Freddie mac accounting scandal summary
The events shocked Wall Street, where Freddie Mac long had enjoyed a reputation as a steady performer and reliable corporate player. In September , an equally stunning accounting scandal came to light at No. Regulators eventually imposed limits on the two companies' multibillion-dollar mortgage debt holdings, which they have been seeking to have lifted as a way to provide cash to the mortgage market in the recent turmoil.
Fannie and Freddie were created by Congress to make mortgages affordable and pump cash into the market by buying blocks of home loans from lenders and bundling them into securities for sale to investors worldwide. In a lawsuit filed in federal court in Washington, the SEC said Freddie Mac "engaged in a fraudulent scheme that deceived investors about its true performance, profitability and growth trends. The settlement with the company is subject to court approval. In a separate action Thursday, OFHEO issued a consent order against Clarke, under which he agreed to cooperate with the agency in its proceedings against other former Freddie Mac executives.
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Copyright The Associated Press. All rights reserved. It is widely held that it is the responsibility of a corporation for maintaining a control environment that will, among other things, accurately record and account for transactions. Many senior staff members at Freddie Mac claim that the incorrect financial reporting was 'an honest mistake.
However, the press have scrutinised the intentions management suggesting that they were deliberately misstating earnings. Auditors have a duty to form and express an opinion as to whether the company's accounts demonstrate an accurate view of the entity's financial position. Arthur Andersen, the auditor, judged that Freddie's accounts were compliant with GAAP and therefore the audit was 'unqualified'. In doing so, Andersen appeared to have failed to notice the fact that Freddie kept their loan loss reserves at levels higher than that permitted by GAAP, maintaining a reserve account to cushion fluctuations in premiums and discounts resulting from mortgage prepayments.
Neither did Andersen realise Freddie's illegitimate reporting of the derivatives trading.
Freddie Mac settles accounting-fraud charges - Business - US business | NBC News
Many people feel that the auditors, as professionals and specialists, should be responsible for realising such material misstatement. It is widely acknowledged in the auditing profession that it is the auditor's responsibility in detecting fraud through a company's internal controls.
Such cases highlight the expectations gap whereby 'auditors are performing at a variance with the beliefs and desires of those whose benefit the audit are being carried out'. However, it is commonly accepted that auditors cannot be held liable for every incident of fraud in companies. A crucial deciding factor on auditor liability concerns the extent to which the auditor dedicated adequate time and resources to the audit, and whether sufficient assurance was provided through substantive and compliance testing.
It must be remembered that it is not the auditor's responsibility to detect fraud. Rather the auditor has a responsibility to " properly plan, perform and evaluate their audit work so as to have a reasonable expectation of detecting material misstatements in financial statements. However, such material misstatements associated with fraud would ultimately affect the truth and fairness of the report, hence would suggest audit failure.
OFHEO employs a full range of supervisory and enforcement tools including examinations, capital standards, and prompt corrective action procedures suggesting that perhaps, OFHEO should have detected the misstatements earlier. The scandal highlighted several issues in Corporate Governance, many which now have been addressed in the Sarbanes Oxley Act and the Higgs and Smith reports.
Freddie Mac settles accounting-fraud charges
This structure implies too much empowerment in an individual resulting in transparency and communication problems in within the company. Additionally, Freddie's remuneration structure rewarded executives with extortionate pay for high performance. Arguably, such incentives encouraged management to inflate earnings.
Moreover, the remuneration disclosure was not clearly reported for.
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Another hot topic is the retirement packages of senior executives. Freddie gave out huge retirement compensations which were largely unrelated to their performance e. Much of the public were startled at this figure which is overly generous to say the least. Finally, because of Freddie's political objectives, it is one of only two companies which are exempt from disclosing certain information to the SEC which is highly controversial due to differential treatment, especially as it concerns a public company.
This suggests that Freddie's unique position eroded transparency in its accounting facilitating its ability to commit unidentifiable fraud. Consequently, independence is 'essential for ensuring the credibility of auditors' work' and is referred to as 'the cornerstone of auditing'. For the auditor's opinion to be credible, the auditors must be perceived to be independent from management and the company.
