The Freddie Mac accounting scandal was a five-year earnings manipulation scheme, running from 1998 through 2002, in which the government-sponsored mortgage giant misstated billions of dollars in net income to project the image of steady, predictable growth. When the fraud unraveled in 2003, Freddie Mac restated cumulative net income upward by $5 billion, fired its top three executives, and eventually paid a $125 million regulatory fine, a $50 million SEC penalty, and a $410 million class action settlement.1 The episode also reshaped how the company was regulated and foreshadowed the governance failures that would push Freddie Mac into federal conservatorship in 2008.
What the Fraud Actually Was
Inside the company, senior leadership cultivated what the SEC and regulators later described as a “Steady Freddie” culture, one that prized the appearance of smooth earnings over honest reporting. Executive bonuses were tied to specific earnings-per-share targets, giving top officers a direct financial stake in shifting income between quarters and years.
The mechanics were technical, but the goal was simple: hide volatility. When a new derivatives accounting standard (SFAS 133) took effect in January 2001, it threatened to produce a large one-time gain. Management engineered artificial transactions to generate offsetting losses and suppress it. A series of “linked swaps” moved roughly $450 million in operating earnings out of 2001 into future years.
A transaction known internally as the “Coupon Trade-Up Giant,” or CTUG, shuffled bond portfolios between accounting categories to realize losses that could offset derivative gains. Regulators later concluded the CTUG had little or no economic substance and existed solely to manipulate reported results.
In December 2000, management also abandoned current market data on “swaptions” (options to enter interest rate swaps) in favor of older volatility figures, effectively reverse-engineering a lower value. That single move understated the derivatives portfolio by approximately $731 million. On top of all this, the company kept loan loss reserves materially larger than probable losses required, giving it a cushion to smooth results later.
The combined effect was substantial. Freddie Mac misreported net income by 30.5 percent in 2000, 23.9 percent in 2001, and 42.9 percent in 2002.
How It Came to Light
The unraveling began in January 2003, when Freddie Mac announced its 2002 audit would be delayed and prior years would need to be re-audited and restated. The company had already replaced Arthur Andersen with PricewaterhouseCoopers, and the new auditor’s fresh look triggered a sweeping review.
What PwC found was extensive. Accounting errors spanned more than 30 different issue groups, and the company’s accounting policies had not been thoroughly updated in over 12 years. On November 21, 2003, Freddie Mac published its official restatement:
- Cumulative net income revised upward by $5 billion for 2000 through 2002
- Regulatory capital revised upward by $5.2 billion
- Stockholders’ equity revised upward by $6.7 billion
- 2001 earnings had been over-reported by $989 million
- A previously reported $837 million first-quarter 2001 gain became a $111 million net loss
The striking part was the direction of the revision. Freddie Mac had not been losing money it claimed to earn. It had been hiding earnings, and the volatility around them, to keep quarterly results looking smooth.
Who Lost Their Jobs
On June 9, 2003, Freddie Mac dismissed its top three executives. The stock dropped nearly 20 percent that day.
Leland Brendsel, chairman and CEO, officially “retired” at 61 and was initially set to collect $24.3 million in severance. In November 2007 he settled with the Office of Federal Housing Enterprise Oversight (OFHEO), paying a $2.5 million fine, disgorging $10.5 million in salary and bonuses, and waiving more than $3.4 million in additional claims. He was permanently barred from serving as an officer or director of a regulated financial institution.
David Glenn, president and COO, was the only executive the company explicitly accused of misconduct. Internal lawyers discovered he had altered and removed pages from a diary, and the company said he refused to cooperate with the probe. He was fired for cause, forfeiting roughly $11 to $13 million in severance and stock grants. In October 2003 he entered a consent decree with OFHEO carrying a $125,000 fine, neither admitting nor denying wrongdoing.
Vaughn Clarke, the CFO, resigned. He later settled OFHEO charges and separately settled SEC charges with a $125,000 civil penalty and $29,227 in disgorgement.
The board then promoted Gregory Parseghian, the former chief investment officer, to CEO. His tenure lasted about two months. In August 2003, OFHEO demanded his replacement after outside counsel raised concerns about his role in approving strategies designed to obscure the effect of accounting rules. He still walked away with a $14.3 million severance package and nearly $4 million in bonus payments, which drew congressional scrutiny. Richard F. Syron, a former top Federal Reserve executive and former president of the American Stock Exchange, was named CEO and chairman in December 2003.
What Freddie Mac and Its Executives Paid
The OFHEO Consent Order
On December 10, 2003, Freddie Mac entered a consent order with OFHEO and agreed to pay a $125 million civil penalty, which the agency called the largest ever imposed by a safety and soundness regulator at that time. The company neither admitted nor denied the findings. OFHEO’s special examination report described a corporate culture that “casts aside accounting rules, internal controls, disclosure standards and the public trust in the pursuit of steady earnings growth.”
