KMPG's Statement of Facts Re: fannie

7/31/2019 KMPG's Statement of Facts Re: fannie

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IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

In re Fannie Mae Securities Litigation MDL No. 1668

Civil Action No.:1:04-cv-01639 (RJL)

KPMG LLPS STATEMENT OF UNDISPUTED MATERIAL FACTS IN SUPPORT OF

ITS MOTION FOR SUMMARY JUDGMENT

Pursuant to Local Rule 7(h), Defendant KPMG LLP respectfully submits the following

statement of material facts as to which there is no genuine issue to be tried:

I. SCIENTER

A. Fannie Mae and Its Financial Reporting1. During the class period, Fannie Mae was the nations largest source of funds for

mortgage lenders, providing resources to lenders to make mortgage loans. E.g.,Ex. 35,1 Fannie Mae Form 10-K for the year ending December 31, 2003 (2003Form 10-K) (Mar. 15, 2004) at 1.

2. Fannie Mae was a large, complex and financially sophisticated organization witha number of personnel who were highly qualified in accounting and financialmatters. E.g.,Ex. 2, Berliner Tr. at 107:17-108:6;Ex. 3, Fierstein Tr. at 268:8-269:5.

3. Fannie Mae published annual audited financial statements, initially disseminatingthem itself and later filing them with the SEC.

2Ex. 33, Fannie Mae Information

Statement dated April 1, 2002 (2001 Information Statement); Ex. 34, FannieMae Form 10-K for the year ending December 31, 2002 (2002 Form 10-K)(Mar. 31, 2003); Ex. 35, 2003 Form 10-K. KPMG served as Fannie Maes

1 All citations are to exhibits in KPMG LLPs Motion for Summary Judgment EvidentiaryAppendix, identified by Ex.__. All of the exhibits in the Evidentiary Appendix are supportedby the declaration of Monica K. Loseman.

2 Fannie Mae was not registered with the SEC until early 2003, when its 2002 financialstatements were filed. Prior to year-end 2002, Fannie Mae published annual InformationStatements and quarterly Supplements to Information Statements, which in some waysresembled form 10-Ks and 10-Qs.

Case 1:04-cv-01639-RJL Document 937-2 Filed 08/22/11 Page 1 of 36

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independent auditor throughout the relevant period. Ex. 33, 2001 InfromationStatement at 55; Ex. 34, 2002 Form 10-K at 146; Ex. 35, 2003 Form 10-K at 170.

4. Fannie Maes management was responsible for preparing the companys financialstatements and ensuring that the financial statements were fairly presented inaccordance with Generally Accepted Accounting Principles, or GAAP. Ex. 24,Fierstein Rebuttal Rep. at 10; Ex. 2, Berliner Tr. at 89:14-17.

5. GAAP is a term of art that encompasses a wide range of acceptable principles.Ex. 2, Berliner Tr. at 89:21-90:10.

6. Applying these accounting principles to particular transactions can require asignificant degree of professional judgment. Ex. 2, Berliner Tr. at 92:19-22.

7. Management must make reasonable estimates based on information that may ormay not be complete. Ex. 2, Berliner Tr. at 92:14-94:10.

8. In exercising such judgment, a primary objective of GAAP is to presentinformation from the point of view of the underlying economics of the reportingentity. Ex. 2, Berliner Tr. at 91:19-92:1.

9. Asked if he had any reason to doubt whether the intent of Fannie Maes FAS 91and FAS 133 policies was to preserve the accuracy and utility of Fannie Maesfinancial statements by reporting what [management] honestly believed were thetrue economics of Fannie Mae's business, Mr. Berliner replied, I have no reasonto doubt that [they] believed that. Ex. 2, Berliner Tr. at 108:20-21.

10. The accounting standards in dispute in this case were complex and difficult tointerpret. Ex. 2, Berliner Tr. at 107:19-21; Ex. 23, Fierstein Rep. 1-1 to 1-4. Forinstance, Mr. Berliner premised one of his criticisms on the complexitiesinvolved in Fannie Maes operations and accounting policies. Ex. 22, BerlinerRep. at 2-6.

11. KPMGs role as the independent auditor was limited to expressing an opinion onmanagements financial statements based on professional standards. Ex. 2,Berliner Tr. at 102:16-103:14. KPMG did not report on the effectiveness of acompanys internal controls because Section 404 of the Sarbanes Oxley Act,which introduced that requirement, was not effective until after the class period.Id. at 121:13-122:2.

12. Auditors do not express an opinion or provide any assurance about the futureearnings of the company, the quality of its management or the quality of itscorporate governance. Ex. 2, Berliner Tr. at 102:22-103:14.

13. KPMGs audit reports, included in and filed with Fannie Maes annualInformation Statements or forms 10-K for the relevant years, set forth the scope ofits opinion as follows:



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We have audited the accompanying balance sheets of Fannie Mae .. . and the related statements of income, changes in stockholdersequity, and cash flows . . . . These financial statements are theresponsibility of Fannie Maes management. Our responsibilityis to express an opinion on these financial statements based on

our audits.

We conducted our audits in accordance with auditing standardsgenerally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free ofmaterialmisstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

In our opinion, the financial statements . . . present fairly, in all

material respects, the financial position of Fannie Mae . . . and theresults of its operations and its cash flows . . ., in conformity withaccounting principles generally accepted in the United States ofAmerica.

Ex. 35, 2003 Form 10-K at 170 (emphasis added). KPMG offered noopinion on, and made no representation to investors about, theeffectiveness of Fannie Maes internal controls. Id.

14. The auditing standards to which KPMG referred are known as GenerallyAccepted Auditing Standards ("GAAS). Ex. 22, Berliner Rep. at 3.

15. Auditors do not and cannot guarantee the accuracy of a companys financialstatements. Rather, GAAS requires only that an auditor obtain reasonableassurance that the financial statements are fairly presented in accordance withGAAP. Ex. 28, AICPA Professional Standards (2005) (hereinafter AU) 230.

The performance of an audit is a complex process, and no matterhow professionally it may be performed the auditor cannot offer aguarantee or insurance (absolute assurance) that the financial

statements are not materially misstated. Fundamentally, the auditprocess is based on professional judgment in planning theengagement and determining the nature, timing and extent of auditprocedures.

For example, an audit generally involves the selective testing ofdata, rather than a 100% examination. There is no guarantee thatmaterial misstatements due to errors or fraud are absent in the



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items not tested. Even for those items tested, the auditor must usejudgment in assessing the implications for the audit and, as in allprofessional services, the assessment might not always be correct.Besides, the accounting process is based on numerous estimatesand judgments, which may or may not be confirmed by future

events. In the audit environment, the best an auditor can do isto collect competent and sufficient evidence that is persuasiverather than convincing. For this reason, the auditors opinion onthe financial statements is based on reasonable assurance but notabsolute assurance.

Ex. 29, Mark S. Beasley & Joseph V. Carcello, Miller GAAS Guide at 26 (2006)(emphasis added); Ex. 28, AU 230 (The nature of most evidence derives, inpart, from the concept of selective testing of the data being audited, whichinvolves judgment regarding both the areas to be tested and the nature, timing,and extent of the tests to be performed.); Ex. 2, Berliner Tr. at 96:4-9, 96:10-16,99:5-9 (agreeing that an auditor is obligated only to obtain reasonable assurancethat the financial statements are free of material misstatements); Ex. 26, LhotkaRep. at 1;see also Ex. 117, Lhotka Tr. at 12:6-11 (authenticating report).

16. An independent auditor exercises professional judgment in planning the audit;deciding which areas to test and the scope of such testing. See Ex. 28, AU 311.14; Ex. 2, Berliner Tr. at 97:11-98:2.

17. To inform that judgment, an auditor develops an understanding of the companysbusiness processes and internal controls. The auditor then executes the audit plan;the auditor obtains evidential matter through testwork and determines whetherthat evidential matter, under relevant circumstances, provides reasonable

assurance that the financial statements are fairly presented in accordance withGAAP. See Ex. 28, AU 150.02, 230.10.

18. Auditors must exercise judgment in determining which procedures are necessaryto provide reasonable assurance, and reasonable auditors may disagree as towhich procedures provide reasonable assurance. Ex. 2, Berliner Tr. at 97:11-20.

19. The amount and kinds of evidential matter required to support an audit opinionare also matters of professional judgment about which reasonable auditors maydisagree. Ex. 2, Berliner Tr. at 98:3-10.

20.

If the auditor obtains reasonable assurance that the financial statements are free ofmaterial misstatements, the auditor provides an unqualified opinion on thefinancial statements. Ex. 28, AU 312.03-312.05. The auditor may disagreewith a companys accounting judgment, or even find a deviation from GAAP, butif the auditor believes the possible misstatement or deviation is not material, theopinion is still unqualified. Id.



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21. Given this degree of professional judgment, it is well recognized that even anaudit conducted in accordance with GAAS may not detect a materialmisstatement. Ex. 2, Berliner Tr. at 97:6-15.

22. Subsequent discovery of new information or a material misstatement does notindicate that the auditor failed to perform the audit in accordance with GAAS.Ex. 2, Berliner Tr. at 547:5-14.

B. KPMGs Audits23. KPMG concluded that Fannie Maes financial statements for 2001, 2002 and

2003 presented fairly, in all material respects, the financial position of FannieMae and the results of its operations and its cash flows in conformity with GAAP.Ex. 33, 2001 Information Statement at 55; Ex. 34, 2002 Form 10-K at 146; Ex.35, 2003 Form 10-K at 170.

24. KPMGs audit team was highly qualified and had extensive experience in thefinancial services industry; it included internal subject-matter experts on issuesrelevant to the Fannie Mae audits. Ex. 26, Lhotka Rep. at 15.

25. Plaintiffs audit expert did not find fault with the qualifications of KPMGs auditteam. Ex. 2, Berliner Tr. at 119:19-22.

