know that

the losses that Fannie Mae had to report were offset by gains on

the hedged item. It doesn't really matter to us how they

account for them because we know that those losses are offset by

hedged items. It doesn't change our evaluation of the business

at all.

We put that evidence in. It is undisputed. They did

not even try to dispute that the analysts understood the change

was not an economic change. In other words, sometimes


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restatements happen because of an incorrect assertion as to what

the actual business is.

THE COURT: Exactly.

MR. FINK: That's not what happened here. Everybody

understood the business. It is only what the accounting was.

And that's a key point because how can you say that the

Defendants were intending to mislead people when they put out

information that enabled the market to understand exactly what

they were doing regardless of how they were accounting for it.

It is a very significant question.

Now, I have talked a fair amount about this change.

How did this change come about? I mean just magically one day

the SEC decided let's revisit that? No. There was confusion out

in the profession about this whole question that Fannie Mae

faced and the SEC chief accountant, not Mr. Nicolaisen but the

new SEC chief accountant three years later said I would like a

white paper from the accounting profession to talk about this

issue.

I don't know if this was going through his head, but

there had been several hundred restatements on 133 and he may

have been thinking, gee, maybe we ought to go back and look at

this, it has caused a big problem.

So we asked the big four, of which KPMG is one, to

write a white paper and they did. All the big four signed it --

PriceWaterhouseCoopers, Ernst & Young, KPMG and Deloitte &


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Touche which was Fannie Mae's auditor. They signed it. And

this white paper gave examples and it said here are different

ways you could interpret this language and we are going to tell

you, Mr. Chief Accountant, that this would be a reasonable

interpretation the way Fannie Mae did it, or, you know, the way

the SEC chief accountant originally did it, that would also be a

reasonable interpretation. It is not that one is black and the

other is white and one is right or one is wrong. It is just

that both of them are reasonable. You just need to decide and

tell people basically so they know what to do.

And they put in examples and some of the examples were

very much like what Fannie Mae was doing.

The Plaintiffs' FAS 133 expert, Mr. Barron, admitted

that both approaches in the white paper were reasonable, they

were rational, and they could be considered to be

GAAP-compliant. That concession we think in and of itself dooms

the Plaintiffs' claim. If both approaches were reasonable,

rational and could be deemed to comply with GAAP, how could it

possibly be said, how could it possibly be said that the

interpretation was so absurd and ridiculous that it had to be

fraud. That just cannot follow.

THE COURT: Is it your position that a reasonable

interpretation of FAS 133 is per se GAAP-compliant?

MR. FINK: I would say a reasonable interpretation is

per se GAAP-compliant, yes.


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THE COURT: So could you have a situation where an

interpretation of FAS 133 was not reasonable but it was still

GAAP-compliant?

MR. FINK: That's somewhat of a metaphysical question.

THE COURT: We try to avoid those questions around

here.

MR. FINK: I think overall, overall one would have to

conclude that it was reasonable. When it is reasonable, it is

reasonable compared to what? It is reasonable compared to the

requirements of GAAP so I think it is kind of a truism a little

bit.

THE COURT: Yes, because there was testimony that I

obviously saw in the first hour and a half either excerpts or

on the video of people who were saying that they believed

everything that they were doing was GAAP-compliant.

MR. FINK: Right.

THE COURT: And I think what is implicit it that but I

don't want to read it into it unfairly something beyond because

they thought it was GAAP-compliant, it was also a fair

application and interpretation of FAS 133, that those kind of --

MR. FINK: I think that's a fair inference.

THE COURT: -- that those kind of go together, so to

speak.

MR. FINK: I think that's an absolutely fair inference.

THE COURT: Okay.


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MR. FINK: So the SEC came out with this interpretation

in 2007. They read the white paper and they said the

interpretation that Fannie Mae was using all along was

acceptable. It was okay. They weren't saying the other one was

wrong. They were just saying this one was also okay. If people

are out there doing it, it is okay.

And Plaintiffs' expert was not able to distinguish

between what the SEC said and what Fannie Mae was doing so it

was clearly applicable. How do I know it was clearly

applicable? Because we asked him so how do you explain what the

SEC did in 2007? And he said they changed their mind. Let's

hear it.


MR. FINK: And he didn't just say it once. We asked

him again slightly differently.


MR. FINK: So Plaintiffs' expert was clear. The words

of FAS 133 hadn't changed, but the SEC's interpretation of FAS

133 had evolved. There had been confusion. People had come in

and said are you sure this doesn't work? And the SEC said, you

know, on reflection those words are susceptible to that

interpretation.

That cannot have been fraud in 2001 for somebody to

read those words and say, you know, I think this is what it

means; and the SEC ultimately said, yeah, gee, I am a little bit


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late, but, yeah, that's a reasonable interpretation.

THE COURT: Did your client -- you represent KPMG,

right?

MR. FINK: I do.

THE COURT: Did your client, were they asked to opine

on how to interpret and apply certain provisions within FAS 133

during this time frame? Were they being asked to give sort of

their expert opinion, so to speak?

MR. FINK: I am not sure exactly what your question is

so let me try it way. Fannie Mae came to KPMG and explained in

great detail what they were planning to do and what their

interpretations were and KPMG agreed that those interpretations

were appropriate under FAS 133 by the time they got to the

final book.

You know, there was back and forth along the way, but

when they got to the final book, KPMG had agreed that those

interpretations were appropriate under 133.

THE COURT: So that's part of the evidence in this

case?

MR. FINK: Absolutely.

THE COURT: And they did that in writing I assume?

MR. FINK: Absolutely, yes. So the key question for

extreme recklessness, your Honor, is: Was there one and only

one conceivable interpretation of FAS 133 that was so clear and

obvious that anybody who interpreted it differently must have


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been committing fraud or was there another interpretation that

experts in the area believed was appropriate and permitted in

practice? We know the answer. The answer was the latter.

That's an objective fact. That's not my spin on it.

And you can make an analogy to statutory

interpretation. There is a new statute. District Judges all

over the country are reading it differently. It goes up to the

Circuits. Circuit Judges are reading it differently. It

eventually goes to the Supreme Court. Five justices read it one

way, four read it the other way. Nobody would think to say

that the judges who got it wrong, wrong whose interpretation was

rejected were engaged in an extreme departure from the standards

of statutory interpretation. We wouldn't ever say that.

This is just like that. They are reading the words of

this book. It has all kinds of paragraphs and provisions. So

we just wouldn't say that.

Now, I want to talk just a bit about what hedging is

and what hedge accounting is. I am not going to get into the

all the nitty-gritty of it. I don't think you need to, but I

think you do need to understand that a hedge is something, as I

mentioned, the value of which moves in the opposite direction

of a risk. The risk here was interest rates would go up and so

Fannie Mae hedged to try to offset that. It is like a see-saw.

One side goes up, the other side goes down. That's the way it

works. Gains and losses and they offset each other.