The SEC Case
In September 2007, the SEC filed a civil fraud case charging that Freddie Mac had engaged in a scheme that “deceived investors about its true performance, profitability and growth trends.” The company agreed to a $50 million penalty, earmarked for distribution to injured investors through a Fair Fund. Four former executives also settled SEC charges of negligent conduct without admitting or denying the allegations:
- David Glenn: $250,000 penalty, $150,000 disgorgement
- Vaughn Clarke: $125,000 penalty, $29,227 disgorgement
- Nazir Dossani, former senior vice president: $75,000 penalty, $61,663 disgorgement
- Robert Dean, former senior vice president: $65,000 penalty, $34,658 disgorgement
The Class Action
A securities fraud class action, Ohio Public Employees Retirement System v. Freddie Mac, was filed on behalf of investors who bought Freddie Mac stock between July 1999 and November 2003. The case was consolidated in the U.S. District Court for the Southern District of New York before Judge John E. Sprizzo, and in 2006 the parties reached a $410 million cash settlement. The court granted final approval on October 26, 2006, with no admission of wrongdoing. The settlement fund has been fully disbursed.
The Criminal Investigation That Produced No Charges
The U.S. Attorney’s Office for the Eastern District of Virginia opened a criminal probe shortly after the scandal broke in June 2003. By 2006 the investigation had been dormant for two years, and no criminal charges were ever brought against any Freddie Mac executive. The U.S. Attorney’s Office declined to comment, consistent with its practice of not publicly confirming the end of an investigation. Freddie Mac said it expected no further action.
A Separate Political Fundraising Penalty
A parallel matter, worth noting because it often gets folded into discussion of the accounting scandal, involved illegal political fundraising. A Federal Election Commission investigation (MUR 5390) found that between 2000 and 2003, Freddie Mac’s Government Relations department organized roughly 85 to 100 campaign fundraising events that raised about $1.7 million for federal candidates using corporate resources. Internal documents called the activity “Political Risk Management.”
Senior Vice President R. Mitchell Delk directed the operation, and CEO Leland Brendsel hosted a fundraising lunch in 2001. The company also made an improper $150,000 contribution to the Republican Governors Association, later returned. In June 2006, Freddie Mac agreed to pay a $3.8 million civil penalty, the largest in FEC history at the time. The FEC issued only admonishment letters to Brendsel, Delk, and Vice President of Congressional Affairs Clarke Camper.
What Reforms Came Out of It
OFHEO’s special examination produced 16 formal recommendations, and the consent order forced structural changes. Freddie Mac had to:
- Separate the roles of CEO and chairman
- Shift executive compensation away from short-term earnings targets toward long-term goals
- Maintain a capital surplus
- Establish a materiality standard for information provided to directors
- Strengthen the internal audit function
- Document the legitimate business purpose of every significant transaction
- Create a formal compliance program under a chief compliance officer
The company reviewed more than 150 accounting policies that had gone largely unchanged for over a decade. It did not resume timely annual financial reporting until March 2007, nearly four years after the scandal broke. Congressional leaders also pushed to repeal Freddie Mac’s special exemption from SEC registration and reporting requirements, bringing it under the same disclosure regime as other public companies.
The internal control failures the scandal exposed were long-standing. An internal audit report from December 1996 had already flagged that controls over derivatives execution, administration, and accounting needed improvement. Neither management, the internal audit department, nor Arthur Andersen addressed those weaknesses over the next seven years. OFHEO characterized the board as “complacent,” with long-tenured directors who let past executive performance cloud their oversight.
How the Scandal Connected to the 2008 Collapse
Richard Syron had been brought in specifically to reform Freddie Mac, but under his leadership the company moved aggressively into riskier mortgage products. In 2004, Chief Risk Officer David Andrukonis sent Syron a memo warning that mortgage lenders were targeting borrowers who could not qualify if their finances were properly disclosed. Andrukonis urged the company to stop purchasing loans with no income or asset documentation, citing “financial and reputational risk to the company and the country” and the “potential for the perception and the reality of predatory lending.” Syron rejected the recommendation. Andrukonis was fired shortly afterward.
By 2007, mounting credit losses on Alt-A and interest-only mortgages had eroded the capital base. Between 2008 and 2011, Freddie Mac and Fannie Mae together lost a combined $216 billion, with roughly 80 percent of credit losses tied to Alt-A or interest-only loans concentrated in Nevada, California, Florida, and Arizona.
On September 6, 2008, the newly created Federal Housing Finance Agency placed both companies into conservatorship with the consent of their boards. Between November 2008 and March 2012, Treasury purchased $187.5 billion in senior preferred stock to cover the enterprises’ losses.
The accounting scandal had directly fueled demand for a stronger regulator. The Housing and Economic Recovery Act of 2008 abolished OFHEO and replaced it with FHFA, giving the new agency expanded authority to regulate the enterprises’ investment portfolios, set capital requirements, and place them into conservatorship. Freddie Mac remains in conservatorship today, more than 17 years after the government took control.