26. Kenneth Russell was KPMGs engagement partner on the Fannie Mae auditswhen the companys FAS 91 and FAS 133 policies were developed. Mr. Russellspent the vast majority of his career auditing companies in the financial servicesindustry. Ex. 16, Russell Mar. 1, 2005 SEC Tr. at 23:12-18. Mr. Russell was alsoa member of KPMGs Department of Professional Practice, KPMGs firm wide

technical resource group. Ex. 2, Berliner Tr. at 290:15-291:5; Ex. 17, Russell Tr.at 42:14-17. While assigned to the Department of Professional Practice, Mr.Russell served on or led the financial instruments and derivatives topic group. Id.at 43:7-44:1. Mr. Russell was a designated KPMG Derivatives, Hedging andFinancial Instruments Specialist. Ex. 2, Berliner Tr. at 290:15-291:5; Ex. 17,Russell Tr. at 45:4-46:1.

27. Mark Serock became the lead engagement partner in 2001. Ex. 19, Serock Tr. at28:10-14. Mr. Serock remained the lead audit partner during the 2002 and 2003audit engagements. Ex. 1, Serock Decl. 3.

28. Mr. Serock was a designated KPMG Derivatives, Hedging and FinancialInstruments Specialist. Ex. 20, Serock Mar. 21, 2005 SEC Tr. at 13:20-16:3.

29. Mr. Argires spent significant time during 2000 reviewing Fannie Maes plannedadoption of FAS 133. Ex. 8, Argires Tr. at 193:4-12.

30. Mr. Argires had extensive experience working in the financial services industry.Mr. Argires was a designated KPMG Derivatives and Financial Instrumentsspecialist. Ex. 2, Berliner Tr. at 293:15-294:9; Ex. 8, Argires Tr. at 91:22-92:10.



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31. Mr. Argires served as an audit partner on the 2001 through 2003 auditengagements. Ex. 8, Argires Tr. at 47:2-8.

32. Mark Serock signed KPMGs audit opinions during the class period. Ex. 1,Serock Decl. 3. Mr. Serock concluded in his professional judgment that KPMGhad obtained sufficient, competent evidential matter that provided reasonableassurance that the financial statements were presented fairly, in all materialrespects, in accordance with GAAP. Ex. 1, Serock Decl. 4.

33. To this day, Mr. Serock believes that KPMGs audit conclusions were appropriateand that the audits were conducted in accordance with GAAS. Ex. 1, SerockDecl. 4.

34. KPMG auditors, consisting of partners, managers, staff and subject-matter expertsspent well over 10,000 hours on the audits of the December 31, 2001, 2002 and2003 financial statements and the reviews of interim quarterly financialstatements for those years. Ex. 1, Serock Decl. 5.

35. KPMGs work is documented in approximately 40,000 pages of KPMG auditwork papers. Ex. 1, Serock Decl. 5; Att. 1, KPMG-CIV-00028836-39258; Att.2, KPMG-CIV-00015309-28835; Att. 3, KPMG-CIV-00000001-15308.

36. Work papers are the principal record of auditing procedures applied, evidenceobtained and conclusions reached by the auditor in the engagement. Ex. 1, SerockDecl. 5.

i. KPMGs Planning Process Was Thorough37. KPMGs planning process was extensive. It included documenting KPMGsunderstanding of Fannie Maes business and its critical accounting policies,

performing analytical reviews of the financial statements, developing apreliminary judgment of materiality for planning purposes and analyzing thestrategic, business and audit risks of the engagement. Ex. 2, Berliner Tr. at108:22-109:19.

38. The audit team used this information to determine the nature, timing and extent ofthe audit procedures performed. Ex. 2, Berliner Tr.at 112:9-12.

39. KPMGs consideration of the information gathered was documented in keyworking papers that explained its audit procedures. For example, KPMG used aBusiness Understanding Document to record its consideration of Fannie Maesobjectives, strategies and business. Ex. 22, Berliner Rep. at 1-9; Ex. 2, BerlinerTr. at 109:21-110:8.

40. KPMG had monthly meetings with Fannie Maes Financial Standards group,which was responsible for accounting policy, devoted solely to discussingaccounting policies, which Mr. Berliner described as a good practice. Ex. 2,Berliner Tr. at 110:9-22; Ex. 22, Berliner Rep. at 3-4.



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41. KPMG documented its findings in several key work papers. The Planning andAnalytical Document set forth KPMGs analysis of Fannie Maes periodicfinancial statement and its overall planning considerations. Ex. 26, Lhotka Rep.at 21; e.g.,Ex. 73,KPMG-CIV-00032539.

42. The Risk Analysis Document set forth KPMGs understanding and criticalanalysis of risks in Fannie Maes business and accounting processes. Ex. 26,Lhotka Rep. at 21; Ex. 74, KPMG-CIV-00032545.

43. The Process Analysis Document explained the processes and financial statementcontrols in relation to strategic business risks, assessed financial statement risksand controls in relation to the significant classes of transactions and determinedhow the processes related to the identified audit objectives. See Ex. 2, BerlinerTr. at 115:4-12.

44. The Consideration of Fraud in a Financial Statement Document memorializedKPMGs consideration of fraud risks and steps taken to address those risks in the

audit. Ex. 26, Lhotka Rep. at 22; Ex. 72, KPMG-CIV-00032509.

45. The Significant Issues and Decisions Document set forth significant issues orbusiness decisions affecting Fannie Maes financial statements. Ex. 26, LhotkaRep. at 22; Ex. 70, KPMG-CIV-00031561.

ii. KPMG Expressly Considered the Accounting Policies at Issue46. The accounting policies that Mr. Berliner claims were erroneous were laid out

clearly in KPMGs working papers. A KPMG memorandum walked through theentire FAS 91 estimation process. Ex. 91, KPMG-CIV-00046334. Mr. Berliner

discusses this memorandum at length and notes it was included in the work papersfor each audit. Ex. 22, Berliner Rep. at 3-5, 3-6.

47. Mr. Berliner cites KPMGs working papers to identify the FAS 133 policies withwhich he disagrees. Ex. 22, Berliner Rep. at 3-14 to 3-15, 3-17 to 3-18.

48. For FAS 115, Mr. Berliner quotes the work papers for the policy and affirms theymake it clear what the supposedly erroneous policy was. Ex. 22, Berliner Rep.at 3-22.

iii. KPMG Assessed the Risks of Financial Statement Error49. The auditors engaged in a risk assessment process and documented their

understanding of strategic business risks. Ex. 2, Berliner Tr. at 113:6-13.

50. KPMG grouped the financial statement assertions for each strategic business riskand significant class of transactions with the associated key process and identifiedthe related audit objectives and procedures. Ex. 2, Berliner Tr. at 115:4-116:5.The auditors engaged in an assessment of the risk of significant misstatement foreach audit objective. Ex. 2, Berliner Tr. at 116:10-17.



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51. KPMG documented the audit objectives and how those audit objectives related tothe financial statement assertions, made an assessment of the risk of significantmisstatement for each audit objective, developed the planned audit proceduresthat were used to gain the necessary audit evidence and considered the need foradditional audit procedures. Ex. 2, Berliner Tr. at 116:6-21.

52. KPMG planned and documented its approach in the audit program by keyprocess. Ex. 2, Berliner Tr. at 116:2-3.

53. For each audit, KPMG identified key control objectives and activities anddeveloped a joint audit plan to test certain controls in collaboration with FannieMae's internal audit department . . . [and] tested key controls that were not testedby internal audit. Ex. 2, Berliner Tr. at 118:17-119:4; cf. Ex. 2, Berliner Tr. at260:2-14.

54. Members of the Office of Audit and members of KPMG's audit team metregularly with the Audit Committee without management present. Ex. 2, Berliner

Tr. at 117:14-118:16.

55. KPMG considered significant issues that it identified during the course of theengagement and critical accounting policies in determining the scope and resultsof its audit procedures. See Ex. 22, Berliner Rep. at 114:1-10.

56. The items KPMG identified included the accounting issues central to this matter,such as Fannie Maes accounting under FAS 133 and FAS 91. Ex. 70, KPMG-CIV-00031560 at 1562.

57. KPMG performed a risk assessment process and gained an understanding ofstrategic business risks, related potential financial statement effects and therelated processes. Ex. 74, KPMG-CIV-00032545; Ex. 61, KPMG-CIV-00017086; Ex. 44, KPMG-CIV-00001038; Ex. 22, Berliner Rep. at 2-9; Ex. 2,Berliner Tr. at 113:6-9.

58. Mr. Berliner described the companys goal of doubling EPS in five years asexcessive, and opined that KPMG should have assessed the corresponding riskarea as high. Ex. 2, Berliner Rep. at 1-16.

59. KPMG assessed the risk of material misstatement due to fraud given thecompanys goal of doubling EPS in five years. Ex. 22, Berliner Rep. 1-17; Ex.43, KPMG-CIV-00000929 at 930. KPMG identified the EPS goal, recognizedthe increased risks resulting from this focus on EPS and took steps to make surethe engagement team understood its impact. Ex. 22, Berliner Rep. at 1-17. Mr.Berliner stated: I dont think [KPMG] gave sufficient attention to it in the designof their procedures. Ex. 2, Berliner Tr. at 173:13-17.

60. For several years prior to 2001, Fannie Mae had achieved double-digit growth.Ex. 26, Lhotka Rep. at 42-43;see also Ex. 2, Berliner Tr. at 175:4-177:6.



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61. Fannie Mae still achieved double-digit EPS growth even after Fannie Maerestated its financial statements. Ex. 36, 2004 Annual Statement, (2004 Form10-K) at F-4 (Dec. 6, 2006).

62. Fannie Maes goal of doubling earnings in five years was consistent with pastperformance. Ex. 26, Lhotka Rep. at 43;see also Ex. 2, Berliner Tr. 647:8-15.Fannie Maes earnings were strongly correlated with the growth in the size of itsportfolio. Ex. 2, Berliner Tr. at 171:5-11.

63. Fannie Maes mortgage portfolio had been growing steadily for a number ofyears prior to 1999, and at the same time, there was a housing boom going on inthe United States. Ex. 2, Berliner Tr. at 171:12-18.

64. The Company was halfway to doubling the size of its portfolio before the ClassPeriod even began. Ex. 2, Berliner Tr. at 175:16-177:2; Ex. 33, 2001 InformationStatement at 5.

65. Fannie Maes EPS goal was not excessively aggressive. Mr. Berliner testified: Idont know that I would say [the EPS goal was] excessively aggressive. Ex. 2,Berliner Tr. at 644:15-19.