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If you are hedging, and it is undisputed that Fannie

Mae was hedging, one way to qualify for hedge accounting would

be to match up the terms of the instruments. When I say terms,

I mean things like interest rate, maturity amount, things like

when the two pay out cash. It is not the only way to do, but it

is the way that Fannie Mae was doing it.

And there are actually a couple of different paragraphs

of FAS 133 that allow this, and that's what created some of the

confusion. Now, the Plaintiffs say if you want to use this

method, the terms literally have to exactly match in every

respect. Fannie Mae disagreed. KPMG disagreed. Fannie Mae

knew that the terms of many of these hedges didn't exactly match

but they were really, really close.

And Fannie Mae believed that as long as those terms

were so close that any difference in the pay-outs would be

trivial. People here have used the word inconsequential, de

minimus, trivial that you could use this method. Back to my

see-saw analogy. You have a see-saw. If the length of each

side is literally exactly the same, that's great; but if one

side is just a tiny bit shorter than the other, almost

imperceptible, the see-saw is going to work just fine.

If you are sitting on the see-saw, you are not going to

notice that slight difference in the length on one side versus

the other side. It is inconsequential. It is trivial. This is

what the dispute was about. It was about whether or not the


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terms had to exactly match, and there are different provisions

that talk about it and the words in those provisions were the

provisions that caused all the confusion, and the SEC settled

the confusion after getting the white paper in 2007.

Now, this brings me to what I will call Plaintiffs

misuse of a comment by the former chief accountant in 2004. You

have heard it over and over. Plaintiffs stand up usually with

great drama and they talk about how Mr. Nicolaisen said the

accounting was not even on the page. They want the Court to

believe that what Mr. Nicolaisen meant by that was that it was

crazy, it was an extremely ridiculous interpretation.

Now, even if he had that opinion in 2004, we still win

because we have shown through objective evidence that reasonable

people disagreed about this including that the SEC changed its

mind, but that was not his opinion; and I don't want to leave

you with the impression that it was his opinion. This is what

he said when the Plaintiffs asked him about it at his

deposition.


MR. FINK: And he was asked also by the Plaintiffs what

he meant when he said in 2004 that Fannie Mae's interpretation

was outside of professional standards. Let's hear what he had

to say.


MR. FINK: It was his professional judgment, it was an


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opinion, and, oh, by the way, a lot of other people concluded

otherwise. He also admitted that at the time he didn't realize

just how many people didn't interpret FAS 133 the same way that

he did. "Even I was surprised by the number of companies that

after the Fannie Mae restatement actually restated for 133."

So rather than supporting the Plaintiffs' position Mr.

Nicolaisen's testimony completely proves Defendants' point. He

acknowledged that other people in the profession didn't

interpret 133 the way he did. He didn't label them fraudsters.

He didn't label them extremists. The Nicolaisen remark helps

the Plaintiffs prove scienter not one bit. Unless the Court has

questions, I will stop here.

THE COURT: All right. Thank you very much.

MR. STOCK: Your Honor, Chris Stock on behalf of the

Plaintiffs and I think I would like to note at the outset that I

didn't get quite the rousing introduction from Mr. Markovits

that Mr. Warin gave to Mr. Fink so I wanted to make that

perfectly clear on the record.

THE COURT: Don't let it bother you.

MR. STOCK: You know, I took some notes while Mr. Fink

was making his presentation just now and essentially his

arguments for why you should grant Defendants' Summary Judgment

seemed to fall into two category. You heard him talk a lot

about how their approach was reasonable and so that negates an

inference of scienter. And you also heard him talk a lot


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about, a little bit about how they were transparent in their

approach and that too negates an inference of scienter.

Well, I will get into the evidence of why that's not

true in a minute, but in nutshell, there is evidence in the

record that Defendants' approach to FAS 133 was not only not

reasonable, but numerous third parties, the other third parties

Defendants like to make a note of how there is other third

parties concluding the same way they did. Well, there is also a

number of third parties in this case that determined that this

was clearly outside of professional accounting standards. In

fact, you heard part of Mr. Nicolaisen's testimony that it was

outside of professional accounting standards.

Now, I know we just went through the sheet of paper and

I will try not to stand up and be dramatic as Mr. Fink

indicated, but the point is if I was talking to a jury and I

held up the piece of paper and explained what Mr. Nicolaisen

said, the jury could fairly draw the inference that, wow, these

guys were -- to quote Mr. Nicolaisen -- not even on the page,

extremely reckless.

Now, you hear Mr. Fink say, well, wait a minute, that's

not what Mr. Nicolaisen meant. He meant that he was close

enough to the page and, you know, there were other people out

there, but again that was Mr. Nicolaisen's, a chief accountant's

view in 2004, the moment before they required them to eliminate

the use of hedge accounting and, by the way, brought an


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enforcement action against them for violating FAS 133 in such a

material way.

Certainly the jury could take an inference that, well,

gosh, Mr. Nicolaisen who was the chief accountant seemed to be

on to something about extreme recklessness here. Now, in

fairness the jury could take the position that Mr. Fink

advances, but at bottom we are arguing over what the evidence

says. I can ask the jury to make an inference. He can ask the

jury to make an inference. That's what it is. It is

inferences.

I want to go back again and sort of talk to you --

THE COURT: So you agree it is an issue for the jury as

opposed to an issue of law for the Judge?

MR. STOCK: I absolutely agree that the issue of

extreme recklessness is an issue for the jury, especially where

given the substantial amount of evidence that I hope to go

through with you shows that Fannie Mae was knowingly violating

these clear requirements of GAAP.

Now, remember you heard Mr. Stern talk earlier about

how this was an extraordinarily complex standard. I know your

Honor talked about this being the accounting rule against

perpetuities, but at the end of the day as Mr. Nicolaisen was

testifying, in the sense of what these requirements were that

they violated, he indicated that those rules are not overly

complex. In fact, Kevin, could you pull up slide 91? This is


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Mr. Nicolaisen's deposition.

In talking about the rules that the Defendants

violated, he said those rules are not overly complex. I think

those rules are clear, and I think they are laid out. They are

laid out 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. So clearly Mr.

Nicolaisen at this point has said, yeah, those rules are clear

and you have got to follow them.

And what the SEC found at that point in 2004 was that

these guys are not following the clear requirements. Again,

bringing an enforcement action.

So I want to go back and start with the basics, start

with this extreme recklessness prong. Under the scienter

analysis, you can prove scienter two different ways. You can

prove it through actual knowledge of GAAP violations or, like we

have talked about, you can prove it through an extremely

reckless application of FAS 133.

Well, let's start with the actual knowledge prong.

There is clear evidence in this case that the Defendants were

knowingly circumventing FAS 133's clear requirements because FAS

133 conflicted with Fannie Mae's business operations. In fact,

in 2004, this is during the class period now when Mr. Boyles was

asked -- can you put up slide 78, please -- when Mr. Boyles was

asked is Fannie Mae applying a little bit inartfully when it is


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not consistent with the guidance in FAS 133?

