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The Freddie Scandal: Follow the Money, or the Accountants, or Both

Here's what the Freddie Mac "restatement scandal" really boils down to: who in their right mind at the company was supporting the concept of hiding or smoothing out the firm's stellar earnings?

That's what it's all about. Oh, there are other ancillary issues, too - but the earnings and the concepts behind how and when earnings should be booked is what it's all about. As this scandal unravels you can anticipate reading - and hearing - a lot about hedging, derivatives, held-to-maturity accounts, GAAP, PMVS (portfolio market value sensitivity) and an accounting firm called Arthur Andersen.

Remember that name: Arthur Andersen. Andersen is the firm that Freddie Mac fired in early March 2002 as energy giant Enron was melting down into a financial abyss. Andersen, as you might recall, was Enron's accountant. Remember how high and mighty and politically well connected Enron once was? Remember Ken Lay, its former chairman? He had political juice big time, as in George W. Bush. But we're getting a bit sidetracked.

The issue here is Freddie Mac, its hedge accounting (we think) and Arthur Andersen. When it comes to employees getting canned, this is how the Freddie Mac scandal is going to play out: anyone (and I do mean anyone) at Freddie Mac who was boldly in favor of adopting accounting policies that would allow it to hide or smooth out earnings is toast. Hasta la vista, baby.

Not only is Freddie Mac investigating its own accounting policies and practices, but so is the U.S. Attorney's office, the Securities and Exchange Commission and the Office of Federal Housing Enterprise Oversight. (Former SEC counsel James Doty has been retained by Freddie to handle its in-house probe.) There will be zero tolerance for anyone who screwed up, anyone who is on-the-record in company documents cheerleading the idea of deferring income because it would look good to Wall Street. (Analysts hate surprises, either good or bad.)

Any Freddie Mac employee whose name is on a memo, a working paper, or any other accounting-related document supporting the idea of booking today's profits tomorrow will be fired. End of story.

It's possible that some Freddie Mac and former Freddie Mac officials will try to hang this "recognition of earnings" mess on Andersen. And why not? Andersen has more or less been dissolved. Why not blame the dead guy?

But is it really fair to blame Andersen? Better yet, here's another question: Would Freddie Mac have fired Andersen at all if Enron hadn't happened?

And what about all the Freddie Mac employees who joined the company from Arthur Andersen? Will they become pariahs just because they used to work for Andersen?

In late June, a few weeks after David Glenn was fired as president and chairman Leland Brendsel was offered the retirement sword, Gregory Reynolds, a former Freddie comptroller who was then working on the "business side" of company was forced out. No explanation was given for his departure.

From April 1998 to the spring of 2002, Mr. Reynolds served as senior vice president and comptroller. He had joined the company in 1991 from, you guessed it, Arthur Andersen. I'm told there are plenty of other Andersen employees at Freddie as well. One former Freddie official noted recently there was a virtual revolving door between the two firms.

Of course, it's not at all unusual for an auditor to join the auditee. Martin Baumann, who was named chief financial officer of Freddie on that fateful Monday June 9, used to work at PricewaterhouseCoopers, Freddie's current auditor. Also, John Woods, senior vice president of control and accounting in the company's funding and investments division, used to work at Andersen.

But again, the key issue is who stood for what and when. The answers will determine who is shown the door when Freddie Mac's management and board complete their purge. So far, four have been canned: three with public fanfare (Messrs. Brendsel, Glenn and Vaughn Clarke) and one very quietly (Reynolds).

How many more heads will roll? And will any of them be in the corporate suites? Good questions one and all. We should have the answers by year-end.

Paul Muolo is executive editor of both Mortgage Servicing News and its affiliate, National Mortgage News. He can be e-mailed at: Paul.MuoloThomsonMedia.com

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