66. Fannie Maes EPS goal would be appropriate if realistic. Ex. 2, Berliner Tr. at646:16-19.

67. Mr. Berliner did nothing to determine whether the goal was realistic. Ex. 2,Berliner Tr. at 646:19-647:2.

Q. Now, you would agree with me that it is appropriate for

companies to set aggressive goals, would you not?

A. As long as they are realistic.

Q. Did you perform any analysis to determine whether or notFannie Mae's goal of double-digit earnings growth during theperiod 1999 to 2003 was realistic?

A. No.

Id. at 646:16-647:2.

68. Even after Fannie Mae restated its financial statements to correct all of thealleged errors in its financial statements,its 2003 earnings were about $8.00 pershare,beating the $6.46 per share goal by a large margin. Ex. 36, 2004 Form 10-K at F-4.

69. Mr. Berliner was unaware that Fannie Mae did not have to resort to accountingfraud to meet its target. Ex. 2, Berliner Tr. at 183:10-184:3.



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C. KPMG and Internal Audits70. Mr. Berliner asserts that KPMG erroneously concluded that it could rely on

certain internal controls at Fannie Mae in conducting its audits. Ex. 22, BerlinerRep. at 1-20. He notes that Fannie Mae later concluded it had numerous material

weaknesses in internal controls. Ex. 22, Berliner Rep. at 2-10.

71. KPMG relied in some respects on Internal Audit to conduct certain testwork.KPMG met with internal auditors and internal audit management frequently andconcluded that internal audit was qualified to perform certain testwork. Ex. 2,Berliner Tr. at 205:5-206:2;Ex. 40, KPMG-CIV-00000263;Ex. 60, KPMG-CIV-00016928. Mr. Berliner admits that KPMG examined the internal audit functionand that: In form, the structure of [the Office of Audit] appeared appropriate,and KPMGs audit work papers throughout the Class Period document thisapparent proper relationship between [the Office of Audit] and seniormanagement. Ex. 22, Berliner Rep. at 2-3.

72. KPMG noted that an independent Quality Assessment Review by the InvestmentTraining and Consulting Institute, Inc. gave Fannie Maes Office of Audit thehighest rating possible. Ex. 59, KPMG-CIV 00016367 at 6369. The reviewsingled out for praise Fannie Maes [d]evelopment of innovative processeswhich include automated work papers, risk assessment models/tools and internalquality assurance program and [c]ommitment to a strong internal controlenvironment throughout Fannie Mae. Ex. 59, KPMG-CIV 00016367 at 6369.The report also said that, the depth of talent exhibited by Fannie Mae's [InternalAudit] staff was very impressive.Id. at 6374.

73. Mr. Berliner claims that OA was criticized in a third party Quality AssessmentReview during the Class Period. Ex. 2, Berliner Rep. at 2-7. Mr. Berliner didnot disagree with the findings of the Quality Assessment Review: he was simplyunaware of the actual findings when he said the report criticized the internalauditors. Ex. 2, Berliner Tr. at 223:10-229:8.

74. Contrary to Mr. Berliners assertion that the internal auditors had no training inFAS 133 (which he described as a significant departure from the auditingstandard of due professional care, Ex. 22, Berliner Rep. at 207), they did in facthave training and indeed more training than Mr. Berliner. Ex. 2, Berliner Tr. at403:18-405:9

75. KPMG was aware that OFHEO reviewed the performance of Fannie Maes Officeof Audit. Ex. 66, KPMG-CIV-00020347.76. OFHEO concluded at the time as to the Office of Audit: The scope of [internal]

audit work performed is appropriate, and the [internal] audit work is complete,and that the [internal] audit functions exceed safety and soundness standards.Ex. 37, OFHEO Rep. to Congress (2001) at 16, 17, 19; Ex. 38, OFHEO Rep. toCongress (2002) at 44.



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77. OFHEO concluded that Fannie Maes internal control framework and themanagement of that framework exceeded safety and soundness standards. Ex.37, OFHEO Rep. to Congress (2001) at 16; Ex. 38,OFHEO Rep. to Congress(2002) at 44.

78. OFHEOs examiners reviewed Fannie Maes internal controls each year duringthe Class Period, using dozens of examiners over the course of the entire year, andconcluded that Fannie Maes internal controls exceeded safety and soundnessstandards. Ex. 2, Berliner Tr. at 608:22-611:3.

79. Mr. Berliner did not review the OFHEO examinations. Ex. 2, Berliner Tr. at611:21-612:6.

80. Mr. Berliner did not review Fannie Maes internal controls and could not offerany independent opinion on the state of such controls. Ex. 2, Berliner Tr. at 55:1-4, 209:15-210:5, 592:4-12, 600:10-15, 708:7-711:5.

81. Mr. Berliner has not identified any specific alleged internal control weakness thatdates back to the class period. Ex. 2, Berliner Tr. at 207:13-20.

82. The systems Fannie Mae built to computerize the FAS 133 accounting did whatthey were intended to do. Ex. 4, Barron Tr. at 114, 116-17; Ex. 2, Berliner Tr. at100-01, 127:12-21.

83. It was Fannie Maes precision threshold policy that led to the restatement in theFAS 91 area, as opposed to internal control weaknesses. Ex. 2, Berliner Tr. at495:14-20.

84.

Fannie Maes system of classifying debt securities (FAS 115) was operating asdescribed, and if Fannie Mae's accounting were viewed as permissible, Mr.Berliner would not have found fault with KPMG's auditing in the FAS 115 area.Ex. 2, Berliner Tr. at 546:4-19.

D. Fannie Maes Accounting for Derivatives (FAS 133)85. Mr. Berliner criticizes KPMG for accepting major deviations from GAAP in

Fannie Maes hedge accounting policy that were known to KPMG anddocumented in its workpapers. Ex. 22, Berliner Rep. at 3-14. He said thatKPMG recognized that there were departures from GAAP but felt comfortableaccepting those departures on the basis of materiality. Id. at 3-13.

Mr. Berliner quotes the following email by KPMG partner Harry Argires inhis expert report: I do know that the SEC has taken the view that applyingFAS 133 needs to be in strict compliance with the letter of the standard, this isobviously a departure from that although as they demonstrate an immaterialdeparture. Ex. 22, Berliner Rep. at 3-15.



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He also quotes a KPMG work paper: Therefore, although the Deminimustest is not in strict compliance with FAS 133, KPMG has indicated that aslong as the dollar offset method is used to measure ineffectiveness recorded inthe P&L, that the deminimus test (using 10 bps) threshold is an immaterialdeparture from GAAP and results in a materially consistent impact to the

P&L. Ex. 22, Berliner Rep. at 3-19.

And Mr. Berliner quotes a Fannie Mae document as well: [W]e stated in ourhedge guidelines that we would test the hypothesis that ineffectiveness wasimmaterial on an annual basis [and] [o]ur tests . . . confirmed our belief. Ex.22, Berliner Rep. at 3-16.

Mr. Berliner testified that KPMG documented that it considered it to be aviolation of GAAP, again, with an immaterial effect. Ex. 2, Berliner Tr. at329:15-330:4.

86. Well before Fannie Mae was required to implement the standard, KPMGrecognized that FAS 133 would be significant to Fannie Maes financialreporting. Because FAS 133 was scheduled to go live on January 1, 2001, KPMGidentified the implementation of FAS 133 as a critical audit objective during theplanning process for the audit of Fannie Maes financial statements for the year-ending December 31, 2000. Ex. 2, Berliner Tr. at 294:20-295:2; Ex. 85, KPMG-CIV-00039531-36.

87. In reviewing Fannie Maes planned implementation of FAS 133, KPMG usedhighly trained and qualified auditors. Ex. 26, Lhotka Rep. at 15.

88. Plaintiffs expert does not criticize the qualifications of KPMGs auditors. Ex. 2,Berliner Tr. at 119:19-22.

89. KPMG also used its Department of Professional Practice as a resource. Ex. 93,Theobald Tr. at 58:17-63:4; Ex. 118, KPMG-CIV-0039526-30 at 9529.

90. The audit team prepared an audit program to guide the testing of Fannie Maesimplementation process. KPMG separated the audit program into four stages:Stage 1 Understanding the process and risk identification; Stage 2 Auditprocedures evaluating effectiveness of controls; Stage 3 Additional auditprocedures based on final risk assessment; and Stage 4 Conclude on auditobjectives. Ex. 87, KPMG-CIV-00045702-6.

91. KPMG took steps to understand Fannie Maes use of derivatives and how itintended to account for them. Ex. 104, KPMG-CIV-00192914-65, at 2914; Ex.2, Berliner Tr. at 295:3-296:7, Ex. 26, Lhotka Rep. at 52-55.

92. KPMG reviewed Fannie Maes Derivative Accounting Guidelines (DAG), a475-page document that set forth Fannie Maes FAS 133 accounting policy. Ex2, Berliner Tr. at 295:14-296:2.



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93. The DAG explained and diagramed how each transaction worked and set out theparameters that would have to be satisfied for Fannie Mae to assume that itshedging transactions created no ineffectiveness. Ex. 98, KPMG-CIV-00108327-801; Ex. 2, Berliner Tr. at 282:7-283:22.

94. KPMG reviewed each of the 67 proposed transactions in the DAG and howFannie Mae intended to account for them, and KPMG concluded that theproposed accounting treatment for each was reasonable. Ex. 101, KPMG-CIV-00138847; Ex. 2, Berliner Tr. at 278:16-279:3.

95. Prior to implementation, Fannie Mae performed testing to demonstrate that whereit intended to assume no ineffectiveness, such ineffectiveness would beinconsequential. See Ex. 9, Boyles Tr. at 209:16-210:22; Ex. 15, Matt JohnsonSEC Tr. at 85:17-87:20. KPMG reviewed this analysis. Ex. 18, Russell SEC Tr.at 230:19-231:8;see also Ex. 2, Berliner Tr. 313:7-314:19.

96. KPMG auditors met with several Fannie Mae personnel to discuss the FAS 133Accounting System, including specifically the scope of the project, systemfunctionality, system flows between various functions and the control andmanagement reports produced by the system. The meeting also addressed thetiming of the implementation of the various FAS 133 Accounting Systemcomponents. Ex. 89, KPMG-CIV-00045790; Ex. 2, Berliner Tr. 295:3-13.