Mr. Boyles states quote: "We have several known

departures from GAAP." Now, a little context first before we

talk about what those known departures were. To understand what

the known departures were, you got to have some sense of what

FAS 133's clear requirements were. In a nutshell, and you heard

Mr. Fink talking about this before, there is certain criteria

that need to be met before you can comply with FAS 133. Some of

those criteria are found in the short-cut method paragraph 68.

Some are found in what's called the critical terms match method.

I don't want to get into it. They essentially come to the same

place.

Fannie Mae in its DAG that we have talked about

indicated that, you know, we are using the short-cut method. We

are following the short-cut method. The short-cut method is

what we are doing. But the problem was Defendants weren't

actually following the requirements in the short-cut method.

They created a series of exceptions to the short-cut method and

then followed those requirements, and that's what got the OFHEO

and SEC and Rudman and everyone after them.

THE COURT: What would you point to the record if you

have anything to indicate that they are doing it that way was

done with the intent to defraud shareholders? Do you have like

someone testify to that effect or do you have a document like an

e-mail or some kind of memo or anything?


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MR. STOCK: We have a number of memos, and I can point

to that in the record, where there are recognitions on the part

of Fannie Mae and on the part of KPMG that these are known

departures from strict compliance with FAS 133. For instance --

THE COURT: I am trying to go to the next step. In

other words, I am trying to see if the record that's been

developed over the last six years in the depositions and in the

document review has yielded any statements under oath or any

documents that have been uncovered that indicate that the reason

why the people were doing what you just said they were doing,

failing to comply with certain requirements of FAS 133, were

being done in order to carry out an intent to deceive

shareholders and the marketplace?

MR. STOCK: Sure. I think it is a several step

process. Certainly what we don't have are Fannie Mae employees

who are deposed raising their hand and saying, you know what?

We were trying to defraud investors. I mean, unfortunately we

don't have that evidence. But what we do is a ton of

circumstantial evidence that gets to that point. So let's start

from the beginning and build it up.

Kevin, if you could pull up slide 89. This is a memo

from Mr. Boyles during 2003 when he was looking back at the

implementation efforts of FAS 133. And he said essentially

there were three tenents that were guiding our implementation

efforts. We wanted to -- earnings volatility was to minimized


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and if there was earnings volatility it should be as predictable

as possible. We were to leverage off existing systems as much

as possible and operating earnings needed to be simple and

easily understood.

The driving principle behind these known departures

from GAAP was the fact that they had these tenents in place that

said we have got to minimize earnings volatility because

earnings volatility is bad for the investor, and we have got to

avoid costly systems upgrades because that's going to cost us

money and it is going to slow us down.

Now, the second part of the response to your question

comes actually in the form of their transparency or lack of

transparency. Now, remember, we have evidence of these known

departures from GAAP and then Mr. Fink at the end of his

presentation talked about how those departures were

inconsequential. Essentially what the Defendants were saying

is, look, we know we are violating FAS 133 here, but we believe

we are violating FAS 133 because on such an inconsequential

basis that we are allowed to do that.

But if you look at their DAG, this DAG that they have

been touting and saying we give the DAG to everybody, everybody

signed off on it, the DAG doesn't include those meat and

potatoes violations. It is silent as to them. It is silent as

to the known departures. There is nothing in the DAG that says

we know we are departing from FAS 133 here and it is silent as


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to this concept of inconsequential ineffectiveness.

So whereas this DAG is suggesting that it is following

paragraph 68 of 133, easy enough, right, I mean no controversy

there, it is not talking about the known departures from GAAP.

It is not talking about this concept of inconsequential

ineffectiveness.

And in fact, Kevin, if you could pull up slide 102. In

2004 Fannie Mae went to the SEC and sort of a last ditch attempt

to qualify their hedge accounting policy. Again, we know that

that didn't work, but after seeing the letter where Fannie Mae

was attempting to justify this policy, OFHEO said wait a minute.

That's not what your policy says you were doing. So they wrote

a letter to the SEC attempting to clarify this lack of

transparency. You see that in slide 102.

OFHEO notes: To explain its actions on hedge

accounting, Fannie Mae now introduces a novel term quote

"inconsequential ineffectiveness." While this term does not

exist in accounting standards or literature, it is employed to

overlay the concept of materiality into a matter where

materiality does not apply.

As OFHEO noted, Fannie always assumed perfect

effectiveness and took no steps to determine if ineffectiveness

existed. Finally, what is quote "inconsequential" is nowhere

defined in the current letter or in any earlier documentation

reviewed by OFHEO.


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That's OFHEO saying we have never seen this before.

Where is this coming from? What are you talking about? And two

Deloitte auditors who were in there doing the restatement work

came up with the same conclusion. I would like to pull up slide

103, Kevin. This is an e-mail between two Deloitte auditors

after having reviewed that same letter to the SEC where in

talking about the concept of inconsequential ineffectiveness

quote: I don't believe you find that term, that is,

"inconsequential ineffectiveness," in the literature." It

appears to be yet another addition to the many examples of quote

"Fannie speak." You skip down a sentence. What strikes me most

is that they appear to be rewriting history in this letter and

then there is a little discussion about how this idea of

inconsequential ineffectiveness never shows up in their policy.

In fact, no where -- and suggesting that, well, if they would

have done that, maybe that would be one thing. Quote: But

that's not what they did. Nowhere in their hedging policies or

documentation is the term mentioned. The term I believe we saw

repeatedly throughout their documentation is perfectly effective

and short-cut.

This letter, that is, the letter to the SEC that they

were attempting to justify their policy, this letter would lead

a reader to believe that they had initially designated and

documented their hedges in a manner differently from what we

know their documentation says. These are two Deloitte auditors


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saying where are these guys coming up with this stuff?

THE COURT: Were they deposed, these auditors?

MR. STOCK: Ms. DeLeo was deposed. I am sorry, your

Honor, I am not sure if Mr. Thompson was.

THE COURT: Okay.

MR. STOCK: And, by the way, that's consistent with the

actions that Defendants took in 2004. Now, remember at the end

of 2004 OFHEO has already tagged them and said, look, these

known departures are clear violations from GAAP. Your idea of

inconsequential ineffectiveness is a rouse and we have never

seen it anywhere in your documentation before. Don't you think

that in this SEC letter, their last ditch effort to justify,

they would have said, hey, wait a minute, we told everybody

about this. We told everybody about this concept of

inconsequential ineffectiveness. We told you that we were

knowingly departing from GAAP, but they never said that. There

is nothing in those SEC letters that talks about, hey, we

cleared known departures with OFHEO, we cleared this with the

GAO. We cleared it with everyone.

What you are hearing Mr. Fink say is we were

transparent because we passed our DAG around to everybody, but

the problem is the key provisions, the key problems, the key

violations with the DAG weren't in there. So passing around a

derivatives accounting guideline that excises the key stuff,

that's not exactly transparency.


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100

Let's talk about transparency in the context of Fannie

Mae a little bit more. I think I heard Mr. Stern earlier this

morning and to a lesser extent Mr. Fink this afternoon argue

that Defendants were consistently applying this policy.

