Independent Report Points Finger at Freddie Mac's Governance Practices

NEW YORK – A report issued July 23 by law firm Baker Botts LLP, special counsel to the outside directors of the board of Freddie Mac as part of its review of the scope of the government-sponsored enterprise’s accounting problems and management shakeup and “allegations of wrongdoing”, found the causes of the situation inherent in Freddie Mac. The 107-page report completed after a seven-month investigation by the New York-based firm, cited accounting policy and financial reporting; internal control adequacy; former management’s governance practices; and disclosure policy as key issues for the GSE. The report said Freddie Mac became “overly reliant” for basic accounting decisions on its former independent auditor Arthur Andersen, and said former Chairman and Chief Executive Leland Brendsel and Vice Chairman David Glenn controlled the information flow to help “steady Freddie” report “nonvolatile” profit growth. “This is a painful day for Freddie Mac. But I am confident the Board has chosen a strong new management team.that team will be able to use this information as it develops and implements a plan to remedy the issues Mr. Doty has identified,” said Freddie Mac Chairman Shaun O’Malley in a company release. O’Malley was referring to SEC General Counsel James Doty who is conducting the investigation of Freddie Mac. In March 2002, Freddie Mac hired PricewaterhouseCoopers to replace Arthur Andersen. As part of its investigation, Baker Botts looked into Freddie Mac’s reserves and reserve adjustments practices. It reported that “Corporate Accounting made reserve adjustments and altered the models that supported reserve policy, with a view to presenting a steady, nonvolatile pattern of earnings growth. These reserve adjustments frequently did not comply with GAAP and were driven more by the desire to achieve earnings targets than by a balanced assessment of the underlying probable losses.” Regarding disclosure processes, the law firm found, “The Company’s disclosure processes, especially as regards sensitive transactions such as Linked Swaps and those designed as a response to SFAS 133, tended to produce generalized disclosures of strategies, rather than transparent disclosures of transactions. As a result, disclosure processes and practices fell below the standards required of a registered public company.” As for Freddie Mac’s internal controls and governance processes, the report found there were “weaknesses.” On the plus side, Baker Botts said it did not find any pattern of “systematic withholding of information” by Freddie Mac from its auditor at the time, Arthur Andersen. But it did state that from late 2000 to late 2001, Freddie Mac “became overly reliant on Arthur Andersen with respect to basic accounting decisions and policies.” Several former members of Arthur Andersen’s audit team are now employees of Freddie Mac. The GSE’s senior management played a key role in controlling the information flow to help Freddie Mac “achieve the goal of steady, nonvolatile earnings growth,” and this control “was a contributing factor to the accounting and disclosure problems,” the report states. Cited were former Freddie Mac Chairman and CEO Leland Brandsel and Vice Chairman David Glenn. Glenn was fired in June as part of the management shakeup at Freddie Mac, and Brendsel retired at the same time. [email protected]