97. Consistent with the audit program, the auditors tested the effectiveness of thecontrols in mitigating the identified risks. Ex. 26, Lhotka Rep. at 54; Ex. 2,Berliner Tr. 301:4-305:22, 295:14-300:9.

98. KPMG performed walkthrough testing of the FAS 133 System to determine ifthe system was properly classifying hedge transactions. Ex. 90, KPMG-CIV-00045827; Ex. 2, Berliner Tr. 296:3-7.

99. KPMG auditors relied on personnel from KPMGs Information Risk ManagementGroup (IRM), its computer auditing specialists, to assist in selecting a sample often transactions for testing. Ex. 84, KPMG-CIV-00034349; Ex. 2, Berliner Tr. at268:3-18, 296:8-12.

100. The auditors then followed the system for each transaction, step by step, to gainan understanding of the operation. Based on the results of its testing, KPMGconcluded that the items tested were properly classified by the system and notedno exceptions to the hedge accounting policies. Ex. 90, KPMG-CIV-00045827.

101. The IRM also confirmed that, based on the testing, the system identified andcorrectly classified the transactions. Ex. 114, KPMG-CIV-00045872; Ex. 2,Berliner Tr. at 268:3-18, 296:14-21.

102. During its year-end work, KPMG performed several procedures around FannieMaes FAS 133 implementation:



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Gained an understanding of the derivatives and hedging processes and therelated controls

Tested the valuation and correlation of hedge positions

Determined that the Hedge Accounting Policy Manual policies andprocedures were reasonable

Reviewed the transactions in the Hedge Accounting Policy Manual anddetermined that the accounting treatment is reasonable

Gained an understanding of the FAS 133 Accounting System and usingwalkthroughs determined how the system and interfaces with other systemsworked

Tested a sample of transactions to ensure that the FAS 133 AccountingSystem was properly classifying hedge transactions as cash flow hedges, fair

value hedges, or hedges that did not qualify

Reviewed the functionality and system controls of the FAS 133 AccountingSystem to ensure that the system logic agrees with the requirements of FAS133

Reviewed the FAS 133 Accounting System documentation Reviewed the appropriateness of standard journal entries and determined that

the entries were properly recording derivative and hedging activities

Reviewed the general ledger reconciliations and determined that procedureswere in place to ensure proper recording of the transactionsEx. 88, KPMG-CIV-00045784; Ex. 92, KPMG-CIV-00047697; Ex. 94, KPMG-CIV-00083098; Ex. 2, Berliner Tr. at 295:3-301:3; Ex. 26, Lhotka Rep. at 53-55.

103. KPMG concluded that Fannie Mae had appropriately addressed theimplementation of FAS 133, that it was prepared to adopt the new standard onJanuary 1, 2001, and that Fannie Maes proposed FAS 133 accounting compliedwith GAAP. Ex. 86, KPMG-CIV-00039919.

104. The focus of KPMGs audit work for the years ended December 31, 2001, 2002and 2003 was to obtain reasonable assurance that Fannie Maes derivative andhedging transactions continued to comply with the Companys policies and thatthe controls and the FAS 133 Accounting System continued to operateappropriately. E.g., Ex. 75, KPMG-CIV-00034093; Ex. 47, KPMG-CIV-00002806; Ex. 62, KPMG-CIV-00018475; Ex. 26, Lhotka Rep. at 57-61.

105. KPMG again obtained an understanding of how Fannie Mae processed derivativeand hedging transactions, identified the key financial statement assertions and



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identified and tested the design of key controls related to the audit objectives. Ex.75, KPMG-CIV-00034093; Ex. 47, KPMG-CIV-00002806; Ex. 62, KPMG-CIV-00018475.

106. KPMGs work papers documented the procedures that were performed to testboth the design and operational effectiveness of the controls over the accountingfor derivative and hedging activities. The controls tested include: interfacecontrols, reconciliations, access controls, authorization controls, segregation ofduties controls, management reviews, configuration controls, and exceptionreports. E.g., Ex. 76, KPMG-CIV-00034158; Ex. 77, KPMG-CIV-00034172; Ex.81, KPMG-CIV-00034208; Ex. 63, KPMG-CIV-00018514; Ex. 48, KPMG-CIV-00002851; Ex. 2, Berliner Tr. 256:10-257:2, 302:4-305:22.

107. KPMG also reviewed and assessed the results of the work of the Office of Audit.Ex. 79, KPMG-CIV-00034193; Ex. 80, KPMG-CIV-00034197.

108. In addition to its original test work, the Office of Audit performed additionaltesting related to FAS 133 controls and accounting related items at KPMGsrequest. Ex. 78, KPMG-CIV-00034180; Ex. 2, Berliner Tr. at 301:4-305:22,258:16-261:5.

109. KPMG also reviewed the draft financial statement disclosures to assess whetherthe presentation and disclosure complied with the requirements of FAS 133. Ex.83, KPMG-CIV-00034258.

110. KPMG performed analytical procedures related to derivative and hedgingactivities. KPMG concluded that the derivative values were reasonably stated andthat sufficient audit evidence had been obtained to support the conclusion that

derivatives were properly valued and were completely and accurately recorded.Ex. 82, KPMG-CIV-00034211.

111. In 2003, Fannie Mae conducted another mathematical analysis of the amount ofineffectiveness that might be created by using its +/- 7 day rule, which confirmedits original analysis that any ineffectiveness would be inconsequential. Ex. 50,KPMG-CIV-00003282. KPMG reviewed this analysis. Id.; Ex. 2, Berliner Tr. at315:4-317:14 (noting that Mr. Berliner does not dispute that the amount ofineffectiveness would be de minimus to Fannie Mae).

112. KPMG believed that any ineffectiveness created by the companys seven-daypolicy [w]ould not have a material effect on the financial statements. Ex. 2,Berliner Tr. at 314:5-19.

113. KPMG documented that it believed that ineffectiveness caused by another ofFannie Maes hedging policies was immaterial. Ex. 2, Berliner Tr. at 329:18-330:4.

114. KPMG was comfortable that the ineffectiveness was not material. Ex. 22,Berliner Rep. at 3-13;see also Ex. 2, Berliner Tr. 314:11-16.



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115. Mr. Berliner has no basis to disagree with KPMGs contemporaneous conclusionthat the assumption of inconsequential or no ineffectiveness was reasonable underFAS 133. Ex. 2, Berliner Tr. at 313:7-314:19.

116. When Fannie Mae sought to bring an additional strategy within its FAS 133policy and proposed that it had adequate documentation to support hedgeaccounting, KPMG said no. Ex. 51, KPMG-CIV-00003595.

117. At various times during the class period, Fannie Mae and KPMG raised issueswith the Financial Accounting Standards Board (the FASB) related to theCompanys derivatives accounting. For example, in 2001, Fannie Mae proposedapplying the Derivatives Implementation Group (DIG) issue G-20 to cash-flowoptions, which would have shielded Fannie Maes income statement fromfluctuations in value arising from changes in the time value of the options. Ex.71, KPMG-CIV-00031587; Ex. 2, Berliner Tr. at 156:2-8.

118. KPMG had a different interpretation of this guidance, despite the fact that FannieMaes position was a reasoned interpretation of the standard. After furtherdiscussions with Fannie Mae, the auditors consulted with KPMGs nationaloffice, and the national office agreed with the auditors interpretation. Ex. 71,KPMG-CIV-00031587; Ex. 2, Berliner Tr. at 156:9-158:10; Ex. 2, Berliner Tr. at156:2-158:10.

119. Fannie Mae then consulted with the FASB, which agreed with KPMGsinterpretation. Ex. 71, KPMG-CIV-00031587.

120. Fannie Mae booked the changes in the time value of purchased options eachperiod through income. This generated significant income volatilitythe amount

recorded in 2001 for all options was $40 million in losses, in 2002 it was over$4.55 billion in losses, and in 2003 it was $2.18 billion in losses. Ex. 35, 2003Form 10-K at 163. The volatility recorded in a single quarter could approach $2billion. Id. at 172.

121. This was significant and unpredictable volatility. Ex. 2, Berliner Tr. at 185:7-15.122. Booking the changes in the time value of purchased options was inconsistent with

what one might expect if executives intended to manipulate accounting policies tosmooth earnings.

Q. Right. What is the jagged line that you see going up and down?

A. That's the GAAP earnings.

Q. And what is the smoother line?

A. That's the core earnings, the operating earnings, with the removal of thepurchased option expense.



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Q. And the fact that the GAAP earnings is going up and down in thischart, that is inconsistent with what one might expect if executivesintended to manipulate accounting policies to smooth earnings, isn't it?

MR. SOMMERS: Object to form.

THE WITNESS: It certainly would appear that way, yes.

Ex. 2, Berliner Tr. at 163:6-20;see alsoid. at 429:9-17.

123. If KPMG had acquiesced to Fannie Maes original approach, it would haveeliminated billions of dollars of volatility on Fannie Maes financial statements.Ex. 2, Berliner Tr. at 156:9-12. Mr. Berliner testified that saying no [is] not easybecause the client may have devoted considerable resources, time and effort andmoney in the development of a standard and they might be very disinclined tomake modifications of that standard and so they might view an auditors tellingthem that the standard doesnt comply with GAAP as negativism on the part of

their external auditor. Ex. 2, Berliner Tr. at 429:9-17.

124. In another instance, KPMG revisited some of the FAS 133 accounting treatmentthat it had previously approved and, upon reconsideration, concluded it did notqualify for hedge accounting. Ex. 13, Boyles Apr. 12, 2005 SEC Tr. at 140:13-20.

125. Fannie Mae and KPMG consulted the FASB about this issue. This time, theFASB thought KPMG was too restrictive. Ex. 13, Boyles Apr. 12, 2005 SEC Tr.at 140:21-145:1; Ex. 10, Boyles Aug. 3, 2004 OFHEO Tr. at 245:19-250:22; Ex.11, Boyles Aug. 24, 2004 OFHEO Tr. at 164:4-168:7; Ex. 100, KPMG-CIV-

00135047; Ex. 2, Berliner Tr. at 443:11-444:22.