Remember, Defendants consistently applied this policy and that

is evidence somehow a lack of scienter. Well, the problem is

there is evidence in the record that they weren't in fact

consistently applying the policy. And you see that at slide

105.

This is Mr. Barron's testimony where he is asked to

look at the derivative accounting policy and he says at the

bottom in the middle there he says quote: "So within their

policies they described critical matched terms perfectly" --

excuse me. I misread that. Let me start over. Quote: So

within their policies, they described critical terms match

perfectly. The problem is they don't follow and comply with the

provisions of 133 that are their policies.

Now, the OFHEO interim report makes the same point at

page 99. That's slide 106, Kevin. I will quote. Fannie Mae's

assumption of perfect effectiveness upon a hedge designation is

not only inconsistent with FAS-133 guidance, it is inconsistent

with Fannie Mae's own internal accounting guidance.

So to suggest that Fannie Mae was consistently applying

its policy, there is evidence in the record that it wasn't

consistently applying its policy. Let's look at this concept of


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101

distributing the DAG to everyone we have already talked about,

but again the DAG failed to disclose those key violations and

Mr. Barron makes that point as well in slide 107.

THE COURT: But is the inconsistent application of

their policy an inconsistent application that's based upon

varying or changing interpretations of it, or is it based upon

an intent to defraud the marketplace?

MR. STOCK: Well, we suggest that it is an intent to

defraud the marketplace in that what they are saying in their

policy is, hey, we are following the clear -- we are following

FAS 133 and here are the provisions of FAS 133 that we are

following; but the problem was they weren't following those

provisions of FAS 133.

THE COURT: What would the differential have been if

they had followed it? How different would -- does the record

develop what it would have looked like if they had followed it

in the way that you think they should have, how much different

their public profile would have been in the marketplace? How big

a difference it would have been?

MR. STOCK: I think I understand your Honor's question.

Let me see if I can respond to it two parts. The problem is

they weren't measuring and assessing ineffectiveness, part of

the concept of 133. Had they been doing that, their earnings

would have been significantly more volatile. Remember, I

showed that three tenents memo where they were worried about


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102

earnings volatility.

There would have been much more volatility, and

Defendants would concede that. So investors would have seen a

profile that instead of showing a significantly diminished

earnings volatility as you saw with the policy they implemented,

there would have been more earnings volatility. So it is a fair

inference that investors would have said on the basis of this

additional earnings volatility, we are not going to invest in

that stock. The concept of earnings volatility being --

THE COURT: That's speculative, right?

MR. STOCK: That's an inference that the jury could

draw, correct, your Honor. We haven't, with the possible

exception of Mr. Barron, we don't have any of the fact witnesses

from Fannie Mae suggesting that that could happen.

The problem is put in front of a jury and a jury could

certainly make that determination.

I want to talk a little bit more about this concept of

transparency with investors that your Honor has raised. Now, I

think I heard your Honor ask the question was it known in the

market what happened? And Mr. Fink responded in sum and

substance that, yes, it was known in the market what happened.

This was just a movement of transactions from point A to point B

and analysts recognized that.

If analysts recognized what it was wrong with FAS 133,

if analysts recognized that there was these known departures


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103

from GAAP, that there were these explicit violations of GAAP,

then on the day that the SEC determined that they were going to

require Fannie Mae the eliminate their use of hedge accounting,

there would be no price drop in the stock due to the indication

because the analyst and the market would have already priced

this concept that, hey, if you are knowingly departing from

GAAP, that's one thing and we recognize that, but that's not

what happened. The stock dropped on news that Fannie Mae was

violating GAAP. So clearly investors didn't know that this was

going on, analysts may or may not have known, but the stock

dropped anyway.

And in fact --

THE COURT: You are talking about violations of GAAP

based on the Rudman Report?

MR. STOCK: Excuse me, no. I am talking about the

violations of FAS 133 that were disclosed by the SEC chief

accountant with the extraordinarily dramatic holding up of the

piece of paper on December 17, 2004 or thereabouts. Slide 120

if you could, Kevin. Representative Royce sort of made that

same point in Lead Plaintiffs' Exhibit 14, page seven. Quote:

Fannie Mae's misapplication of FAS 133 prevents outsiders from

getting a clean view of the true risk at the company.

So that's representative Royce indicating that, look,

we didn't know what was going to with respect to FAS 133.

THE COURT: This is a Congressman?


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104

MR. STOCK: That's correct. It is during the

hearing --

THE COURT: He wasn't under oath, was he?

MR. STOCK: No, your Honor. No.

THE COURT: Well, then what evidentiary value does this

have? This is just some Congressman's thinking on what's going

on? That's not evidence in this case. I mean you are not

relying on that as evidence, are you?

MR. STOCK: I am not relying on that as evidence.

THE COURT: I hope.

MR. STOCK: What I am relying on as evidence is the

fact that the stock price dropped on the day of the disclosures

that FAS 133 was not being complied with.

THE COURT: Why the stock price or didn't drop is a

matter for experts under oath subject to Cross-Examination, not

some comment by some Congressman who is sitting up on a deias

giving his or her opinion on what's going on. That is not

evidence. So stick to the evidence.

MR. STOCK: I recognize that, your Honor. Thank you.

I think I would like to turn to the FASB, the evidence of the

transparency or lack of transparency with respect to the FASB.


MR. STOCK: There is also no evidence that Defendants

went to FASB with respect to these violations of GAAP. In fact,

there is evidence from Mr. Barron's rebuttal report, slide 114


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105

where Mr. Barron is discussing, you know, 35 communications from

Fannie Mae to the FASB and none of those communications quote

"describe or revealed to the FASB the numerous practical

interpretation of the critical terms match provision."

THE COURT: Hold on a second. The evidence that the

Defendants are pointing out on the record, and you can take a

different position obviously, you are entitled to do that, they

are saying that the evidence that's been developed in this

record indicates that the people at Fannie Mae thought that what

they were doing as it related to applying FAS 133 was consistent

with GAAP. They cited numerous statements under oath, people

who were being deposed saying that what they were doing was

consistent with GAAP.

Now, obviously that's their interpretation. If they

think it is consistent with GAAP, they have no reason to go to

FASB about it. That wouldn't make any sense. So I am looking

for what the counter evidence is to what they have, counter

evidence on this record that the people at Fannie Mae knew or

believed, I should say, at least believed if not knew, that what

they were doing was not consistent with GAAP and kept that from

the FASB.

MR. STOCK: Kevin, could you call up in response to the

Judge's question slide 85? This is Lead Plaintiffs' Exhibit 30.

THE COURT: 30. Okay.

MR. STOCK: This is a discussion of one of those known


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106

departures from GAAP.

THE COURT: Okay.

