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WASHINGTON (Reuters) - Freddie Mac executives massaged earnings and breached accounting principles, an independent report found, but the mortgage finance company's board on Wednesday backed its new chief executive despite his knowledge of the transactions at the time.
CEO Greg Parseghian was Freddie Mac's former chief investment officer and replaced Leland Brendsel in June as the accounting scandal became public. He had signed off on transactions Freddie Mac now admits were designed to defer earnings, said James Doty, a former general counsel of the Securities and Exchange Commission (news - web sites) who conducted the report for Freddie Mac's (NYSE:FRE - news) board. The report was released on Wednesday.
Parseghian was told by company and external accountants at the time of the transactions that they were legitimate, Doty told analysts and reporters in a conference call.
"He was aware that the objective of some of the transactions was to defer earnings," said Doty.
"We believe he relied in good faith on corporate accounting and/or Arthur Andersen to provide the necessary accounting advice and to ensure the transactions were accounted for in accordance with GAAP (Generally Accepted Accounting Principles)," he said.
Parseghian has cooperated fully with the board's inquiry into questionable accounting, the lawyer said.
PRIOR MANAGEMENT FAULTED
Doty's report, commissioned after anonymous letters were sent to Franklin Raines, the chief executive of mortgage finance rival Fannie Mae (NYSE:FNM - news), blames prior management for past accounting problems and lapses in internal controls and disclosure.
"The prior senior management maintained a public corporate image at the expense of good management practices and effective internal controls. The previous senior management micro-managed the information flow to the board and ultimately to the public and the markets," Doty said.
Shaun O'Malley, installed last month as Freddie Mac's chairman, in the same conference call called release of the report"a painful day for Freddie Mac." But he said that despite problems related to management conduct and accounting, the firm is strong financially.
Markets appeared indifferent to the news, having already absorbed some of the shocks of the accounting scandal. The company's stock, down around 16 percent since the June management shake-up, rose 1 percent to $51.61 in afternoon trading on the New York Stock Exchange (news - web sites).
Freddie Mac said it still expects it will increase retained earnings as of Dec. 31, 2002 by $1.5 billion to $4.5 billion.
Doty's report said prior management knew transactions intended to smooth earnings were questionable under generally accepted accounting principles, or GAAP. It said managers failed to take steps to correct problems when accountants raised concerns and tried to cover up missteps.
"The accounting rules that were violated are rules that are complicated, and need to be understood and enforced by accountants," said Susan Wachter, professor of real estate at the University of Pennsylvania's Wharton School.
"We're not talking about an Enron event," she added."There was not fundamental economic weakness in the company, or criminal activity, or activity for the personal financial benefit of people responsible for the errors. This is a different kind of error, but Freddie Mac has long prided itself on its carefulness."
REPORT SEES FAILURE TO ACT
As board members became worried about the quality of the accounting, starting in the fall of 2001,"Brendsel and (former Vice Chairman David) Glenn failed to take prompt corrective action," the report said.
Freddie Mac fired Glenn in June and Brendsel retired.
A spokesman for Brendsel had no comment. A lawyer for Glenn, Thomas Vartanian, declined to comment on the report, saying he would need to review it. But he said Glenn had depended on the advice of internal and external accountants.
Efforts to reach former Chief Financial Officer Vaughn Clarke, who also left the company in June, were unsuccessful.
The company's board stands firmly behind Parseghian, O'Malley said."He is absolutely the right person for the job."
However, Bert Ely, a financial institution and monetary policy consultant in Alexandria, Virginia, and a long-time critic of the government-sponsored enterprises, said Parseghian bears responsibility for the accounting debacle.
"He is a high-level guy. He's where he is because he's very good and very knowledgeable. He can't use the excuse of just following orders."
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