126. KPMGs conclusion that Fannie Maes approach to assuming no ineffectivenessunder FAS 133 was GAAP compliant was consistent with conclusions reached byother major accounting firms and other major financial institutions. See Ex. 107,FMCIV-03 03091798 (advice in Ernst & Young implementation guide); Ex. 110,FMCIV-10-11170007-08 (historical perspective described inPricewaterhouseCoopers manual); Ex. 7, Mills Tr. at 156:22-157:7 (I would sayin almost every instance the fair value was other than zero, but to the extent it wasan immaterial amount [another financial institution] would still apply theassumption of no ineffectiveness.).

127. The Big Four accounting firms acknowledged ongoing confusion on this issue,and plaintiffs FAS 133 expert admitted frankly that no one has figured out whatto do with this yet. Ex. 4, Barron Tr. at 257:3-259:8; Ex. 5, Barron Tr. Ex. 15Aat 5-6.

128. Even the SEC staff, plaintiffs FAS 133 expert testified, had changed theirinterpretation of FAS 133 and decided to support an approach no different thanthat KPMG had accepted. Ex. 4, Barron Tr. at 241:2-12.



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129. Mr. Berliner criticizes KPMG for assessing the inherent risk of misstatement dueto potential errors in the valuation of derivatives as moderate. Ex. 22, BerlinerRep. at 1-9. Fannie Maes restatement in the area of derivatives had nothing to dowith valuation issues whether Fannie Mae correctly estimated the current fairmarket value of derivatives it owned but rather hinged on whether Fannie Maes

hedge accounting policy itself was appropriate. Ex. 2, Berliner Tr. at 166:8-21,262:16-263:6.

130. Mr. Berliner does not dispute that the KPMG auditors believed the financialstatements were correct in all material respects. Ex. 2, Berliner Tr. at 126:1-14.

E. Fannie Maes Accounting for Amortization of Premiums and Discounts (FAS 91)131. Because interest rates are constantly changing between the date that mortgage

loans are made by lenders to consumers and the date on which Fannie Mae buyssuch loans from lenders, the values of such loans fluctuate. If interest rates godown after a loan is made, the loan will be more valuable because the loan isearning a higher interest rate than one could then obtain. If rates go up after aloan is made, the loan will be less valuable because one can no longer lend moneyat as favorable a rate. Ex. 25, Holder Rep. at 3;see also Ex. 25, Holder Tr. at 9:9-15 (authenticating report).

132. Thus, when Fannie Mae buys loans from mortgage originators, it typically paysmore or less than the face amounts of those loans (i.e., the original amount lent orthe unpaid principal balance of the loans). Ex. 25, Holder Rep. at 3. Thesedifferences represent premiums (where Fannie Mae pays more than the balanceof the loan) and discounts (where Fannie Mae pays less). Ex. 25,Id.;see alsoEx. 35, 2003 Form 10-K at 42. Fannie Mae has to account for and report these

premiums and discounts. Id.

133. The return on the loan what Fannie Mae expects to receive on its loan purchase,more commonly referred to as the effective yield depends not only on the loanbalance and stated interest rate but also on the amount that Fannie Mae paid forthe loan. Ex. 25, Holder Rep. at 4.

134. The effective yield also depends on when the principal amount of the loan isrepaid. Ex. 25, Holder Rep. at 4. When a loan is prepaid, Fannie Mae receivesthe principal amount and any accrued interest immediately, but interest that it hadhoped to earn through the full life of the loan will not be received. Id.

135. Exactly when any given loan will be repaid is unknown because there are avariety of unpredictable factors that affect the timing of repayment. Ex. 25,Holder Rep. at 9. When interest rates decrease, borrowers often refinance:borrowers take out new loans at more favorable rates and then use the proceeds ofthe new loan to repay their outstanding loans in full. Changes in the speed atwhich loans are prepaid can affect a company's estimate of the effective yield onthose loans. Id. at 4.



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136. FAS 91, Accounting for Nonrefundable Fees and Costs Associated withOriginating or Acquiring Loans and Initial Direct Costs of Leases, requirespremium and discount to be classified as adjustments to the carrying amount ofloans receivable in a company's balance sheet. Ex. 30, FAS 91 4, 15. Theseamounts are recognized as an adjustment of yield over the life of the loan . . . to

arrive at periodic interest income . . . at a constant effective yield on the netinvestment in the receivable. Ex. 30, FAS 91 15, 18.

137. As mortgage loans may be prepaid at any time, the life of the loan or a group ofloans is unknown but can be estimated. Cf. Ex. 24, Fierstein Rebuttal Rep. at 11.

138. If prepayments can be reasonably estimated, companies may considerestimates of future principal prepayments when determining a constant effectiveyield. Ex. 30, FAS 91 19.

139. Prepayments are often influenced by changes in interest rates, which may causeborrowers to refinance their loans, but prepayments can also be influenced by

factors unrelated to the mortgage loan, such as general and localized economicgrowth rates, marriages, divorces, job transfers and deaths. Ex. 25, Holder Rep. at9.

140. Future events and their effects cannot be perceived with certainty; estimating,therefore, requires the exercise of judgment. Thus accounting estimates change asnew events occur, as more experience is acquired, or as additional information isobtained. Ex. 23, Fierstein Rep. at 1-18 at n. 15 (quoting paragraph 10 ofAccounting Principles Board (APB) Opinion No. 20).

141. A high level of judgment and extensive subjectivity was involved in the FAS 91amortization estimates. See Ex. 2, Berliner Tr. at 340:11-341:2.

142. If a difference arises between the prepayments anticipated and the actualprepayments received, then the company shall recalculate the effective yield toreflect actual payments to date and anticipated future payments. The netinvestment in the loans shall be adjusted to the amount that would have existedhad the new effective yield been applied since the acquisition of the loans. Ex.30, FAS 91 19. The adjustment resulting from the change in estimate iscolloquially referred to as a catch-up.

143. Fannie Maes net mortgage portfolio was $706.8 billion at the end of 2001, $801billion the end of 2002 and $901.8 billion at the end of $2003. Ex. 35, 2003 Form10-K at 58.

144. Fannie Mae had net discounts of $2.1 billion in 2001, but net premiums of $472million and $3.7 billion in 2002 and 2003. Ex. 35, 2003 Form 10-Kat 43. Thisreflected a decreasing interest rate environment during the class period. Id.

145. The process of estimating prepayment speeds at Fannie Mae was necessarilycomplex due to the size and diversity of its portfolio. See Ex. 23, Fierstein Rep.



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1-1, 1-4.

146. Fannie Maes hundreds of billions of dollars in loans represented mortgagesentered into in many different years, on many different terms, in many differentgeographical locations, by people in many different economic circumstances. Ex.25, Holder Rep. at 9.

147. Prepayments had to be estimated for each pool of similar loans. Fannie Maegrouped its vast portfolio of loans and estimated the average life of each groupaccordingly. Ex. 25, Holder Rep. at 8. Prepayments had to be estimated for eachpool of similar loans. Fannie Mae grouped its vast portfolio of loans andestimated the average life of each group accordingly. Id. Those projections wererolled up into a single estimate, Fannie Maes net investment in loans. Id.

148. During the class period, Fannie Mae sought to factor the imprecision in estimatingprepayments in two ways: (1) by taking an average potential catch-up using fivedata points based on set deviations from the base projected interest rate path;

and (2) by using a threshold of precision within which Fannie Mae wouldconclude that its prior estimate continued to be reasonable and hence would notalter its prior estimate. Ex. 91, KPMG-CIV-00046334 at 6335-6336.

149. In determining the size of the threshold, management observed that on any givenday, there are a number of different quoted prepayment speeds for the same MBSsecurity or loan by large, reputable dealers in the market. Ex. 91, KPMG-CIV-0046334. They identified several independent, respected dealers publishingprepayment-rate estimates, each of which would be considered reasonableapproximations of prepayment speeds under FAS 91. Id.

150. Depending on which of those reasonable approximations were used, the FAS 91catch-up calculation could fluctuate significantly. The difference in catch-upresulting from the use of these different, but reasonable, dealer estimates wasapproximately $70 million. Ex. 91, KPMG-CIV-0046334 at 6336.

151. This was roughly equal to one percent of the Companys annual net interestincome (NII), and thus one percent of NII was used as a proxy for the spread indealer estimates. Ex. 91, KPMG-CIV-0046334 at 6336.

152. At least once each quarter, Fannie Mae tested its estimate against its currentprojections, including a shock test projecting prepayments if interest rates werehigher or lower by one percentage point and by one-half a percentage point. See,e.g., Ex. 49, KPMG-CIV-0002943; Ex. 65, KPMG-CIV-00020036;see also Ex.35, 2003 Form 10-K at 43.

153. If the difference between the potential catch-upas calculated by averaging thecatch-up produced by the five rate pathswas within this range of plus/minus onepercent of annual NII, Fannie Mae would conclude that its existing estimateremained reasonable and would not change it. Ex. 91, KPMG-CIV-0046334 at6335-6336. If the potential catch-up was outside of this range, then it would



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book an adjustment to the edge of the range. Id. at 4336.

154. The precision threshold could not have caused Fannie Maes financial statementsto be in error by any more than the size of the threshold itself. Ex. 3, Fierstein Tr.at 618:15-623:5.

155. Ms. Fierstein admitted that $135 million was not quantitatively material to FannieMaes financial statements. Ex. 3, Fierstein Tr. at 645:13-19;see also Ex. 2,Berliner Tr. at 343:17-345:9.

156. The threshold for premium and discount was therefore not quantitatively material,because it never grew as large as $135 million. See, e.g., Ex. 103, AmortizationSensitivity Chart, 3

rdQuarter, 2003, KPMG-CIV-00177467.

157. Calculated as no more than one percent of related revenue, which was net interestincome, the initial threshold was $70 million. At year-end 2000, Fannie Maesnet investment in loans was $607.4 billion. Ex. 32, 2000 Annual Information

Statement at 59. Thus, the threshold was slightly more than 1/100th of onepercent of Fannie Maes total investment in loans.

158. The amounts that Mr. Berliner claims were erroneously not recorded during theClass Period are $6.4 million in 2001, $78.8 million in 2002 and $119.5 million in2003. Ex. 22, Berliner Rep. at 4-11-12.

