FREDDIE MAC SCANDALS REPORT

FORENSIC ACCOUNTING AND

FRAUD EXAMINATION

PREPARED BY:
N
O.
1.

NAME.

NO. I/D

NURULALIYANI PUTRI
BINTI MOHAMAD IZAHAR

62288214096

2.

NIK NURAKMALAILY BINTI

KAMARUDIN

62288214120

3.

MYRA SHAZWANI BNTI

SIR
HAIDZIR

4.

CHE ADIBAH BINTI CHE

MAT JONI

PREPARED
62288214332

FOR:
MUHAMMAD BIN HASSAN
62288313137

CLASS:
AC 20

Table of Contents
1.0 COMPANYS PROFILE.......................................................................................... 2
1.1 SENIOR OPERATING COMMITTEE.....................................................................4
1.2 BOARDS OF DIRECTOR.................................................................................... 5
2.0 MAIN PLAYERS................................................................................................... 6
3.0 TIMELINE OF FREDDIE MAC COMPANY................................................................7
3.1 THE SEC'S JUDGMENT...................................................................................... 8
4.0 FRAUD SCHEME............................................................................................... 11
5.0 FINAL DECISION............................................................................................... 13
6.0 CONCLUSION................................................................................................... 15
7.0 RECOMMENDATION.......................................................................................... 16

1.0 COMPANYS PROFILE

Originally known as the Federal Home Loan Mortgage Corporation, Freddie Mac was
chartered by Congress in 1970 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
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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 55% of all new single-family home mortgages today are sold
to secondary market conduits.

1.1.

SENIOR OPERATING COMMITTEE

Donald H.

Layton

Chief

Executive Officer

David M. Brickman
Executive Vice President,
Multifamily Business

James G. Mackey
Executive Vice President and
Chief Financial Officer

Michael Hutchins
Executive Vice President,
Investments and Capital
Markets

William McDavid
Executive Vice President,
General Counsel and
Corporate Secretary

Timothy F. Kenny
Senior Vice President and
General Auditor

Dwight Robinson
Senior Vice President of
Human Resources, Diversity &
Inclusion and Chief Officer.

David Lowman
Executive Vice President,
Single-Family Business

Carol Wambeke
Senior Vice President and
Chief Compliance Officer

Robert Lux
Executive Vice President and
Chief Information Officer

Jerry Weiss
Executive Vice President and
Chief Administrative Officer

1.2 BOARDS OF DIRECTOR

Raphael W. Bostic
Bedrosian Chair in
Governance and
Public Enterprise
University of Southern
California

Carolyn H. Byrd
Chairman and Chief
Executive Officer
GlobalTech Financial,
LLC

Lance F. Drummond
Retired Executive Vice
President, Operations
and Technology TD
Canada Trust

Thomas M.
Goldstein Veteran
Financial Services
Executive

Richard C. Hartnack
Retired Vice Chairman
and Head of
Consumer and Small
Business Banking U.S.
Bancorp

Steven W.
Kohlhagen Veteran
Financial Services and
Investment Industry
Executive

Donald H. Layton
Chief Executive
Officer Freddie Mac

Christopher S.
Lynch: Non-Executive
Chairman Retired
Partner KPMG LLP

Sara Mathew
Retired Chairman and
Chief Executive
Officer The Dun &
Bradstreet
Corporation

Saiyid T. Naqvi
Retired President and
Chief Executive
Officer PNC Mortgage

Nicolas P. Retsinas
Senior Lecturer in Real
Estate Harvard
Business School

Eugene B. Shanks,
Jr. Former President
Bankers Trust
Company

Anthony A. Williams
Chief Executive
Officer and Executive
Director Federal City
Council

2.0 MAIN PLAYERS

Vaughn
Clarke
ExChief
Financi
al
Officer

Controllership Duties: Reporting

accurate and timely historical
financial information. Treasury
Duties: where to invest the
company's money & Economic
Strategy and Forecasting: able
to identify and report what
areas of the company were
most efficient and how the
company can capitalize on the
information given

Leland
Brends
el
Chairm
an/Chie
f
Executi
ve
Officer
Robert
Dean
and
Nazzir
Dossan
i Senior
Vice
Preside
nts

In charge of Market Risk

Oversight and Capital
Strategy

David
Glenn
Preside
nt/Chie
f
Operati
ng
Officer
In charge of total
management of the
company

