OFHEO Dir. Armando Falcon - GSE Accounting testimony [my tittle]

WASHINGTON (Dow Jones)--Freddie Mac's (FRE) federal regulator told lawmakers Thursday that the company's accounting problems have been brewing for several years, and it questioned Freddie's competence in that area when it tried to implement complicated derivatives rules in early 2001.

The Office of Federal Housing Enterprise Oversight flagged problems with Freddie's 2000 and 2001 consolidated financial statements which were also noted by Freddie's auditor Arthur Andersen in an internal letter to senior managers.

Outgoing OFHEO Director Armando Falcon told the Senate Banking Committee that he realized the agency needed a team of accountants on its examination staff to oversee Financial Accounting Standard 133, or FAS 133, which requires companies to report changes in the value of their derivatives contracts.

The agency's examiners were stretched thin when the Financial Accounting Standards Board introduced FAS 133 in 1999 with a stringent Y2K examination schedule, Falcon said. It was also busy with new corporate governance standards at a time when the companies were experiencing record growth rates.

Falcon said in written testimony that Freddie entered into several transactions to minimize the impact of FAS 133 in the fourth quarter of 2000 and the first quarter of 2001 which were later questioned by a new auditor.

The company replaced Arthur Andersen LLP (X.AND) with PricewaterhouseCoopers (X.PWC) in late 2001, which also identified problems with Freddie's loan loss reserve accounts.

In January of this year, PwC told Freddie's audit committee that it wouldn't be able to certify financial reports previously approved by Andersen until it resolved several serious questions about the company's accounting policies, Falcon said.

PwC is now reauditing Freddie's financial statements from 2000 through 2001 while federal investigators probe whether the company and/or its executives violated any securities laws.

In all, PwC reviewed more than 100 of Freddie's accounting policies, identifying about 20 major problems that will affect Freddie's financial statements. The company estimated that the restatements will cumulatively increase earnings by up to $4.5 billion.

Falcon said about half of the company's derivatives were improperly accounted for under FAS 133 and amortized over time. Those transactions will now be marked to market. The company will also have to record about half of its off-balance-sheet guarantee business at fair value, he said. The combination of the two major corrections will increase earnings volatility in prior and future years and will decrease future earnings, he added.

OFHEO has come under fire for declaring in a June 4 report to Congress that Freddie Mac's management and internal controls were strong - just days before the company announced that it had forced out its top three executives.

But Falcon said OFHEO was keeping close tabs on Freddie's progress the entire time. He said the agency has been wrongly accused of mishandling the matter. Freddie Mac officials and its consultants withheld key information Falcon said would have affected OFHEO's conclusions in its report.

"There is a misperception based on my original report to Congress that we weren't aware of the accounting problems or weren't working on it," Falcon told lawmakers.

PwC told the board in early May that it didn't believe information provided by Freddie's Chief Financial Officer Vaughn Clarke and President David Glenn. Glenn was later accused of destroying pages from a business notebook requested by Baker Botts, a law firm hired by Freddie's audit committee to investigate the accounting problems.

But Falcon said Baker Botts in a May 27 meeting, "expressed no concerns regarding the management team of inappropriate or improper management behavior."

OFHEO wasn't informed until the morning of June 5 that Freddie had an "urgent communication" to discuss with the regulator, Falcon said. Freddie's board told OFHEO the next day that it decided to remove Chief Executive Leland Brendsel, Glenn and Clarke from their posts.

OFHEO officials met with members of Freddie Mac's board on Saturday, June 7, to reviewing much of what OFHEO already knew about the restatement process.

"However, new issues relating to Mr. Glenn and the termination and replacement of senior management were also presented; particularly the lack of confidence in Mr. Glenn expressed a month earlier by PwC," Falcon said. "I considered the information regarding Mr. Glenn to be a clear signal of a breakdown in the integrity of Freddie Mac's control environment at the highest levels."

OFHEO opened a formal investigation that day into the company's accounting practices and employee misconduct.

"Following this meeting, as occurred after the meeting on May 27, additional matters came to light and, again, reflected a lack of candor that concerned me deeply," Falcon said.

Falcon asked lawmakers to speed through an additional $4.5 million in funding this year so the agency can wrap up its investigations. It is also reexamining the accounting policies of fellow government-sponsored company Fannie Mae (FNM).

To: AdamSelene235; AntiGuv; arete; Black Agnes; Cicero; David; Fractal Trader; gabby hayes; imawit; ...

3 posted on 07/17/2003 8:56:38 AM PDT by ken5050 (ann coulter NEEDS to have kids ASAP....her gene pool has to be passed on.....any volunteers?)

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4 posted on 07/17/2003 9:00:19 AM PDT by Support Free Republic (Your support keeps Free Republic going strong!)

There's a remedial class in headline writing starting at 4PM...(g)

What? It wasn't tittlating enough?

LOL..well, if your intention is to get folks to click on the thread to see WTF it's all about....then you've succeeded brilliantly........regards...

6 posted on 07/17/2003 9:02:55 AM PDT by ken5050 (ann coulter NEEDS to have kids ASAP....her gene pool has to be passed on.....any volunteers?)

A financial services company needs accountants? Who wouldda thunk it?

Derivatives should be outlawed. They are simply playing games with numbers and the numbers end up being real dollars, lots of them.

7 posted on 07/17/2003 9:34:04 AM PDT by Mind-numbed Robot (Not all things that need to be done need to be done by the government.)

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