IRS Probes Freddie Mac 401K Plan, Derivatives Deals

WASHINGTON (Dow Jones)--The Internal Revenue Service and Labor Department are now investigating Freddie Mac (NYSE:FRE - News) and issues surrounding its retirement plan and certain derivatives transactions, which could result in an additional tax bill of up to $750 million, plus interest.

The company quietly posted the information on its Web site in a Sept. 25 information supplement, which was first reported by Federal Financial Analytics in its GSE Activity Report Tuesday.

Spokesmen for the IRS and U.S. Labor Department declined to comment about the matter.

The company, in its monthly disclosure that supplement its annual financial statements, said the IRS is looking at the company's tax returns for prior years, "some of which relate to matters connected with the restatement."

The IRS investigation revolves around the company's use of so-called linked swaps, the company said.

"Freddie Mac has reported and paid tax treating each pair of linked swaps as a single integrated transaction for federal income tax purposes," the company stated. "There is a risk, however, that the Internal Revenue Service (IRS) could challenge Freddie Mac's tax treatment of the linked swaps and make an adverse determination relating to this tax treatment."

The company added that the potential aggregate additional tax liability could come to as much as $750 million, plus interest.

Company executives entered into a series of transactions in late 2001, referred to as linked swaps, that the internal report prepared for Freddie's board of directors said "had minimal business justification other than the shifting of operating earnings."

The linked swaps transactions, which were executed with Morgan Stanley to offset a surge in Freddie's earnings due to a refinancing boom, generated an estimated $420 million loss in the last half of 2001. That was then accounted for as an increase in earnings of the same amount in 2002 and beyond.

The company said in its September statement that it's not providing reserves for any tax issues related to the linked swaps because it does not believe the final resolution of the issue will result in IRS adjustments that have "a material adverse impact on Freddie Mac's financial condition or results of operations."

However, the company conceded that if the IRS pursues the maximum penalties and additional tax liability against Freddie, that could have an adverse impact on Freddie's earnings "in the quarter in which it was recognized."

The company also disclosed in its September release that outgoing Chief Executive Greg Parseghian, who was tapped by Freddie's board of directors to replace Leland Brendsel in June, is named as a defendant in a July lawsuit against the board and several former executives.

The company had previously defended Parseghian's actions in devising transactions to smooth earnings, saying he relied upon the advice of external and internal auditors in crafting the deals and thought they complied with accounting rules.

Current members of Freddie's board of directors were recently dismissed "with consent of the plaintiff." But Parseghian, former CEO Brendsel and former chief financial officers Vaughn Clarke and John Gibbons are still named in the suit.

The Office of Federal Housing Enterprise Oversight, which regulates Freddie and fellow government-sponsored enterprise Fannie Mae (NYSE:FNM - News) , forced Freddie to remove Parseghian and former general counsel Maud Mater in late August.

Freddie is currently holding a nationwide search to replace both executives. There are currently about 20 different lawsuits against Freddie Mac for manipulating its earnings, including suits filed by the Ohio Public Employees Retirement System, the State Teachers Retirement System of Ohio, the West Virginia Investment Management Board and the Central States, Southeast and Southwest Areas Pension Fund.

Rep Shays Questions Freddie On Tax Liability Disclosures Tuesday October 21, 7:33 pm ET

By Dawn Kopecki, Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- Rep. Christopher Shays, R-Conn., questioned in a letter late Tuesday to Freddie Mac (NYSE:FRE - News) board member George Gould why he withheld key information about the company's tax liability when Shays queried him on the issue at a House hearing last month.

The Internal Revenue Service is investigating Freddie Mac and its accounting for certain derivatives transactions, a probe that could result in bill for back taxes as high as $750 million plus interest, the company said in a little- noticed disclosure posted on its Web site Sept. 25. That's the same day Gould testified before Shays at the House Financial Services Committee. The IRS investigation was first reported Tuesday by Federal Financial Analytics in its GSE Activity Report.

The company also publicly disclosed Sept. 25 the fact that it had to postpone its much-anticipated earnings restatement into November.

But Gould downplayed the company's possible tax liability at the committee hearing that same day, saying any taxes owed after correcting the company's earnings statements from 2000 through 2002 would be minor compared with the $4.5 billion or more in additional earnings it expects to record.

"Oh, gosh, the amount of taxes, if any, additional taxes payable would be minuscule compared to that amount of money," Gould said, responding to a question from Shays.

Shays questioned whether Gould was aware of the disclosure the day of the hearing.

"If you were, I am interested to know if it is therefore your assertion that a tax liability of $750 million plus interest is `miniscule'?" he asked in his letter.

Shays also asked Gould specifically how Freddie released the information, whether it was posted on the company's Web site or disseminated directly to news organizations.

"If this information was available before you testified, why was it not included as part of your testimony before the committee or at least offered in response to my question?" Shays asked. "Finally I would like to know whether this type of financial disclosure is what Freddie Mac refers to when it describes its disclosure as "best in class' and states that it is already exceeding the requirements set by the Securities and Exchange Commission (News - Websites) ?"

Freddie, which is exempt from most securities disclosure laws, has postponed its voluntary registration with the SEC while it works out its accounting problems. Its larger sibling, Fannie Mae (NYSE:FNM - News) , registered its common stock with the SEC in March.

The company's accounting misdeeds are being investigated by a number of federal law enforcement agencies, including the SEC, the U.S. Attorney's Office in Alexandria, Va., and its regulator, the Office of Federal Housing Enterprise Oversight.

The IRS investigation revolves around the company's use of so-called linked swaps, the company said in its Sept. 25 disclosure. The company had previously disclosed the fact that it was being investigated by the IRS as well as the Labor Department (for issues surrounding its 401(k) thrift savings plan) in its August information supplement. But it didn't detail the amount of money at risk.

The company added that the potential aggregate additional tax liability could come to as much as $750 million, plus interest.

"If this one goes our way, great; if not we need to set up a reserve for it," said Freddie Mac spokeswoman Sharon McHale.

Company executives entered into a series of transactions in late 2001, referred to as linked swaps, that an internal report prepared for Freddie's board of directors said "had minimal business justification other than the shifting of operating earnings."

However, the company conceded that if the IRS pursues the maximum penalties and additional tax liability against Freddie, that could adversely impact Freddie's earnings.

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