MR. STOCK: And Mr. Boyles is suggesting in a memo from

the class period that: Included in our hedge guidelines is the

concept of duration matching, that subject to certain criteria

allowed the hedge desk to assume no ineffectiveness in their

hedge relationships. While this has been a known departure from

strict compliance with GAAP, we allowed that treatment because

from an economics standpoint the correlation from matching and

durations between the anticipated debt and the actual debt to

be issued is better than just matching notional and payment

reset dates. Now, that's a lot of gobbledegook --

THE COURT: I would like to see a D.C. jury unravel

that. I would like to see you explain that to a D.C. jury. Try

explaining it to a Federal Judge in the first instance because I

am trying to imagine a D.C. jury unraveling that one. Go ahead.

What did he just say in plain old fashioned English?

MR. STOCK: Plain English. Let's look at line 79 and

see if we can unravel it for Court. Essentially what the short

short-cut method is saying is there are various terms that you

need to match. The terms in connection with this known

departure from GAAP were the notional terms and the expiration

date, and the maturity date. Now, it doesn't matter what

notional terms were. It doesn't matter what these other

expiration date and maturity date is.


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107

What you need to know is in number six. Number six is

a DIG issue E4 and that's a derivative implementation guideline.

And essentially what it is saying is the verb match is used in

this specified conditions to mean exactly the same or

corresponding exactly.

What Mr. Boyles is saying in this memo is, hey, forget

about us matching number two. Forget about us matching number

three. Let's come up with our own matching concept, and we will

call it duration matching but there is nowhere in FAS --

THE COURT: Who is that memo to?

MR. STOCK: That was an internal memo to distribution.

THE COURT: Okay. It goes to like to Raines, Howard,

Spencer? Did it go to those kind of folks or the board?

MR. STOCK: Kevin, could you -- it did not go to the

board, your Honor.

THE COURT: I am trying to determine whether the record

indicates, maybe you know off the top of your head, does the

record indicate that this memo that Boyles wrote was actually

reviewed, A, and if reviewed, B, relied upon in the

implementation of policies that resulted stock fluctuation.

MR. STOCK: Well, certainly KPMG reviewed it. You see

that in slide 86 which is an e-mail between two KPMG auditors

talking about the same concept, talking about this duration

matching concept that didn't exist in FAS 133.

THE COURT: Okay.


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108

MR. STOCK: Saying: I do know that the SEC has taken a

view that applying FAS 133 needs to be in strict compliance with

the letter of the standard. This is obviously a departure from

that, although as they demonstrated an immaterial departure.

Then he recognizes later in the same e-mail: Should we go ahead

and insist that they employ the long hall at this juncture just

to be by the book. I not believe so. We have already agreed to

this policy.

This is KPMG suggesting we know that Fannie Mae's

policy violates 133 at least with respect to this duration

matching concept. They demonstrate -- it is an immaterial

departure but the problem was they hadn't done the calculations

required under FAS 133 the to make that determination.

THE COURT: What kind of, if you know, what kind of

application -- he is referencing here an application of FAS 133.

So what was the kind of application that he is referencing here

that was not in quote "strict compliance" with the letter of the

standard?

MR. STOCK: This concept of duration matching. This

concept as we talked about earlier with ignoring numbers 2 and 3

determining that they don't need to match, but instead we will

come up with this new concept of matching durations. That's the

concept that Mr. Boyles indicated in his previous e-mail that

that was a known departure from GAAP.

THE COURT: Was that some kind of novel interpretation


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109

of FAS 133?

MR. STOCK: It was indeed, your Honor.

THE COURT: Okay. And is it your position or thinking

or your expert's position and thinking that before they could

take a novel interpretation of that kind, they had to first go

to the FASB to get a blessing on it?

MR. STOCK: Well, what Mr. Barron is saying, our

expert, is, look, there have been 35 times -- you are running up

to the FASB for every issue, on all kinds of issues but then

when you came up with these known departures from GAAP, you

didn't go to the FASB and Mr. Barron makes the conclusion that

on the basis of that evidence, this was quote "intentionally

flying under the radar" on this issue. They were intentionally

flying under the radar on this issue with respect to OFHEO as

well. We sort of talked about how that's the case especially

with OFHEO in the letter to the SEC.

THE COURT: Did your expert say that the failure to

comply, strictly comply under these circumstances had a material

effect on the market or on the market's impression of the

company's financial well-being at that time?

MR. STOCK: What Mr. Barron said is on the basis of all

of these known departures, this is one of a group of known

departures, but what he said was on the basis of all of these

known departures, the investors weren't in a position --

investors, OFHEO, FASB, SEC all of these entities weren't in a


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110

position to accurately assess Fannie Mae's accounting policies.

And the case law suggests this that where is there is a knowing

violation of GAAP, a recognized violation of GAAP, that's enough

in and of itself to establish scienter.

THE COURT: Well, that's the second point. I don't

know if you have shown me the evidence of that yet. You have

shown me a piece of evidence here that suggests that the

interpretation and application of FAS 133 under these

circumstances was not a strict compliance with FAS 133; but as

we have had earlier discussions today, as you may recall, just

because it is not a strict compliance of FAS 133 doesn't

necessarily mean it is a violation of GAAP. It is not a

necessary connection between those two things.

MR. STOCK: Well, I think Fannie Mae in its restatement

already admitted that these known departures from GAAP were

material misstatements of previous --

THE COURT: Known departures from FAS 133 or known

departures from GAAP?

MR. STOCK: Known departures from FAS 133. Fannie Mae

has already admitted in its restatement that they violated FAS

133 for exactly what we are talking about here, the fact that

they didn't do the assessment and measurement required and

knowingly departed from FAS 133 on these issues.

THE COURT: Is it your position that any violation of

FAS 133 is per se or necessarily a violation of GAAP? Is that


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111

the Plaintiffs' position?

MR. STOCK: No. That wouldn't the Plaintiffs'

position.

THE COURT: So you could have a violation of FAS 133

that's not in strict compliance that's of an interpretive nature

that still -- well, I will put it in the negative. That isn't

inconsistent with GAAP?

MR. STOCK: No. No that's not what I am saying. I

understood your Honor's previous question to be could there be

errors with respect to FAS 133 that were immaterial and thus not

violations of GAAP, and we would concede that there could be a

situation where that would be happen.

THE COURT: Okay.

MR. STOCK: But in this case as you remember the letter

from OFHEO, the idea of immateriality in this particular context

with respect to these known violations, they are attempting, as

OFHEO said, the Defendants were attempting to impute a

materiality standard where no materiality standard exists.

That's in the OFHEO letter. Deloitte says it too. There is no

evidence that they were actually following the standard here.

THE COURT: Well, where is the evidence that this was

being done with an intent to defraud? That's what I am trying to

get your help to help me to see where if any there is any

evidence of that.

MR. STOCK: Well, I think the evidence is pretty


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112

apparent from the fact that they weren't out -- they didn't

disclose those. They would go to these various entities and

disclose the fact that, hey, we are out here doing all this

stuff with respect to FAS 133; and then never disclose the known

departures, the very issues that the SEC filed an enforcement

action against them.

Now, remember they trotted this concept of we were okay

to knowingly depart from GAAP under this inconsequential and

effectiveness idea to OFHEO and Deloitte, and OFHEO and Deloitte

rejected it, the SEC rejected it, Rudman rejected it as well.