159. KPMG requested that Fannie Mae formalize its FAS 91 policy prior to the classperiod. Ex. 23, Fierstein Rep. at 1-7. After its implementation by Fannie Mae,KPMG performed testwork to evaluate Fannie Maes quarterly catch-upestimates. Three partners and a senior manager documented KPMGs

understanding of the policy. Ex. 91, KPMG-CIV-00046334. KPMG metquarterly with the head of Fannie Maes Controllers Office and the Office ofFinancial Reporting to have a detailed discussion of the Companys amortizationprocess and review the catch-up sensitivity charts for the quarter, which KPMGdocumented. E.g., Ex. 68, KPMG-CIV-00028913 at 915; Ex. 69, KPMG-CIV-00029252 at 253; Ex. 65, KPMG-CIV-00020036 at 037; Ex. 67, KPMG-CIV-00020910; Ex. 64, KPMG-CIV-00019340; Ex. 2, Berliner Tr. at 278:16-279:3.

160. Where management changed its assumptions or modified its methodology,KPMG obtained an explanation for those changes. Ex. 2, Berliner Tr. at 279:5-9.

161. KPMG also re-assessed the reasonableness of the threshold itself. KPMGobserved whether the spreads in dealer-estimated pre-payment speeds werenarrowing or expanding to determine if a change in the size of the precisionthreshold was necessary. Ex. 95, KPMG-CIV-00085642 at 5643-5645.

162. In 2003, the engagement team again evaluated the reasonableness of FannieMaes prepayment model in light of the dealer estimates in the market, bycomparing Fannie Maes prepayment projections to contemporaneous projectionsby investment banks, including Citigroup and Lehman Brothers, and found that



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the models produced widely varied projections. Ex. 21, Tascher Jan. 13, 2006SEC Tr. at 308:5-22, 318:12-319:22.

163. The auditors observed that Fannie Maes prepayment estimates were generallywithin the high-low range of the industry estimates. Ex. 57, KPMG-CIV-00005403; Ex. 53, KPMG-CIV-00005051; Ex. 55, KPMG-CIV-0005293.

164. The auditors also consulted with a specialist from KPMGs Structured FinanceGroup, who reviewed the methodology of the Office of Audits recalculation ofamortization factors for a sample of loan pools and concurred with themethodology. Ex. 55, KPMG-CIV-00005293-96 at 5295; Ex. 54, KPMG-CIV-00005221. KPMGs Structured Finance Group also created a model andrecalculated the unamortized balance, and verified that the amortization wascalculated and recorded in accordance with FAS 91. Ex. 54, KPMG-CIV-00005221.

165. The auditors reviewed information that suggested that, although Fannie Maesability to forecast prepayments had improved, significant imprecision remained inits modeling justifying the continued use of the precision threshold. See generallyEx. 56, KPMG-CIV-00005297 at 307.

166. A 2002 report by Fannie Maes Office of Audit stated that the Companysprepayment estimates achieved a 90 percent correlation with actual prepayments.Ex. 56, KPMG-CIV-00005297 at 307.

167. A sensitivity analysis is not unusual, especially when an estimate is subject tosignificant uncertainty. Ex. 2, Berliner Tr. at 354:16-21.

168. An analysis producing a result close to an existing estimate increases confidencein that estimate. Ex. 2, Berliner Tr. at 356:11-22.169. Whether or not a sensitivity analysis was close enough to support the existing

estimate is a matter of judgment. Ex. 2, Berliner Tr. at 357:17-358:2. A 5%difference would not be out of bounds but would depend on the financialstatements of the entity that was making that estimate. Id. at 358:3-10.

Q. Would you agree that the degree of confidence that you place inan estimate needs to be on a percentages basis?

A. No.

Q. Have you ever?

A. Could be a subjective judgement [sic].

. . .



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Q. Would you agree that if a legitimate sensitivity analysisproduced a number five percent different than the estimate, thatwould not be a reason to alter materially the estimate?

A. It would depend upon the financial statements of the entity thatwas making that estimate.

Id. at 357:17-358:10.

170. [A] precision threshold may have been appropriate for use by KPMG when itassessed Fannie Maes SFAS 91 calculations; auditing literature supports thisconcept. Ex. 24, Fierstein RebuttalRep.at 12;see also Ex. 3, Fierstein Tr. at634:18-22.

171. KPMG believed the precision threshold was reasonable application of FAS 91.Ex. 91, KPMG-CIV-00046334; Ex. 2, Berliner Tr. at 313:7-314:19 (concedingKPMG believed the precision threshold was reasonable application of FAS 91).

172. Reasonable differences between estimates would not be considered a likelymisstatement under the auditing literature. Ex. 25, Holder Rep. at 15 (citing Ex.28, AU 312.36, 342.14).

173. Fannie Mae presented charts in its disclosure documents showing the percentageimpact that 50 and 100 basis point increases and 50 and 100 basis point decreasesin the base refinance rate would have on its net income. Ex. 34, 2002 Form 10-Kat 58; Ex 35, 2003 10-K at 43.

174. Thus, KPMG observed that Fannie Mae disclosed what the impact would be on itsfinancial results of immediate interest rate shocks of the size used in FannieMaes five interest-rate path methodology. Ex. 34, 2002 10-K at 58; Ex. 35, 200310-K at 43.

175. In his report, Mr. Berliner stated that KPMG's acceptance of Fannie Maes FAS91 accounting policy continued even after it was alerted to a whistleblower'sallegations of the possibility of earnings management due to Fannie Maesmisapplication of this policy. Ex. 22, Berliner Rep. at 1-7. He asserted furtherthat [i]n violation of GAAS, KPMG failed to expand its audit procedures inresponse to these allegations. Id.

176. The allegations of an alleged whistleblower, Roger Barnes, were followed by aseries of urgent meetings, Ex. 2, Berliner Tr. at 484:17-20, and a majorinvestigation by the company. Id. at 496:2-3.

177. In response to these allegations, KPMG expanded its testing of manualadjustments. Ex. 2, Berliner Tr. at 493:11-20.

178. KPMG reviewed Mr. Barnes allegations as to anomalous amortization factors.Ex. 2, Berliner Tr. at 501:11-13.



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179. KPMG performed additional procedures to respond to the risk of a possible illegalact. Ex. 2, Berliner Tr. at 487:6-10.

180. The auditors consulted with forensic specialists, who reviewed the companysresponse to the allegations. Ex. 2, Berliner Tr. at 487:18-488:7.

181. Mr. Berliner found no grounds upon which to criticize KPMGs review of thatinvestigation or the investigation itself. Ex. 2, Berliner Tr. at 497:17-21. Mr.Barnes allegations did not evidence a material misstatement of the financialstatements. Ex. 2, Berliner Tr. at 497:14-17.

182. Mr. Barnes allegations did not relate to the precision threshold policy. Ex. 2,Berliner Tr. at 496:15-19, 501:14-16 (I dont believe [Barnes] allegationsrelated to the threshold policy.).

183. Mr. Berliner places quotation marks around the phrase turn a blind eye and thenimmediately cites to a KPMG document. Ex. 22, Berliner Rep. at 3-9 (citing Ex.

99, KPMG-CIV-00132852-3). The phrase turn a blind eye appears nowhere inthat document.

F. Fannie Maes Accounting for Debt Securities (FAS 115)184. Mr. Berliner criticizes KPMGs acceptance of Fannie Maes application of FAS

115. Ex. 22, Berliner Rep. at 3-23.

Ex. 22, Berliner Rep.(quoting Ex. 116, Deloitte-FNMA-M-027217-41 at7236). Ms. Fierstein opined

that this tainted the portfolio. Ex. 23, Fierstein Rep. 2-9. Mr. Berlinerdescribed this as an obvious violation of GAAP that should have alerted KPMGto the possibility that the month-end convention could in fact be used as a tool tomanipulate Fannie Maes financial statements. Ex. 22, Berliner Rep. at 3-22 to3-23.

185. FAS 115 provides that [a]t acquisition, an enterprise shall classify debt securitiesinto one of three categories: held-to-maturity [HTM], available-for-sale[AFS], or trading. Ex. 31, FAS 115 6. FAS 115 provides the criteria forclassification of securities and the resulting accounting treatment:

Debt securities that the enterprise has the positive intent and ability tohold to maturity are classified as held to maturity securities and reportedat amortized cost. Debt and equity securities that are bought and heldprincipally for the purpose of selling them in the near term are classifiedas trading securities and reported at fair value with unrealized gains andlosses included in earnings. Debt and equity securities not classified aseither held-to-maturity securities or trading securities are classified asavailable for sale securities and reported at fair value with unrealized gains



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and losses excluded from earnings and reported in separate component ofshareholders equity.

Ex. 31, FAS 115 at 2 (emphasis added).

186. During the class period, Fannie Mae purchased mortgage-backed securities(MBS) for its portfolio. Ex. 45, KPMG-CIV-00001495 at 496. Most of thesecurities purchased by Fannie Mae were HTM, with a smaller percentagedesignated as AFS, and few or none designated as trading. Ex. 3, Fierstein Tr. at689:19-690:2.

187. HTM securities were accounted for at amortized cost, and, per FAS 115, changesin the market value of the security were not recorded in the financial statements.Ex. 31, FAS 115 7; Ex. 26, Lhotka Rep. at 87. AFS securities were carried atfair value, and adjusted to market value, or marked-to-market, on a periodicbasis. Ex. 31, FAS 115 13; Ex. 26, Lhotka Rep. at 87. Changes in fair valuewere reflected in a balance sheet account but did not affect current income. Ex. 3,Fierstein Tr. at 704:7-17.

188. When Fannie Mae purchased a security, the transaction was processed in FannieMaes securities computer systems. Ex. 45, KPMG-CIV-00001495-515 at 508.The system required that traders enter a value for the security designation at thetime of execution: for example, I for HTM, S for AFS, or R for Trading.Id.; Ex. 14, Douthit Tr. at 73:10-74:22. The default entry was I for HTM. Ex.45, KPMG-CIV-00001495 at 508.

189. The default assigned to each security at the time of trade had no relation to FannieMaes intent or ability to hold the security to maturity. See generally Ex. 12,

Boyles Dec. 7, 2004 OFHEO Tr. at 216:9-20.

190. Unlike other financial institutions, such as banks, that are required to close theiraccounting records on a daily basis, Fannie Mae closed its books i.e., postedtransactions to the general ledger at the end of the month. Ex. 12, Boyles Dec.7, 2004 OFHEO Tr. at 216:9-20. In Mr. Lhotkas experience, it is not unusual forclients to record transactions on a monthly or other basis. Ex. 117, Lhotka Tr. at265:2-18.

