Brendsel, OFHEO Agree to Settle

By David S. Hilzenrath
Washington Post Staff Writer
Wednesday, November 7, 2007

The government yesterday settled its case against former Freddie Mac chairman and chief executive Leland C. Brendsel for a fraction of the more than $1 billion in damages and penalties it had been seeking for his alleged participation in accounting manipulations.

As Brendsel's trial on regulatory charges was about to enter its fourth week, the federal agency accusing him announced that he would give up $13 million, including $10.5 million of past compensation, and would waive claims against Freddie Mac for more than $3.4 million of additional pay.

The government had sought to freeze $50 million in pay and benefits after Brendsel was pushed into early retirement in 2003. Though he will pay far less than that, he will pay significantly more than other former Freddie Mac executives who reached agreements with regulators.

Most of the proceeds from the settlement are to be used to help keep at-risk borrowers in their homes, the government said.

Brendsel's trial had been scheduled to continue before an administrative law judge through the end of February. The government agency pressing the case, the Office of Federal Housing Enterprise Oversight, had planned to call other former executives to testify against Brendsel.

"Although Mr. Brendsel and OFHEO disagree strongly about what happened in the past at Freddie Mac, Mr. Brendsel agreed to a settlement because it requires that most of the money paid will be used to assist families who are threatened with the loss of their homes in the current mortgage credit crisis," Kevin M. Downey, Brendsel's lead attorney, said in a statement.

Brendsel "did not admit and specifically denies any liability in connection with the matters alleged by OFHEO," Downey added.

The OFHEO director, James B. Lockhart III, issued a statement saying the settlement "represents a satisfactory conclusion."

The administrative law process under which the case was being tried gave OFHEO special leverage over Brendsel. The judge's role was to recommend a decision to the OFHEO director, who would determine the outcome subject to a judicial appeal.

The case was a forerunner of a similar one pending against former Fannie Mae chairman and chief executive Franklin D. Raines, who was also pushed out in an accounting scandal. Raines is represented by the lawyer who defended Brendsel, and the same judge was presiding over both cases. Raines is scheduled to go to trial next year.

The accounting problems at Freddie Mac surfaced in 2003, after the McLean mortgage-funding company replaced its embattled auditor, Arthur Andersen. The company later revealed that it had understated profit by 30.5 percent in 2000 and 42.9 percent in 2002, and overstated profit by 23.9 percent in 2001. Freddie Mac has agreed to pay about $590 million to settle claims by regulators and investors.

Though the government said it would show that Brendsel participated in a scheme to distort earnings, in an opening statement, government lawyer Stephen E. Hart said the agency was required to show only that Brendsel ran the company in an unsafe and unsound manner.

During the trial, the government showed that Brendsel received warnings from his staff as early as 1999 that the company's internal controls were deficient.

"As I have mentioned in past reports, our accounting processes are falling short of what it takes to produce consistent, reliable and timely financial information either for analysis or for disclosure," John Gibbons, the company's chief financial officer at the time, wrote in a 1999 memo to Brendsel.

Gibbons added that the shortcomings "stem from management failure to anticipate and communicate changes in business results that are relatively easy to foresee."

Brendsel testified that he received assurances that the company's financial reporting was sound.

The government alleged that Brendsel established a corporate culture that favored steady earnings growth, and some of Brendsel's testimony contributed to that impression.

For example, Hart presented Brendsel with an internal document from 1999 saying that net interest income was surging and the company was undertaking transactions to smooth the gains over time. When Hart asked why the company would want to smooth the time pattern of earnings, Brendsel answered, "to have a more stable earnings stream and one that would be more reflective of the economics of the business and how we manage the business."

The heart of the alleged accounting machinations involved a series of economically meaningless transactions meant to flatten a one-time spike in earnings associated with a new accounting rule and defer that windfall, totaling hundreds of millions of dollars, into future years. Under questioning by Hart, Brendsel said he concurred that a spike of less than $20 million or $25 million was an appropriate objective for the company.

That position was seemingly at odds with an attitude of letting the accounting chips fall where they may.

At one point in the trial, billionaire investor Warren E. Buffett took the stand. Once a major investor in Freddie Mac, Buffett, who sits of the board of The Washington Post Co., testified that he liquidated his stake in the company partly because he thought Brendsel's pledges of mid-teens earnings growth could lead to trouble. However, under cross-examination by Brendsel's lawyer, Buffett said many companies made earnings projections and his opposition to the practice was a minority view.

Richard F. Syron, Freddie's chief executive, testified that the company was financially safe and sound when he took over in 2004.

Yet Freddie Mac's internal controls and the systems it used to track earnings were so deeply flawed that the company has been unable to issue routine financial statements on a timely basis.

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