Plaintiffs' experts reviewed it and rejected it.

And I want to talk about what Mr. Barron says in his

concept -- excuse me -- in this context. Look at slide 104.

THE COURT: You say Rudman rejected it. Senator Rudman

wasn't taking a position on whether or not the concept of

inconsequential effectiveness was in some inconsistent with

GAAP, was he? He is not an expert in accounting.

MR. STOCK: The Rudman Report. Excuse me. I misspoke.

THE COURT: Right.

MR. STOCK: The Rudman Report took the position that

this was inconsistent with the strict requirements of FAS 133.

Now, if you look at what Mr. Barron is saying, FAS 133 doesn't

include any reference to inconsequential ineffectiveness, and

skip to the bottom. The only options available under FAS 133

are either to, number one, qualify for the assumption of no


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113

ineffectiveness or, number two, assess and measure

effectiveness.

What Fannie Mae was doing was coming up with

work-arounds to say, hey, we now qualify for the assumption of

no ineffectiveness and, therefore, we don't have to assess and

measure under these two prongs. But --

THE COURT: What was the benefit that inured to Fannie

Mae for doing it this way?

MR. STOCK: That's exactly it. The three tenents memo

that we looked at before, the first prong allowing them to

qualify for the assumption of no ineffectiveness met their

tenent of reducing earnings volatility. If they could qualify

for that assumption no ineffectiveness, there would be no

earnings volatility in their statements.

Secondly, the second tenent if you remember was to

avoid those costly systems upgrades. If they could qualify for

the assumption of ineffectiveness under number one here, they

wouldn't have to do those assessments and measurements which

could be costly for a company like Fannie Mae who had 30,000

hedging transactions.

So it is clear that these work-arounds were in the

service of those three tenents that we looked at earlier. We

have to leverage off existing systems and we have to minimize

earnings volatility. That's the genesis of these known

departures from GAAP, and it fits consistently with the


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motivation of, you know, following those three tenents we

discussed.

THE COURT: And the person who came up with this

concept, was he deposed?

MR. STOCK: This is Mr. Boyles. The memo was from Mr.

Boyles during 2003.

THE COURT: Did he confirm under oath that he did it in

order to meet those tenents?

MR. STOCK: He did not confirm under oath that -- I

guess I don't follow your Honor's question aside from --

THE COURT: Well, are you suggesting that he did what

he did in order to comply with certain tenents that he had been

given by management that were to be kind of the objectives that

he was to be striving to achieve? Did he under oath confirm

that he came up with this approach, which is novel, as a means

to enable him to comply with these tenents that he had been

given by management? Did he say that under oath?

MR. STOCK: What he said under oath -- I don't think he

said exactly that under oath. I think what he said under oath

was these -- and what the document itself says -- is these were

the three tenents that were driving our implementation efforts.

But I want to point to the evidence where other third parties

have in fact determined that they were violating GAAP to serve

these tenents.

You look at OFHEO in its final report at page ten,


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slide 93 said that by inappropriately assuming that the vast

majority of its derivatives were quote perfectly effective

hedges, the hedging system adopted by Fannie Mae management

achieved the volatility dampening benefits of the hedge

accounting without the need to address the associated

operational challenges. As a result of their preoccupation with

reducing earnings volatility and minimizing infrastructure

investment, senior management caused the enterprise to adopt a

FAS 133 policy that did not comply with GAAP, consistent with

what I just said. Mr. Barron says the same thing. Slide 95.

Fannie Mae personnel were aware early in the

implementation process that the company;s edging strategies did

not fit within the strict requirements to qualify for the

assumption of no ineffectiveness yet they chose to develop

accounting policies that worked around the requirements in order

the avoid the required quarterly assessments and measurements

rather than develop adequate systems.

Again, the same concept. There are these tenents out

there and they worked around the requirements to serve the three

tenents and, in fact, in this scienter context, Mr. Barron makes

a couple of other points that spoke directly to Defendants'

actual knowledge of these work-arounds. If you look at slide

96, this is Mr. Barron's report at page 34. Fannie Mae's

management knew that the accounting policies it established with

respect to the application of hedge accounting were not in


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conformity with FAS 133.

I mean what better way to discuss the fact that this

was at least extremely reckless than a recognition on the part

of Fannie Mae that we know what the requirements of FAS 133 are,

yet we are deliberately going to come up with a policy that

doesn't follow that.

And Mr. Barron makes that point at slide 100. Fannie

Mae's senior management recognized and documented the

requirements of FAS 133. They understood what FAS 133 was

saying but then quote "designed, implemented and applied a

policy for accounting for derivatives that violated FAS 133 in

several respects."

This is all evidence of affirmative scienter. At the

very least, it is evidence of extreme recklessness.

THE COURT: Were the people who did this confronted in

depositions about this conduct?

MR. STOCK: Were the people --

THE COURT: Was Barron confronted?

MR. STOCK: Mr. Barron was certainly confronted for

two days I think over this.

THE COURT: And what did he say as to his explanation

for why he did what he did?

MR. STOCK: Why Mr. Boyles did he what he did?

THE COURT: Boyles. Not Barron. Boyles.

MR. STOCK: Why did Mr. Boyles -- I see. Mr. Boyles


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said that we believed we were complying with the spirit of the

standard. In fact, if you look at slide 41 -- Kevin, I am

sorry, Kevin -- 125. Mr. Boyles in Exhibit 10 at page 65 says:

When we developed the duration short-cut, we felt like it was in

the spirit of 133 while not exactly to the letter.

Now, I want to speak to Mr. Boyles' spirit argument

because --

THE COURT: Hold on. Read the rest of that.

MR. STOCK: And so we built that into our adoption of

133 because we felt like that was within the tenents of 133 of a

match, and then on an annual basis we would report back to our

auditors and the management what the effect of -- had we gone

long haul on those transactions and not taken the duration

short-cut -- what the effect would have been on earnings.

Now, FAS 133 doesn't allow companies to make this sort

of testing on an annual basis. If you are not following the

strict requirements of FAS 133, you have an obligation under FAS

133 to assess and measure the ineffectiveness on at least a

quarterly basis. And this is Mr. Boyles saying we would go back

and look at this on an annual basis.

So even under that, even under Mr. Boyles' explanation

that violates FAS 133, but I want to --

THE COURT: So you think this is evidence of an intent

to defraud on his part?

MR. STOCK: I think it is.


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THE COURT: Would you point to that to the jury as

evidence of his intent to defraud shareholders?

MR. STOCK: I would point to this -- excuse me --

sorry. I would point to this as evidence of extreme

recklessness with respect to this position. In fact, one of

these other people that Defendants are fond of citing talked

about this exact concept. The PWC publication that Defendants

rely upon. Kevin, if you could, pull up 126.

