Securities regulators told Freddie Mac yesterday that they are considering bringing civil charges against the mortgage giant for allegedly manipulating its reported earnings, Freddie Mac confirmed.
The Securities and Exchange Commission gave the McLean-based company what is known as a Wells notice, informing the board of directors that the agency might file a civil complaint, seeking a permanent injunction and a fine, over the company's accounting errors. Freddie Mac has acknowledged that it misstated profits by $5 billion over three years, 2000 through 2002.
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Freddie Mac and Fannie Mae: Understanding the complexities of the organizations that help fund the nation's housing market
An SEC lawsuit would come at a tumultuous time for Freddie Mac, which faces criticism from Congress, the White House and private industry that it and its larger rival, Fannie Mae, have grown so big they pose a threat to the nation's economic stability. The companies are fighting efforts by the Bush administration to impose stronger regulation and restrict their growth.
Freddie Mac and Fannie Mae are congressionally chartered, publicly traded companies known as government-sponsored enterprises. They buy home loans from banks and other lenders and package them into mortgage-backed securities that are then sold to investors. The process makes more money available for home loans.
The SEC, the federal agency that polices publicly traded companies, now will allow Freddie Mac to respond with arguments why the government should not pursue a civil case. Lawyers in the SEC's division of enforcement will then decide what to recommend to the agency's five commissioners.
Usually the commissioners vote in favor of what the division recommends.
The SEC's investigation of Freddie Mac began last year, with disclosure of the company's accounting errors. The errors centered mostly on the company's failure to report gains and losses in the value of derivatives, which are complex financial instruments it uses to hedge against interest rate swings. Accounting rules require the company to adjust its income as the value of those instruments goes up or down, even if the company still holds them and hasn't actually realized a gain or loss.
The effect of the corrections was to increase past earnings by $5 billion, including $600 million from before 2000. But part of the mistake was an overstatement of profit by $1 billion in 2001, and the reporting of a profit in one quarter when the company had a loss.
The problems have led to the ouster of several top Freddie Mac executives in the past 18 months, including two chief executives, who could face separate sanctions from the government, and caused Freddie Mac to fall behind in its financial reporting to the SEC. The company reported 2003 results in June and expects to report 2004 numbers next year.
A fine from the SEC would be in addition to the $125 million civil penalty the company's federal financial regulator imposed earlier this year in connection with the accounting missteps.
"Freddie Mac has been cooperating with the SEC's investigation and will continue to do so as we evaluate the manner in which we will respond to the receipt of the Wells Notice," the company said.