For the past four years–since FAS 133, the accounting standard from the Financial Accounting Standards Board (FASB) that forced companies to mark to market derivatives, took effect–U.S. mortgage giant Fannie Mae has apparently been unjustifiably claiming its derivative hedges qualified for certain accounting treatment. At least, that is what its regulators, the Office of Federal Housing Enterprise Oversight and the Securities and Exchange Commission, now have concluded. It will be a costly error since Fannie Mae is now expected to revise downwards its earnings since 2001 by as much as $9 billion as it retrospectively accounts for derivatives losses it had previously reported outside of earnings.

Up until the last, Fannie Mae insisted on its innocence. After all, its accounting had passed several audits, and the shortcut method it used to support its claims is one that was approved by the FASB and is widely popular. Therein lies the problem that could transform a scandal for one company into a cautionary tale for any U.S. company using derivatives.

DEMANDS FOR CHANGE While Fannie Mae appears to have lost its battle, many financial professionals believe that there may be a bigger war to fight, with the high-stakes Fannie Mae row revealing as much about the foibles of FAS 133 as it does about the transgressions of the mortgage company. In other words, how many other companies may be out there pushing the envelope–innocently or not–on application of FAS 133? Given the rigor and complexity of FAS 133, some fear it could be a lot. There is evidence that suggests these fears are not unfounded. In November, a Fitch Ratings study of 57 nonfinancial companies (42 of which are U.S.–based) found wide disparities in the way FAS 133 was applied. The agency said it had found a "lack of consensus" about how to apply FAS 133 and warned that it is "concerned with the potential for reporting and restatement risk across corporate sectors due to difficulties associated with hedge accounting." It goes without saying that this controversy could not have been more ill-timed. As thousands of U.S. companies await word from external auditors about whether their internal controls are in compliance with Section 404 of the Sarbanes-Oxley Act, a major accounting standard could be in flux. And some in the financial community don't want to wait and see.