This is one of the other accountants that supposedly

went the same way as Fannie Mae. Well, in a separate portion

that they didn't quote of the publication, you see about halfway

down, they note that, in contrast to Mr. Boyles in the spirit of

argument, in some instances registrants have assumed that they

did not need to assess or measure ineffectiveness because they

had met the quote "spirit" of the short-cut method. The SEC

staff does not believe that the short-cut criteria have a spirit

or principle that can be met without strict compliance with the

stated requirements.

And, by the way, this PWC publication came out at the

same time as this white paper and SEC exposure draft were

working through what means critical terms match so clearly

PriceWaterhouseCoopers, one of the big four that signed on to

the white paper, was suggesting there is no spirit of the

standard here. There is -- you have to meet the requirements

or you don't. And that's another example of at least an extreme


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recklessness.

And, by the way, your Honor, I mean if they believed

that this was an approach that was coming up close to the line

or there was clearly a recognition on their part that they had

the opportunity to go to the FASB, they could go to their

regulator OFHEO. They could go to the SEC as they did in 2004

and preclear it or clear it or even discuss it, but there is no

evidence in the record that they ever went to any of these

entities, GAO included, to say, look, we have got this policy,

it is 1998, 2000, 2001. The standard is new. What should we do

with this?

Even though they were going to the FASB on almost every

other application as we saw in the evidence.

So I want to conclude with slide 127 which is a quote

from Mr. Barron's report, rebuttal report at 25. Mr. Barron

pointed out that quote: None of the restatements I reviewed

resulted in the total elimination of hedge accounting. Fannie

Mae truly stands out in this regard indicating the pervasiveness

and severity of its violations FAS 133. Now, that pervasiveness

and severity led to 12.1 billion dollar restatement of earnings

based on these material misrepresentations. And I recognize

that while scienter can't be established by publishing

inaccurate figures alone, courts have held that quote

"significant violations of GAAP standards can provide evidence

of scienter," and one of those cases is the In Re: Daou Systems


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D A O U Systems case, 411 F.3d 1006.

As to the scienter issue, there is evidence in this

case that Defendants knew they were violating FAS 133, that

Defendants were at best extremely reckless in adopting a policy

that they knew violated GAAP on multiple occasions, that they

deliberately obscured these known departures from GAAP from

their regulator, from the FASB, from the SEC, and from their

investors and that there were numerous other entities that

concluded that Fannie Mae's FAS 133 policy was entirely

unreasonable.

All of this evidence, not to mention the evidence in

our papers, suggest a strong inference of scienter, certainly

creates at least a general issue of material fact on the issue

of FAS 133. So with so much evidence of scienter here, the

Defendants cannot possibly be entitled to Summary Judgment. So

for those reasons, we respectfully request this Court to deny

it.

THE COURT: Let me ask you this question. Do you agree

with Mr. Fink that if they were to win this Motion, that would

be the end of the case?

MR. STOCK: I think if FAS -- there is no question that

FAS 133 is a large portion of the restatement.

THE COURT: What would be left?

MR. STOCK: Well, there were 30 accounting violations

in this case so they have not sought Summary Judgment as to the


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other 29 accounting policy violations so one out of 30. I mean

recognizing again that 13 is a large part of this here and

that's another problem with the approach the Defendants have

taken. They attempt to isolate and decontectualize one of

these standards away from all the scienter evidence of the other

standards.

THE COURT: Decontecturalize?

MR. STOCK: I am riffing here, your Honor.

THE COURT: Is that a midwestern term?

MR. STOCK: It must be.

THE COURT: That's interesting.

MR. STOCK: Under these facts, your Honor, not

including the representative Royce transcript --

THE COURT: What would the ripple effect be as to the

individual Defendants?

MR. STOCK: If you were to grant Summary Judgment?

THE COURT: On this one.

MR. STOCK: I think we would have the same issue. The

individuals would -- again there are still allegations here as

to 29 other GAAP violations. We would have to still prove that

there were scienter and all the other Rule 10(b)5 elements with

respect to all the other 29 GAAP violations, but we don't think

the Court needs to reach that issue here. If there are no other

questions, thank you, your Honor.

THE COURT: You are welcome. You have got ten minutes,


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Mr. Fink.

MR. FINK: Thank you, your Honor. Before I respond to

some of the specific points made by Mr. Stock, I would like to

first say is that nothing he said creates a genuine issue of

fact for trial on the issue scienter as to FAS 133. Nothing

overcomes the showing that we made that Fannie Mae showed all

kinds of outsiders its playbook. It gave its playbook to OFHEO,

to the GAO, to KPMG.

THE COURT: Now, this most recent one he just put up on

the screen here he contends that Mr. Boyles acknowledged that

under that situation that was a kind of a modification of the

playbook as it occurred in that situation. Do you disagree with

that characterization?

MR. FINK: Absolutely 100 percent. What Fannie Mae did

was to write down in writing in detail exactly what it was going

to do. Did it label it known departures from GAAP? No, it did

not label it as known departures from GAAP because they didn't

believe that those policies materially departed from GAAP.

Now, you have asked a number of questions about what if

you violated 133, would that automatically be a violation of

GAAP? The answer is no. The reason the answer is no is because

you have always embed the issue of materiality. You could have

a departure from an accounting standard, but if it is not a

material departure, if the amount of the departure is

immaterial, it doesn't violate GAAP.


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They believed, and it is undisputed they believed, that

the policies as written as detailed in the DAG materially

complied with GAAP and so they were not afraid to hand it over

to people who could read it and say, well, maybe you don't think

it materially violates GAAP, but I have some questions. They

were not afraid of that scrutiny, and that's why they wrote it

down and handed it out.

THE COURT: So this concept of inconsequential

effectiveness that Mr. Boyles talked about, testified about,

wrote about in the documents, this was something that was known

in advance of its execution and application?


THE COURT: It was known to the people at OFHEO?


THE COURT: It was known to the people at the SEC?

MR. FINK: Well, they didn't go to the SEC to discuss

their policies in advance, but let me explain --

THE COURT: But --

MR. FINK: -- let me explain how they know that from

getting the DAG. Any time you have a derivative in a hedged

item, they will literally not offset to the penny. It is just

humanly impossible. So the question is if the derivative goes

up in value, how much does the hedged item go down and vice

versa? It is never going to be to the penny.

What if it is a dollar? Who cares? What if it $10? Who


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cares? Well, in this situation when the change in value of the

derivatives was in the tens of billions of dollars and you asked

him that question, how much was it, the part that wasn't

completely offset, that's the ineffectiveness. The part that

was not completely offset was in the low millions of dollars on

tens of billions of dollars of change in value. That is by

anybody's definition de minimus, inconsequential, trivial,

whatever word you want to use.

THE COURT: How about immaterial?

MR. FINK: It is nothing and their experts said they

had no basis to disagree with the company's tests which they did

and which we put into evidence that showed that the

ineffectiveness was trivial, inconsequential, immaterial.

That's what we are talking about, and anybody who understood

this area when they read paragraphs 68, when they read paragraph

65 would know that's exactly what it means.