Responsible for the daily

operation in the company

3.0 TIMELINE OF FREDDIE MAC COMPANY

2002
Jan 2003
Jun 2003
Nov 2003

Freddie commited to comply with the SECs disclosure standard

Freddie announced to restate financial reports for the past 3 years
Freddie suddenly dismissed top 3 executives
Stock price plunged by nearly 20%
The restatement of past accounting results was released

Total revised Net income for 3 years upward ~ 5 bil. USD

Year Reported Net Income

Restated Net Income

Difference

2000 $2.547

$3.666

$ 1.119

2001 4.147

3.158

(0.989)

2002 5.764

10.090

4.326

Dec 2003

investigate by Office of Federal Housing Enterprise Oversight

But Freddie Mac not admit that they do not make anything wrong but
still paid the $125 million fine

Oct 2005
Nov 2005

2 bills to restructure GSEs regulation were passed

Freddie: restated and reduced $200 million income of the first half
Year.

3.1 THE SEC'S JUDGMENT

June 2003 the U.S. Securities and Exchange Commission (SEC) file an investigation due to
concerns of faulty accounting practices.
The SEC issued Litigation Release No. 20304 on Sept. 27. The SEC alleges that the
corporation engaged in an accounting fraud from 2000 to 2002. The manipulation of earnings
occurred by incorrectly accounting for various derivative instruments of the firm as well as
manipulating the accounting for loan origination costs and reserves for losses. Freddie Mac
will pay a $50 million fine. The four executives who conceived and executed this fraud were
also punished. Their fines ranged from $65,000 to $250,000; they paid out disgorgement
amounts that ranged from $29,227 to $150,000. More details are laid out in the SEC
complaint in this matter.
The fascinating thing about this accounting scandal is that it involved the understating of net
income. In particular, the SEC contrasts the reported income with the restated net income (in
billions of dollars):

Year Reported Net Income

Restated Net Income

Difference

2000 $2.547

$3.666

$ 1.119

2001 4.147

3.158

(0.989)

2002 5.764

10.090

4.326

This fraud creates three problems for investors and creditors:

The first consequence of the fraud is that it misleads capital providers with respect to the
firm; the investment community will not think it as deserving as other organizations. The
economy suffers a misallocation of resources.

The second consequence of the fraud is that it supplies the corporate executives with
incentives to engage in insider trading. The market thinks the business entity has the lower
income and may bid down the stock price and the bond prices. The managers who are
partaking in the fraud know that the earnings stream is actually higher and can profit from
this knowledge illegally.
The third consequence is that the market may misestimate the risk of the corporation and, in
this case, that seems to provide the motivation for the accounting fraud. Corporate managers
wanted to portray a picture of a steady, reliable company that was ever growing in resources
and income. That picture was phony inasmuch as the true income stream is far more volatile
than the reported earnings would indicate.
This case is fascinating for another reason. The SEC continues to give miscreants a slap on
the wrist while hitting the innocents with a massive fine. Yes, I said that the SEC continues to
dote on the bad guys by only slapping their wrist. The largest fine plus disgorgement is only
$400,000. For the salaries and stock options and perquisites that these guys got while
working at Freddie Mac, the fines plus disgorgement amounts to a speeding ticket for those
mortals with at most six-digit incomes. The fines are trivial. If the SEC wants to dissuade
managers from committing accounting frauds, then they must impose meaningful and
enormous fines and prison sentences. Petty and insubstantial fines imply that the SEC no
longer cares for investors and creditors. And managers at other entities surely take notice.
Worse, the SEC fined Freddie Mac $50 million; interestingly, this is the same amount the
SEC fined Tyco for its shenanigans. But, who is really paying this $50 million fine? That's
right; it is the investors of Freddie Mac -- those who were defrauded by the management
team!
(We could analyse this more deeply by stating that the current investors are not necessarily
the same investors who lost their shirts when the prices tumbled. Even so, assuming an
efficient market, the current investors subtracted out the estimated fines to be paid by the
corporation for this fine. Assuming an unbiased estimate, we are then back where we started:
the investors at the time of the scandal are paying this $50 million fine.)
The SEC apparently does not understand the purpose of civil penalties and criminal sentences
in our society. While they satisfy our collective sense of justice, more importantly, society
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issues civil penalties and criminal sentences to deter future crimes. If the disincentives are
sufficiently repugnant and if the probability of enforcement is sufficiently high, then future
managers are less likely to commit accounting frauds.
If the SEC hopes to deter future accounting frauds, it must align its punishment with the
thieves who carry out these misdeeds instead of punishing the shareholders. Next time the
SEC ought to fine the executives $50 million each. That would send the right message to
Wall Street. And it would alleviate the pain and suffering by the shareholders.

