By David S. Hilzenrath
Washington Post Staff Writer
Thursday, October 11, 2007
Four years after he was pushed out as chairman and chief executive of Freddie Mac and charged with responsibility for elaborate accounting manipulations, Leland C. Brendsel is about to get his day in court.
With hundreds of millions of dollars of potential penalties riding on the outcome, a trial-like proceeding is set to begin Monday before an administrative law judge. It is scheduled to continue through the end of February.
The dozens of witnesses slated to testify include Warren E. Buffett, the billionaire investor, and C.E. Andrews, the chief executive of student loan marketer Sallie Mae who helped lead audits of Freddie Mac when he was a partner at Arthur Andersen. The government plans to call senior executives who served under Brendsel to testify against him.
In addition to seeking vast fines, the government wants Brendsel to repay Freddie Mac any compensation he received unjustly.
Brendsel's legal team summarized its defense in a recent court filing, saying the financial stability of Freddie Mac was never compromised.
"Mr. Brendsel was not making detailed decisions about the daily operations of Freddie Mac during the period in question and could not, even by exercising 'reasonable supervision,' be aware of each of the hundreds of activities, projects and trades that Freddie Mac's 4,500 employees were pursuing at any given moment," the filing said.
The government tells a different story. It says Brendsel "directed, was aware of, and participated in the unsafe and unsound financial transactions and manipulations."
"Any attempts by him to place blame for his unsafe and unsound conduct on others, or claim that Arthur Andersen's audits shield him from culpability and liability should be summarily rejected," a government agency said in a recent legal filing.
Several years ago, Brendsel was one of the preeminent figures in American finance, having built Freddie Mac into a mortgage funding powerhouse with a reputation for financial sophistication. Raised on a farm in South Dakota, the onetime academic rose to become proprietor of Wye Hall, one of Maryland's historic estates.
Then, in 2003, the McLean company revealed that it had misstated its financial results by billions of dollars. The board of the government-sponsored firm drove Brendsel, now 65, into early retirement. An investigation commissioned by Freddie Mac's outside directors found that the company engaged in a variety of machinations to report smooth earnings growth and preserve its reputation as "Steady Freddie."
A federal regulator argued that Brendsel should have been fired for cause, and officials sought to block him from receiving tens of millions of dollars of compensation and benefits.
The scandal has been costly for Freddie Mac. It has agreed to pay about $590 million to settle claims by regulators and investors, and it has spent large sums overhauling computer systems and other internal controls that were revealed to be deficient. It has been unable to perform a basic function of any public company, issuing audited financial statements on a timely basis. The company has said that it expects to resume doing so next year, which would be five years after the accounting problems came light.
Meanwhile, Freddie Mac has been subjected to special regulatory limits on its growth.
The upcoming hearing tests both Brendsel and his accuser, the Office of Federal Housing Enterprise Oversight, a government agency whose sole mission is to oversee Freddie Mac and its competitor Fannie Mae.
The agency lost an early round in 2004, after a federal district court judge ruled that OFHEO overreached in trying to freeze about $50 million in benefits owed to Brendsel when he left Freddie Mac.
But OFHEO won a major victory over the summer. William B. Moran, the administrative law judge presiding over the case, rejected Brendsel's motion to decide the case in favor of the former chief executive without a trial. In the process, the judge rejected arguments at the heart of Brendsel's defense.
In effect, Brendsel's legal team at the law firm Williams & Connolly had sought to put OFHEO on trial by showing that the agency knew about problems at Freddie Mac and nonetheless gave it favorable reviews in annual public reports.
"A defense of finger pointing at OFHEO will not do," the judge wrote. "[U]ltimate accountability for the improper acts rests with the acts of those who ran Freddie Mac, not those who review such acts," the judge wrote.
The case is being heard in the arena of administrative law rather than in a civil or criminal trial court, and that poses a special challenge for Brendsel because it puts OFHEO in the role of both prosecutor and jury.
At the end of the months-long hearing, the administrative judge will make a recommendation to the OFHEO director, who decides the case. The director's decision can be challenged in a federal appeals court.
A similar case is pending against Franklin D. Raines and other former executives of District-based Fannie Mae, which experienced an accounting scandal of its own in 2004.
Freddie Mac's alleged manipulations and accounting errors caused it to understate profit by 30.5 percent in 2000 and 42.9 percent in 2002, and to overstate profit by 23.9 percent in 2001.
The alleged manipulations included transactions that shifted windfall earnings into later periods, when it might have been harder for the company to meet Wall Street's expectations. One series of transactions in 2001, known as the "linked swaps," postponed $420 million of operating earnings. The government said Brendsel learned about those transactions in 2001 and insisted that board members be given less information about them than another executive intended to provide.
Both Arthur Andersen and Freddie Mac's legal department raised concerns about the transactions, and then-President David Glenn urged Brendsel to unwind them, the government said. Brendsel waited almost three months to do so, by which time the $420 million shift had been accomplished, OFHEO has claimed.
The government also accuses Brendsel of maintaining unjustifiably high "cookie jar" reserves that Freddie Mac could dip into as needed to meet earnings goals.
A list of witnesses whom Brendsel's legal team plans to call suggests that Brendsel intends to take the stand to "deny all allegations" in the charges against him. Testimony by Andrews, the former Arthur Andersen global managing partner for audit and advisory services, will show that Freddie Mac and the audit firm "acted reasonably and in good faith," the witness list says.
OFHEO's witness list says Buffett, who sits of the board of The Washington Post Co., is expected to testify about his liquidation of about 60 million shares of Freddie Mac stock in 2000 and "any discussions he may have had" with Brendsel and other Freddie Mac executives "concerning earnings management and inappropriate accounting."
A spokeswoman for Buffett said he was unavailable for comment. A spokeswoman for Sallie Mae did not respond to an inquiry. Neither Brendsel nor members of his legal team returned calls. A spokeswoman for OFHEO declined to comment.
Some people appear on both sides' witness lists, including Glenn and former chief financial officer Vaughn Clarke. Without admitting or denying wrongdoing, Clarke recently settled a negligence case with the Securities and Exchange Commission and agreed to cooperate with OFHEO.
Brendsel's list says Clarke's testimony will show he believed the disputed accounting decisions were handled appropriately.
The government's list says Clarke is expected to testify "that his instruction to manage earnings came from Mr. Brendsel" and that Brendsel was involved in day-to-day decisions about transactions allegedly used to manipulate the company's financial results.
An attorney for Clarke did not return a call.