So let's put up, if we can, paragraph 68 which is I

think number seven. Oh, sorry. This is paragraph 68. What's

important here is that paragraph 68 which is one -- I remember I

told you there were two paragraphs -- this is one of them. It

uses the word match. The terms have to match.

People started asking questions. Well, what does that

mean? Let's put up number three which is the slide that Mr.

Stock used I think on paragraph 68. Yes. It is the same slide,

but I just highlighted what he talked about. He said, well,


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there was DIG, DIG was an arm of the FASB, Derivatives

Implementation Group. People were so confused about FAS 133

they had to form a special group just to answer questions about

13.

THE COURT: No wonder.

MR. FINK: People are wondering what does match mean?

Does that mean literally exactly match? So the DIG came out

with E4 and said the verb match means exactly the same, exactly

the same. Okay?

Now let's look at paragraph 65. This is the other

paragraph that allows for this quote "assumption" of no

ineffectiveness that's been discussed. Let's put up, yes, slide

eight I think. Okay. So this is paragraph 65. It uses

different language. It doesn't say match. It says the terms,

the critical terms must be the same. Well, why did they use

different words? There must have been some reason.

This is the debate. This is what people were

debating -- wow, why did they do that? Does it mean maybe it is

not exactly the same? The DIG came out and said match means

exactly the same. There is no DIG E4 or E5 or E6 or E7 that

tells you what the same means.

So people started thinking and believing that the same

had some wiggle room. If two people are both 62 years old but

one is born in August and the other born in April they would

both say they are the same age. They are not exactly the same


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age, but for all intents and purposes, for any reason that it

would matter to anyone, they are the same age.

And that's what Fannie Mae did. They said we think

that if we design the derivatives so that they are so close that

they are essentially the same, that we can do this. This is the

issue that the SEC disagreed with them in 2004, and this is the

same issue, the exact same issue, that in 2007 the SEC said you

know what? Same doesn't have to be exactly the same. If the

terms are close enough so that that ineffectiveness, that

differential so small that it doesn't matter to anyone, then we

are going to let you do this. It is okay. And that

interpretation is the same words.

So Fannie Mae interpreted those words in 2001 to mean

what I just told and the SEC interpreted those exact same words

in 2007 to mean what I just told you. It cannot have been a

fraudulent interpretation of the same words just because it

happened six years earlier. They are the same exact words. So

that's why I say objectively it can't be the case that it was a

fraudulent interpretation.

Now Mr. Stock said, well, OFHEO and SEC originally

although they changed their mind and Deloitte were over here and

then there were other people over here. That's my point.

Different people interpreted the exact same words differently.

It doesn't mean either one was committing fraud. It just means

they read these words differently.


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THE COURT: He says they were doing it the way -- they

were doing it that way in order to deal with the volatility

issues that was set forth in those tenents knowing full well

will that if they were successful in minimizing the volatility,

it would have a positive effect on the stock price, the value of

the stock price on the marketplace. What do you say to that?

MR. FINK: Well, what I say to that is that hedge

accounting in fact is designed to avoid volatility. That's the

whole purpose of hedge accounting. Otherwise, you would have

the hedges and the derivatives going up and down like this.

What the FASB says if you meet certain tests, you get to -- you

have earned the privilege of not having volatile financial

statements.

And, remember, the volatility is not reflecting what's

actually happening in the business. If everybody knows the loss

is offset by the gain, what purpose would it serve to have

earnings that are going like this instead of actually reflecting

what was happening in the business? To say that somebody wants

to, I am motivated by this evil desire to portray the economics

accurately, what kind of fraud is that? It doesn't make any

sense.

That is not an intent to materially mislead investors.

It is an intent to the accurately portray the business. Let me

address the three tenents because this comes up all the time in

this case and somebody is going to have to explain this so I


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might as well be the person to do it.

The three tenents. The first tenent was earnings

volatility should be minimized and, if there is earnings

volatility, it should be as predictable as possible.

THE COURT: Who created these three tenents?

MR. FINK: Jonathan Boyles wrote them in a memo in 2003

talking about the implementation of 133 in--

THE COURT: Where?

MR. FINK: He was trying to explain to senior

management what motivated some of the decisions that had been

previously made . He was actually talking more about

operational issues, but let's take them at face value.

THE COURT: So these were his tenents?

MR. FINK: Right. Exactly. Their experts said there

is nothing wrong with that. Earnings volatility should be

minimized and if there is to be earnings volatility, it should

be as predictable as possible. What's wrong with that?

Nothing. And their experts agreed nothing wrong with it. If

that's evil, if that's evil, then the inverse of it should be

pure and good.

What's the inverse? Earnings volatility should be

maximized and earnings volatility should be as unpredictable as

possible. That's ridiculous and --

THE COURT: At a minimum that would outlaw hedge

accounting, wouldn't it?


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MR. FINK: Yes. And all the other tenents are the

same. Fannie Mae should leverage off existing systems as much

as possible. What's the pure and good inverse? Fannie Mae

should leverage off existing systems as little as possible.

That's ridiculous. Operating earnings need to be simple and

easily understood. Operating earnings need to be complicated

and difficult to understand.

Now, if they had adopted those three tenents maybe we

would be talking about some kind of fraud but --

THE COURT: OFHEO liked that idea.

MR. FINK: But I mean those tenents, they are not evil

motivation. They are nothing at all like evil motivation. Your

Honor, I know I am running out of time here so I am not going to

try to respond to every point. It would be difficult to do

that. It is in our briefs. I would say as you observed yourself

much of what they showed you was inadmissible hearsay -- OFHEO

reports, the Paul Weiss report, complaints that various people

have filed, you know, internal e-mails and documents from people

who didn't testify that aren't -- you know, don't show, you

know, what the person meant or they weren't cross-examined.

There is all kinds of documents in the record like this.

They flashed a lot of them up. We objected to them.

We stand on those objections. We would like you to take those

into consideration.

Your Honor, if you are having trouble seeing clear and


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obvious answers as to what the accounting should or should not

have been, I say welcome to the club. This went on year and

year after year, the confusion about what these words meant.

The SEC ultimately settled it. They came in and said you can

interpret it this way.

So we respectfully request, your Honor, that the Court

enter Summary Judgment on the issue of scienter in favor of the

Defendants.

THE COURT: All right. Counsel. We will back tomorrow

for the three individual Defendants have Summary Judgment

Motions. We will be covering Raines' and Howard's Motions in

the morning before lunch and in the afternoon the Spencer

Motion. So we will start at ten with the Raines' Motion and

take a break at 11:30 and then we will do the Howard Motion from

12:00 to 1:30. There will be a late lunch tomorrow but we will

get back going with the Spencer Summary Judgment Motion at 3:30

tomorrow. It will be a long day. Get your rest. See you

tomorrow. Thank you.

(Whereupon, at 4:24 p.m., the proceedings were

concluded.)


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CERTIFICATE OF REPORTER

I, Patty A. Gels, certify that the foregoing is a

correct transcript from the record of proceedings in the

above-entitled matter.

_________________________


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