This is reflected in the fundamental 'objectivity and independence' principle of auditing where it is essential that auditors are both:. Avoid situations which might cause others to conclude that the auditor might not be maintaining an unbiased attitude of mind. Despite the apparent simplicity of these requirements, in reality, independence is easily compromised as illustrated by the Freddie scandal.
There are many threats to independence and steps and proposes have been designed to preserve independence. These are. It can be considered that the self interest threat always exists to a certain extent as "auditors are hired, fired and paid by their clients' managements" therefore auditors are under pressure to provide clean reports.
The fact that Andersen were the auditors for 22 years is controversial falling under the 'familiarity or trust' threat. Professional bodies have always recognised that personal, family and business relationships with an audit client may impair independence. In addition to possibly being over-sympathetic to the management, they may also have become too trusting of the management resulting in insufficient audit testing.
GPES 1 identifies risky situations to avoid, one of them being undue dependence on an audit client for fee income, to prevent the compromise of independence.
Like placing undue dependence on audit clients for fee income, the provision of non audit services to audit clients is regarded as a serious threat to auditors' independence, both in fact and in appearance. Whether provision of non-audit services to an audit client should be allowed has been an ongoing debate. Back when Andersen audited Freddie's financial statements, the rules were less stringent, especially in the US as the SEC introduced newer stricter independence rules in As auditors become familiar with all aspects of the client, it is argued that they are in a prime position to provide financial and managerial advice.
This reduces costs as new consultants would need to familiarise themselves with the corporation. Moreover, external consultants may only focus on particular areas hence the perception that auditors providing consulting work appreciate the wider entity. However this increased efficiency and effectiveness comes at a high cost of independence.
Clearly, there is huge incentive for Andersen to remain on good terms with Freddie and ultimately, audit objectivity is impaired by self-interest. Finally, because so much consulting was being provided, Andersen could be perceived as being too involved with the audit client's management to conduct the audit in an unbiased manner. The company said that it had manipulated its earnings to meet Wall Street's desired objective of steady earnings growth. To that end, it succeeded in doing so and in keeping its stock prices high, it has not hurt investors thus far.
But as one of the four largest financial institutions in the U. Also at issue are oversight and regulation. The companies accounting misdeeds were revealed just days after the federal regulator responsible for its financial oversight gave it a clean bill of health.
In addition, it has not met its specific public interest mission, which is to enhance opportunities for home ownership and affordable rental housing for low-income and minority populations. Originally known as the Federal Home Loan Mortgage Corporation, Freddie Mac was chartered by Congress in as a private company with a public mission to stabilize the nation's mortgage markets and widen opportunities for home ownership and affordable rental housing. Freddie Mac and its sister institution Fannie Mae was set up based on the idea that neither government nor private banking interests could address the nation's housing finance needs.
The company's charter established a board comprising 18 members - thirteen elected by shareholders and five appointed by the President of the United States. Freddie Mac is a Government-Sponsored Enterprise GSE , that is, a business entity that has a distinct relationship with the government. GSEs usually enjoy special perks and privileges that other businesses do not receive. Freddie Mac, for example, is exempt from state and local taxes.
Neither is it subject to standard disclosure rules imposed on other financial institutions.
It is rated by credit rating agencies such as Moody's. GSEs such as Freddie Mac are among the world's largest securities issuers. Freddie Mac is one of the biggest buyers of home mortgages in the U. S and is a publicly traded company. It buys mortgages from mortgage lenders, such as commercial banks and other financial institutions, repackages them as mortgage-backed and debt securities, which are then purchased by investors.
Mortgage-backed securities are more liquid than individual mortgages. Institutions like Freddie Mac make their profits from the difference between the cost of its debts and the return on its mortgage holdings. Their role is to serve as a secondary market conduit between mortgage lenders and investors.
Mortgage lenders use the proceeds from selling loans to Freddie Mac to fund new mortgages. In this way, Freddie Mac replenishes and increases the supply of funds available for homebuyers and apartment owners from mortgage lenders. About fifty percent of all new single-family home mortgages today are sold to secondary market conduits.
A December report by the Federal Reserve Board finds that Freddie like Fannie benefits from its government connection far more than homeowners do. Rather than boosting homeownership, the federal subsidies help the company's shareholders because it increases the company's earnings.