191. Ms. Fierstein testified as follows:Q: What would have happened if there was simply no designation at allon the date of purchase and they designated everything at the end of themonth?

. . .

A: So if you actually purchased it, lets say, on the 10th of themonth and then you dont designate it until the end of the month, I



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would have to think about whether that qualifies as [at] acquisitionor not. . . .

I cant give you an answer right now.

Ex. 3, Fierstein Tr. at 694:10-695:8. If the securities had been designated in someother class, including AFS, a redesignation to HTM at month-end would notviolate GAAP. Id. at 693:22-694:6.

192. Fannie Mae therefore classified its securities as HTM or AFS at the end of themonth. See Ex. 12, Boyles Dec. 7, 2004 OFHEO Tr. 216:9-20.

193. Fannie Mae did so as a matter of operational convenience. Ex. 45, KPMG-CIV-00001495 at 508.

194. Since most of Fannie Maes securities were designated as HTM, the month-endclassification resulted in a relatively smaller number of securities having their

computer designations changed to AFS. Ex. 3, Fierstein Tr. 686:15-687:4.

195. A change in classification of securities from HTM to AFS and recognition ofincreases or decreases in their value would not affect a companys currentearnings. Changes in the value of AFS securities are posted to OtherComprehensive Income (OCI) in the balance sheet. Ex. 45, KPMG-CIV-00001495 at 508; Ex. 31, FAS 115 13;see also Ex. 26, Lhotka Rep. at 87; Ex.3, Fierstein Tr. at 695:20-696:1.

196. Since those changes do not flow through earnings, any improper designation ofsecurities as HTM could not have been used to manipulate income in a quarterly

period. Ex. 3, Fierstein Tr. at 705:11-16. As Ms. Fierstein testified:

A. [I]f it was HTM today and it should have been AFS, you arecorrect that it would not be managing earnings because itwould not flow through the income statement. . . .

Q. Okay. So youre not opining that the impact of this allegedmisclassification was that it enabled Fannie Mae to manageearnings quarter to quarter?

A. That was not what I opined, thats correct.

Ex. 3, Fierstein Tr. at 705:5-16.

197. KPMG obtained an understanding of Fannie Maes process for designatingpurchased securities as HTM or AFS. It performed a walk-through of theprocedure and inquired of relevant personnel. Ex. 45, KPMG-CIV-00001495.

198. KPMG was aware of Fannie Maes policy to classify purchased securities aseither HTM or AFS during its standard month-end close process and found the



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practice to be reasonable and in accordance with GAAP. Ex. 46, KPMG-CIV-00001585.

199. Fannie Mae put controls in place to ensure that no securities were transferred outof HTM after month-end. Ex. 3, Fierstein Tr. at 717-20:718-4.

200. There was only one incident during the relevant period in which a securitydesignated as HTM was subsequently sold. Ex. 46, KPMG-CIV-00001585.

201. Fannie Mae investigated the incident and found no indication that this singleinstance was carried out in an effort to manipulate Fannie Maes earnings or anyaccount balance. Ex. 46, KPMG-CIV-00001585.

202. At the close of its investigation, Fannie Mae implemented additional controls,including implementation of additional written policies and provision ofadditional training to a variety of staff, in order to prevent any further mistakenreclassifications. Ex. 46, KPMG-CIV-00001585.

203. KPMG took note of the single incident and assessed Fannie Maes revisedcontrols. Ex. 46, KPMG-CIV-00001585.

204. This sale was not made to manage earnings. Ex. 3, Fierstein Tr. at 719:1-2 (No,I dont think that one sale was used to manage earnings.).

205. Both the carrying values (amortized cost) and the fair values of Fannie Maesmortgage securities were disclosed in the financial statements. Ex. 35, 2003 Form10-K at 59-60, 137.

206. Fannie Mae had gainson such securities that it was not booking by virtue of theHTM classification. Ex. 35, 2003 Form 10-K at 59-60, 137 (fair value of HTMmortgage securities was $486.1 billion at December 31, 2003, $10.9 billion higherthan the amount at which Fannie Mae was carrying such securities; chart containssimilar disclosure for 2002 and 2001 as well).

207. Ms. Fierstein admitted that Fannie Mae did in fact hold the HTM securities tomaturity. Ex. 23, Fierstein Rep. at 2-11.

G. Other Accounting Issues208. Mr. Berliner states in his report: In the Restatement . . . , Fannie Mae

acknowledged other GAAP violations in more than 30 different areas . . . . The onlyplausible way that Fannie Maes financial statements could suffer from suchsignificant GAAP violations in so many critical accounting areas is that KPMG wasonly rubber stamping Fannie Maes accounting policies. Ex. 2, Berliner Rep. at6-3. Ms. Fierstein opined on the accounting for these issues in only a handful ofareas, including impairment of securities. Ex. __, Fierstein Rep. at 3-1.

209. OFHEO raised questions in May 2004 about whether Fannie Mae incorrectly



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accounted for impairments of debt securities and directed Fannie Mae torecalculate the proper asset impairment on the securities by close of businessFriday, May 14, 2004. Ex. 105, FMCIV-02 00625642. KPMG believed FannieMaes accounting complied with GAAP. Ex. 106, FMCIV-02 05878201 at8211. A second Big Four accounting firm, Ernst & Young, expressed its

opinion that Fannie Maes accounting was in accordance with GAAP. Id.

210. Fannie Mae and OFHEO asked the opinion of the SEC staff, which concludedthat Fannie Maes accounting conformed to GAAP and that no restatement wasnecessary. Ex. 108, FMCIV-07-02128299; Ex. 112, HUD 00000599.

211. In the restatement, Fannie Mae restated other accounting it had previously clearedwith the SEC staff, including its accounting for buy-ups. Ex. 42, KPMG-CIV-00000477; Ex. 41, KPMG-CIV-00000455.

212. In addition, with respect to Fannie Maes accounting for combinations of certaininterest-only and principal-only securities, OFHEO objected to the companys

policy early in the special investigation. Again, another major accounting firmreviewed the policy and agreed it was reasonable. Ex. 106, FMCIV-02 05878201at 8211.

213. The issue was taken to the SEC staff, which asked Fannie Mae to account for suchsecurities as OFHEO wished going forward, but not retrospectively,acknowledging the problem was a lack of clear accounting guidance. Ex. 109,FMCIV-07-02168358.

214. With respect to Fannie Maes valuation of a guaranty asset and correspondingguarantee liability, Fannie Mae cleared two policies with the SEC staff: that the

initial valuations would be equal, and that the company would reduce them byequal amounts if the related security was reacquired. Ex. 97, KPMG-CIV-00092358; Ex. 42, KPMG-CIV-00000477-98; Ex. 102, KPMG-CIV-00159021.Then it restated both policies. Ex. 36, 2004 Form 10-K at 80-86.

215. Then, after the restatement, Fannie Mae changedthe initial valuation backto theoriginal accounting, admitting that the original accounting

andEx. 111, Deloitte-FMNA-2008-

00000028-43.

H. Other Instances in Which KPMG Said No to Fannie Maes Accounting216. With respect to FAS 91, in the third quarter of 2002, Fannie Maes calculation

showed that it was outside of the precision threshold. Ex. 19, Serock Tr. at202:20-206:17.

217. Fannie Mae believed it would be within the threshold by the end of the year, only90 days away, and said it did not need to book an adjustment. KPMG said no.



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Fannie Mae booked the adjustment. Ex. 19, Serock Tr. at 202:20-206:17.

218. With respect to insurance accounting, the KPMG audit team did not agree withthe accounting that Fannie Mae proposed for several transactions. Ex. 71,KPMG-CIV-00031587.

I. OFHEOs Contemporaneous Reports219. During the course of its audits, KPMG became aware of conclusions reached by

OFHEO and reported to Congress regarding Fannie Maes operations. OFHEOissued several positive reports to Congress during the relevant period, stating:

Fannie Maes internal control framework and the management of thatframework exceeded safety and soundness standards. Ex. 37, OFHEO Rep.to Congress (2001) at 16.

Fannie Mae implemented controls to properly address risks assessed bymanagement, and had a reliable process for ensuring the timely resolution ofcontrol-related issues. Ex. 37, OFHEO Rep. to Congress (2001) at 16; Ex.38, OFHEO Rep. to Congress (2002) at 23; Ex. 39, OFHEO Rep. to Congress(2003) at 37.

The Company had established policies and procedures that delineate internalcontrol processes and standards for the control environment, and managementeffectively ensured compliance with established internal controls. Ex. 37,OFHEO Rep. to Congress (2001) at 16; Ex. 38, OFHEO Rep. to Congress(2002) at 44; Ex. 39, OFHEO Rep. to Congress (2003) at 37.

The scope of [internal] audit work performed is appropriate, and the[internal] audit work is complete. Indeed, the [internal] audit functionsexceed safety and soundness standards. Ex. 37, OFHEO Rep. to Congress(2001) at 16-17; Ex. 38, OFHEO Rep. to Congress (2002) at 44.

Management of the internal audit department was effective. Ex. 37,OFHEO Rep. to Congress (2001) at 16; Ex. 38, OFHEO Rep. to Congress(2002) at 44; Ex. 39, OFHEO Rep. to Congress (2003) at 35.

Both the internal and external audit functions had the appropriateindependence, and the auditors performing the work possessed appropriate

professional proficiency. Ex. 37, OFHEO Rep. to Congress (2001) at 16; Ex.38, OFHEO Rep. to Congress (2002) at 44; Ex. 39, OFHEO Rep. to Congress(2003) at 35.

The [internal] auditors risk assessment process was effective. Ex. 37,OFHEO Rep. to Congress (2001) at 16; Ex. 38, OFHEO Rep. to Congress(2002) at 44; Ex. 39, OFHEO Rep. to Congress (2003) at 35.



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220. KPMG made available its work papers for OFHEOs review. Ex. 1, Serock. Decl. 11. OFHEOs 2002 and 2003 reports also evaluated KPMGs work andconcluded:

The external auditor's audit plan includes all activities and operationsnecessary to opine on Fannie Mae's financial statements and the quality of thecompany's controls.