4.0 FRAUD SCHEME

Mortgage finance company Freddie Mac FRE will pay $50 million to settle federal charges
that it fraudulently misstated earnings over a four-year period. The Securities and Exchange
Commission announced the settlement Thursday. McLean, Va.-based Freddie Mac neither
admitted nor denied wrongdoing in the accord but did agree to refrain from future violations
of the securities laws.
Four former Freddie Mac executives settled the SEC's negligent conduct charges by agreeing
to pay a total of $515,000 in civil fines and to make restitution totalling $275,548. They are
former president and chief operating officer David Glenn, ex-chief financial officer Vaughn
Clarke, and former senior vice presidents Robert Dean and Nazir Dossani. An accounting
scandal erupted at the government-sponsored company in June 2003 when it disclosed that it
had misstated earnings by some $5 billion mostly underreported for 2000-2002 to
smooth quarterly volatility in earnings and meet Wall Street expectations.
The company's top executives Glenn, Clarke and then-chairman and chief executive
Leland Brendsel were ousted. The events shocked Wall Street, where Freddie Mac, the
nation's second-largest buyer and guarantor of home mortgages, long had enjoyed a
reputation as a steady performer and reliable corporate player. Freddie paid a then-record
$125 million civil fine in 2003 in a settlement with the Office of Federal Housing Enterprise
Oversight, which blamed management misconduct for the faulty accounting.
In September 2004, an equally stunning accounting scandal came to light at No. 1 mortgage
finance company Fannie Mae. 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."
"As has been seen in so many cases, Freddie Mac's departure from proper accounting
practices was the result of a corporate culture that sought stable earnings growth at any cost,"
SEC Enforcement Director Linda Thomsen said in a statement.
The SEC said Thursday that the $50 million Freddie Mac agreed to pay will be distributed to
shareholders injured by the alleged accounting fraud. The settlement with the company is
subject to court approval.

5.0 FINAL DECISION

FINAL DECISION BY COURT
Freddie Mac, the nation's second-largest financer of home mortgages, is paying a $50 million
fine to settle civil securities fraud charges brought by federal regulators in a four-year
accounting lapse.
In addition, four former executives at the government-sponsored company settled negligent
conduct charges by agreeing to pay a total of $515,000 in civil fines and to make restitution
totalling $275,548. They are former president and chief operating officer David Glenn, exchief financial officer Vaughn Clarke, and former senior vice presidents Robert Dean and
Nazir Dossani.
McLean, Va.-based Freddie Mac neither admitted nor denied wrongdoing under the accord
with the Securities and Exchange Commission announced Thursday, but it agreed to refrain
from future violations of securities laws.
An accounting scandal erupted at Freddie Mac in June 2003 when it disclosed that it had
misstated earnings by some $5 billion _ mostly underreporting them _ for 2000-2002 to
smooth quarterly volatility in earnings and meet Wall Street expectations. The company's top
executives _ Glenn, Clarke and then-chairman and chief executive Leland Brendsel _ were
ousted. The events shocked Wall Street, where Freddie Mac long had enjoyed a reputation as
a steady performer and reliable corporate player. Freddie Mac paid a then-record $125
million civil fine in 2003 in a settlement with the Office of Federal Housing Enterprise
Oversight, which blamed management misconduct for the faulty accounting.
In September 2004, an equally stunning accounting scandal came to light at No. 1 mortgage
finance company Fannie Mae. 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 Mae was fined $400
million in May 2006 in a settlement with OFHEO and the SEC _ one of the largest civil
penalties ever in an accounting fraud case.

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."
"As has been seen in so many cases, Freddie Mac's departure from proper accounting
practices was the result of a corporate culture that sought stable earnings growth at any cost,"
SEC Enforcement Director Linda Thomsen said in a statement. "Investors do not benefit
when good corporate governance takes a back seat to a single-minded drive to achieve
earnings targets."
The SEC said the $50 million Freddie Mac agreed to pay will be distributed to shareholders
injured by the alleged accounting fraud. 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. Clarke also agreed to pay a $125,000 civil fine _ which OFHEO deemed to have
been satisfied by his payment of the same amount under the SEC accord _ and to forego any
bonuses owed him by Freddie Mac. OFHEO previously fined Glenn $125,000 and is
pursuing action against Brendsel.
Clarke agreed to pay $29,227 in restitution under the settlement with the SEC. Glenn is
paying a $250,000 civil fine and $150,000 in restitution, Dean is paying a $65,000 fine and
$34,658 in restitution, and Dossani is paying a $75,000 fine and $61,663 in restitution.

