Freddie Mac To Pay $125M Fine

Mortgage giant Freddie Mac has agreed to pay a $125 million civil fine to settle federal regulators' allegations of management misconduct and directors' complacency, blamed for the company's $5 billion understatement of earnings that led to the ouster of four top executives.

The Office of Federal Housing Enterprise Oversight, which supervises government-sponsored Freddie Mac and its larger rival Fannie Mae, also released Wednesday a critical report citing "a pattern of inappropriate conduct and improper management of earnings" at the company and even "a disdain for appropriate disclosure standards" among former executives.

The second-largest U.S. buyer of home mortgages "disregarded accounting rules, internal controls, disclosure standards, and ultimately, the public trust in pursuit of steady earnings growth," the agency's report found.

Helping fuel the accounting breaches was the compensation of top executives, which was partly based on annual targets for earnings per share, the report said. A series of recommendations made in the report includes a requirement that Freddie Mac reward its executives on the basis of long-term goals rather than short-term earnings.

And, it said, management was able to push the accounting envelope unchecked because the company's board of directors "was complacent and failed to exercise adequate oversight."

Freddie Mac, a publicly traded corporation with $40 billion revenue a year, has acknowledged understating its earnings by $5 billion for 2000-2002 to smooth out volatility in profits and uphold its image on Wall Street as a steady performer. In addition, the company last month admitted inflating 2001 earnings by nearly $1 billion and said it may not be able to complete its accounting for 2003 until next June.

The company on Sunday named Richard Syron, a Wall Street veteran and former Federal Reserve official, as its new chairman and chief executive. The board of directors in June forced out Freddie Mac's then-chairman and CEO, Leland Brendsel, along with the company's president and chief financial officer. In August, the federal regulators ordered the ouster of Brendsel's replacement, Gregory Parseghian, who they said had played a role in some of the company's questionable financial transactions.

The company did not admit to or deny wrongdoing in the settlement, involving the first such fine in the agency's 10-year history. McLean, Va.-based Freddie Mac also said it did not consent to any part of the agency's report.

The agreement with the regulators still leaves to be resolved a criminal investigation by the Justice Department and a civil inquiry by the Securities and Exchange Commission.

The $125 million fine will be paid out of the company's revenues, thereby potentially affecting its bottom line. The restatement by company auditors of Freddie Mac's 2000-2002 earnings, a massive project first announced in January and completed last month, cost the company $100 million. A company spokesman said Wednesday it was not known whether Freddie Mac would try to recoup such costs through changes in its operations.

Under the settlement, Freddie Mac also agreed to strengthen its internal controls and accounting practices and to improve its disclosure of information to the investing public — steps the company already had undertaken after its accounting and management turmoil came to light in early June.

"This settlement and the resulting reforms represent an important step toward the goal of restoring the full confidence of our investors and the public," said Freddie Mac chairman Shaun O'Malley said in a statement. "The reforms to be implemented as part of today's settlement build upon and enhance the company's ongoing remediation program to address its accounting and disclosure weaknesses."

Armando Falcon, director of the Office of Federal Housing Enterprise Oversight, said a government-sponsored company such as Freddie Mac — created by Congress to pump money into the home-mortgage market — "lives on a public trust that should never be violated."

Falcon said his agency "will take strong action against an enterprise and responsible individuals if that trust is ever broken."

The agency also has been examining accounting at Fannie Mae, which disclosed in October a $1.2 billion accounting error for the third quarter. The error was due to a change in accounting rules and does not affect net income, the company said. Some critics say that Fannie Mae does not adequately hedge against swings in interest rates.