The communications from the external auditor to the Audit Committee arecomprehensive, clear, direct and effective.

The communications from the external auditor to the Audit Committee tiedirectly to the approved audit plan.

The external auditor's individual and overall conclusions are supported bywork papers that comport with established standards and among other things,demonstrate the extent of testing and verification performed by the external

auditor.

Ex. 38, OFHEO Rep. to Congress (2002), OFHEO_MUL_00088274 at 8315-8316; Ex. 39,OFHEO Rep. to Congress (2003), OFHEO_MUL_00037336 at7376-77.

221. As to derivatives, in July 2000, OFHEOs Director sent a letter to members ofCongress influential in financial services regulation, stating, [w]e are pleased toreport that both Fannie Mae and Freddie Mac are well positioned to be incompliance with FAS 133 by the implementation date of January 1, 2001. SeeEx. 113, OFHEO_OD_00012793 at 95.

222. In its 2002 Report to Congress, containing OFHEOs conclusions for its 2001annual exam, OFHEO assured Congress that it had overseen Fannie Maessuccessful implementation of FAS 133 and was continuing to monitor FannieMaes application of the standard. Ex. 38, OFHEO Rep. to Congress (2002) at 25(OFHEO carefully scrutinizes Fannie Maes use of derivatives . . . [including]proctoring the implementation of FAS 133 . . . .).

223. The 2002 Report to Congress contained a chart dedicated to the topic ofDerivatives, stating: OFHEO evaluates the appropriateness of GAAPaccounting for derivatives. Ex. 38, OFHEO Rep. to Congress (2002) at 29. The

corresponding observations from OFHEOs evaluation of Fannie Mae state:FAS 133 implementation has been deliberate and well-documented with thenecessary investments made to provide systems needed to ensure ongoingcompliance. . . . Hedge records and accounting records reflect how derivativesare used. Ex. 38, OFHEO Rep. to Congress (2002) at 29-30.

224. OFHEO concluded broadly that Fannie Maes internal control framework andthe management of that framework exceeded safety and soundness standards.



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Ex. 37, OFHEO Rep. to Congress (2001) at 16, FMCIV-03 03496617 at 6635.

225. Mr. Berliners declined to say OFHEO lacked a rational basis for its opinion. Ex.3, Berliner Tr. at 218:19-219:2.

226. As late as April and August 2004, in response to specific inquiries from KPMG,OFHEO told KPMG that it did not know of any material errors ormisstatements in Fannie Maes financial statements. Ex. 58, KPMG-CIV-00010626-27 (Apr. 2 and 12, 2004); Ex. 96, KPMG-CIV-00088080 (Aug. 6,2004).

J. Lead Plaintiffs Audit and Accounting Expertsi. Robert Berliner Audit227. Plaintiffs offer Mr. Robert Berliner as their sole audit expert. No other plaintiffs

expert opines regarding the conduct of KPMGs audits.

228. Mr. Berliner criticizes KPMGs audit in regard to three accounting issues: FAS133, 91 and 115. Ex. 22, Berliner Rep. atpassim. Mr. Berliner also concludesthat KPMGs independence was compromised because it failed to object toFannie Maes accounting in these three areas (id. 6); KPMG lacked due carebecause it permitted this erroneous accounting that did not comply with GAAP(id. 3); the audits were not adequately planned because KPMG failed to conductmore procedures around these three accounting issues (id. 1); KPMG did notobtain a sufficient understanding of Fannie Maes internal controls as they relatedto these three accounting issues (id. 2); insufficient evidential matter wasobtained because KPMG did not object to this accounting (id. 3); and its audit

reports incorrectly stated that the accounting complied with GAAP because theaccounting in these three areas was wrong (id. 4). See Ex. 22, Berliner Rep.passim.

229. Mr. Berliner has been employed solely as a litigation consultant for the past 21years and has been retained as an expert witness over 200 times. Ex. 2, BerlinerTr. at 14:16-20.

230. Mr. Berliner last performed an audit in 1983, nearly 30 years ago. Ex. 2, BerlinerTr. at 20:5-10. Much of the literature that sets forth professional auditingstandards has changed significantly since Mr. Berliner last performed an audit.

Id. at 412:21-413:3.

231. Mr. Berliner has not conducted an audit under any of accounting standards uponwhich he bases his opinions: all of those standards were promulgated after he lastconducted an audit. Ex. 2, Berliner Tr. at 19:19-21:2; 409:17-412:7.

232. Mr. Berliner does not know what procedures auditors do or do not perform whenthey are auditing transactions covered by FAS 133, 91 or 115. Ex. 2, Berliner Tr.at 411:16-412:7.



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233. Mr. Berliner has never conducted an audit under Statement on Auditing StandardsNo. 92 Auditing Derivatives, which was promulgated in 2001, simultaneouswith the effective date of FAS 133. Ex. 2, Berliner Tr. at 413:4-15.

234. Mr. Berliner does not consider himself to be an expert on FAS 133, FAS 91, orFAS 115. Ex. 2, Berliner Tr. at 403:12-408-4, 589:10-590:2.

235. Mr. Berliner has no specific training under any of these standards. Ex. 2, BerlinerTr. at 405:6-409:16.

236. Mr. Berliner has only audited two companies in the financial services industry,neither of which used derivatives or purchased mortgage loans. Ex. 2, Berliner Tr.at 21:3-14.

237. Mr. Berliner reviewed less than 5% of KPMGs work papers. Ex. 2, Berliner Tr.at 62:10-14.

238. Mr. Berliner did not review all of the documents cited by KPMGs auditingexpert. Ex. 2, Berliner Tr. at 86:7-14.239. Mr. Berliner devoted approximately 650 hours to this engagement since being

designated as an expert. Ex. 2, Berliner Tr. at 47:6-9; 57:2-7.

240. Mr. Berliner was first hired four years before being designated as an expert. Ex.2, Berliner Tr. at 56:3-7.

241. Mr. Berliner delegated much of the writing of his report to his staff. Ex. 2,Berliner Tr. at 86:17-87:12.

242. Mr. Berliner concedes that he is criticizing KPMG auditors for auditing understandards that he has no personal experience applying in an audit and on which hehas received no training. Ex. 2, Berliner Tr. at 409:17-410:15.

243. Berliner criticizes KPMG for materials that it never saw. Ex. 22, Berliner Rep. at2-4 (KPMG may not have been privy to this e-mail . . . .); id. at 2-5 (I am notaware of any evidence that KPMG was present for or aware of this . . . .);seealso Ex. 2, Berliner Tr. at 602:21-22 ([T]heres no indication that KPMG eversaw this e-mail . . . .); id. at 238:15-18 (agreeing that there is no evidence thatKPMG was aware or should have been aware of that speech).

244. Mr. Berliner admits that the auditors at KPMG planned its audit, but he claimsthey did not do it appropriately. Ex. 2, Berliner Tr. at 112:19-22. The auditorsrisk assessment process, according to Mr. Berliner, was appropriate, but theirexecution of it was not adequate. Id. at 113:11-15. The auditors did assess therisk of misstatements and developed audit procedures, but not adequately. Id.at 116:10-22. These words appear twenty-three times throughout his testimony.Adequately appears nine times. Ex. 2, Berliner Tr.at 106:19, 113:14, 116:14,116:22, 117:10, 119:5, 401:15, 554:21, 555:1. Appropriately appears fourteen



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times. Id. at 112:16, 112:21, 216:5, 217:20, 218:5, 247:18, 255:16, 298:18,308:20, 411:6, 547:21, 574:17, 603:6.

245. Mr. Berliner admitted he could not offer any independent opinion on the state ofFannie Maes internal controls and that he had never done any review of suchcontrols. Ex. 2, Berliner Tr. at 55:1-4, 209:15-210:5, 592:4-12, 600:10-15, 708:7-711:5. He did not identify any particular control weakness that dated back to theclass period. Id. at 207:13-20.

246. Mr. Berliner is not plaintiffs designated accounting expert and does not intend toopine on FAS 91, FAS 133 or FAS 115. Ex. 2, Berliner Tr. at 31:3-6, 40:9-41:6,589:10-590:2.

ii. Sharon Sabba Fierstein Accounting247. Ms. Fierstein has never audited a company that utilized FAS 91 accounting, or

gained experience on that standard other than through litigation consulting, and

she has never published on FAS 91. Ex. 23, Fierstein Rep. at B-1;see Ex. 3,Fierstein Tr. at 94:14-95:5.

248. Before working on litigation matters, Ms. Fierstein only knew how [FAS 91accounting was] done generally. Ex. 3, Fierstein Tr. at 94:19-95:3.

249. The basis for Ms. Fiersteins purported expertise on FAS 115 is that she has readthe standard a lot. Ex. 3, Fierstein Tr. at 95:8-9.

250. Ms. Fierstein has never audited a company that had to classify debt securities, norbeen involved with the creation or implementation of accounting policies

regarding the classification of debt securities. Ex. 3, Fierstein Tr. at 96:1-6.

251. Ms. Fierstein has never testified at trial or served as an expert witness in anymatter. Ex. 3, Fierstein Tr. at 139:1-3.

252. Ms. Fierstein is offering no opinion on KPMGs audits. Ex. 3, Fierstein Tr. at243:1-5.

253. Ms. Fierstein testified that she addressed in her report only those accountingissues for which she felt she had sufficient documentation to address. Ex. 3,Fierstein Tr. at 111:3-14.

254. Mr. Barron is offering no opinion on KPMGs audits. Ex. 4, Barron Tr. 13:6-10.K. KPMGs Experts

255. Timothy S. Lucas, KPMGs FAS 133 expert, is the former Director of Researchand Technical Activities of the FASB. He was extensively involved in the FASBtechnical project on accounting for derivatives and hedging, which led to theissuance of FAS 133. During that same period, Mr. Lucas served as Chairman of



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the Emerging Issues Task Force (EITF), a group of senior accountingprofessionals who met regularly with the FASB and the SEC to resolve financialreporting issues. Mr. Lucas spent more time on FAS 133 than any other project towhich he was assigned while at the FASB. Ex. 115, Lucas Rep. at 1. Mr. Lucasopined that Fannie Maes approach to implementing FAS 133 was a reasonable

and appropriate application of GAAP in the relevant time period. Id. at 2.

Documents

KMPG's Statement of Facts Re: fannie