6.0 CONCLUSION
The scandal affected the executives that were involved as well as companys customers.
Freddie Mac scandals also the big economic crisis in U.S during that time. During this time,
the companys financial statements were not doing so well at all. The firm income and assets
were affected and started to decrease. Freddie Mac is in danger of going bankrupt as their
stock value is basically worthless.
To be sure, Fannie Mae and Freddie Mac were flawed companies that made several bad
business decisions, and taxpayers should never again have to foot the bill for any financial
institutions greed. But as policymakers look to the future of U.S. housing finance, they must
seek smart reforms that focus on what was broken in the previous system, while maintaining
what worked for decades. The federal government must continue to play a key role in the
housing market, regardless of whether it works through Fannie and Freddie, a new agency, or
purely private firms.
It is clear that oversight of the company was completely inadequate at all levels. The Office
of Federal Housing Enterprise Oversight (OFHEO) failed in its responsibility to ensure its
safety and soundness. HUD allowed it to stray from its fundamental mission of expanding
home ownership and affordable housing. The company's board, as the OFHEO report points
out, was complacent and failed to exercise adequate oversight.
But that does not justify calls for privatization of Freddie Mac and elimination of its core
public mission of providing affordable housing for low-income and minority populations.
Current proposals to create a more effective and independent regulatory agency could work if
they don't become a victim of inter-agency battles. GSEs like Freddie Mac should have the
same disclosure rules that apply to other financial institutions. When oversight of an
institution as important as Freddie Mac falls on one of the smallest federal regulatory
agencies, the public has reasons to be worried. At the same time, the company needs to do
more than just step up it political lobbying expenditures and fulfil its obligation of expanding
opportunities for home ownership and affordable rental housing.
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7.0 RECOMMENDATION
The settlement and the report may help Freddie Mac, the nation's second-largest buyer of
home mortgages behind its corporate sibling, Fannie Mae, to recover from an accounting
scandal that surfaced early this year. But some of the report's recommendations suggest that
regulators may impose new restrictions on the company. They also suggest that regulators
will now shift their focus to the Wall Street firms that engaged in certain transactions with the
company and to accounting at Fannie Mae.
The report by the Office of Federal Housing Enterprise Oversight does not shed much new
light on the transactions at the centre of the improper accounting, which sought to smooth out
earnings volatility, but it is much harsher than previous reports in its assessment of Freddie
Mac's executives and board members.
Freddie Mac reported its revised earnings last month, disclosing that it had understated net
income by nearly $5 billion over more than three years. Many of the transactions that were
accounted for improperly, including swaps and reserves for loan losses, were described in a
preliminary report to the board by an outside law firm and in a supplemental report released
with the restatement. Some lawmakers greeted the report as further evidence of the need for
an overhaul of the regulation of government-sponsored entities, including Freddie Mac and
Fannie Mae.
The information in Ofheo's report clearly confirms that there were serious accounting,
disclosure and management issues that led to Freddie Mac's earnings restatement,'' Senator
Richard C. Shelby of Alabama, chairman of the Senate Banking Committee, said in a
statement. ''It also serves to underscore the deficiencies of Ofheo as a regulator, in that Ofheo
never detected the breakdown in the accounting and audit function at Freddie Mac. The

Banking Committee will continue to consider legislative reform for the G.S.E.'s to ensure that
they have a strong and credible regulator.
Under the terms of the settlement, in addition to the $125 million fine, Freddie Mac's board is
required to review and as necessary revise its bylaws and the frequency of its meetings, along
with the company's codes of conduct. The board is also required to determine whether to
impose limits on the terms of its members. The company, in turn, is required to report on its
internal controls and on plans for strengthening its internal audit function. The company is
required to separate the jobs of chief executive and chairman.
Some of the recommendations in the agency's report -- which Mr. Falcon, the director, said he
might or might not impose on the company -- are more severe. The report proposes
increasing the amount of capital that the company must retain and limiting how much its
portfolio of mortgages may grow. Finally, the report recommends that the regulatory agency
examine the accounting practices of Fannie Mae; the agency has already received bids on that
project, Mr. Falcon said. The agency is also continuing its investigation into investment firms
that participated in the transactions that were accounted for improperly, according to the
report.