Analysis of Fraud in Freddie Mac Company - Essay Example

Name Tutor Course Date Analysis of fraud in “Freddie Mac” Company Introduction The leadership of Freddie Mac executives is based on accounting fraud rooted in dishonest and misrepresentation of company’s financial position. Two executives of the company together with its former CEO Richard Syron were once involved in a fraudulent act of understating Freddie Mac’s earnings by almost five billion dollars as an effort to gain confidence from investors. The details of how Richard Syron, Patricia Cook and Donald Bisenius misrepresented the subprime mortgages of Freddie Mac Company. Also general exposure to more risky mortgages on Government Sponsored enterprises represented as subprime’ to investors will be discussed in this paper. Freddie Mac is the Federal Home Loan Mortgage Corporation. To start with, a brief history of the company will be provided before occurrence of the fraudulent act. An illustration of the investor fraud events will then be stated explaining how the fraud could have been prevented. Third, effects of the three executives’ fraudulent actions on investors and the general security exchange will also be discussed. Lastly, there will be a presentation of concluding remarks (Panchuk, 2013). Company history The history of Freddie Mac explains its business operations in the mortgage market, endorsements and transactions. Federal Home Loan Mortgage Corporation (Freddie Mac) is an enterprise sponsored by the government (GSE) with its head office at CPD Tyson’s corner in McLean, Virginia. The main purpose for establishing the company in 1970 was to cater for development of mortgages secondary market. This was instituted under the 1970 Act of Emergency home finance by the congress. Stocks of the company have traded in New York market since its registration at the commission registrar, resented by FRE. Since its establishment, Freddie Mac executed its duties by purchasing with a guarantee to domestic securities related to mortgages and mortgage loans. The company financed its activities by issuing securities which are mortgage based, equity and debt securities. This was in conformity to the Federal Home Loan Mortgage Corporation Act which qualified the company’s securities as exempt securities. The assets were not required to follow any registration or disclosure procedures provided by the securities laws of the federal government. It has segmented its business operations into three major sections. First is the guarantee for single families, multiple families and investments. According to Hilzenrath & Goldfarb,\ (2008), the company made a registration of its common and preferred securities on voluntary basis as provided by section 12 (g) of act of exchange in July 2008. This was endorsed after filing a registration statement referred to as form 10 at the commission’s office. Before registration, the company submitted its financial reports, both annual and quarterly together with financial statements and supporting documents to the registrar at the commission. This was followed by subsequent submission of financial reports and income statements in the following financial periods. The major business segment for the company is single family segment whose size was reported as 1.4 trillion dollars in December grew in 2007 to 1.7 trillion dollars and in 2008, it was at 1.8 trillion dollars. In April 2007, the company offered preferred stocks amounting to about 7.5 billion dollars. Syron directed all the segments and attended company’s meetings for the board and committee. The CEO elected a senior executive team (SEC) and together they strategically provided direction for Freddie Mac. The company also had an enterprise risk management committee (ERMC) that dealt with weighing operational risks, credit and market risks which Freddie Mac was exposed to. The CEO was one of the committee together with the segments’ senior management. It is from the committee members, who were also company’s executives that the fraud was committed (Hilzenrath & Goldfarb, 2008). Details of the fraud Fraudulent financial misrepresentation and subprime mortgages fraud were the securities and exchange charges against Freddie Mac Company. The plaintiff in this case was Securities Exchange Commission of the United States and the defendants were its former executives; Richard F. Syron, Donald J. Bisenius and Patricia. L Cook were involved in misleading shareholders into believe a false risk exposure status. According to information submitted to investors, the company’s single family segment exposure to seriously risky mortgages was less than what it was. Syron was the former Chief executive officer and board chairman for the company while Cook was the company’s former chief business officer and executive vice president. Bisenius formerly served in the company’s single family guarantee segment as its Executive Vice president. The commission initially alleged that former Freddie Mac executives Richard Syron, Donald Bisenius and Patricia Cook had dishonored the provisions of United States securities laws. These laws provided a rule for anti-fraud. The former executives provided false financial statements regarding company’s exposures to loans which are risky. The facts are that, Freddie Mac financial reports for that relevant year indicated a 2 billion dollars to 6 billion dollar risk exposure to subprime loans of its single family guarantee segment. However, this was not the case since materially, the exposure was greater. 10% of the segment’s portfolio was made up of loans (subprime) in 2006. This figure expanded to comprise of 14% of the total portfolio held by single family guarantee segment by mid-2008. The growth in debt was as a result of Freddie Mac expanding procurement of loans of that nature in order to try and regain its lost share in the market. Allegations were not as a result of one act of fraud but a series of several material fraudulent public revelations. They were in relation to the company’s largest operating segment: the single family segment. Relevant period of the case as considered by the court is the 23rd of March 2007 to 6th of August 2008. This was when investors’ interests on credit risks affecting subprime loans increased. The former CEO Syron had the authority to receive and examine information statements’ drafts for the company including its financial reports submitted to shareholders. He was therefore the one who approved the statements and information supplements published March the 23rd 2007 to May 2008 in addition to the 10-Q form that Securities and Exchange Commission filed in 2008. Bisenius was also accused in his area of accountability. This was in line with the endorsement of some information statement and appendages prepared during the reported relevant period as being accurate in disclosing the subprime elements. With regard to such certification, Binesious was considered faulty as having helped Syron and Freddie Company to present misleading presentations in the statements. Another fault is found in helping Syron and Cook to make misstatements orally to shareholders concerning subprime since he did not correct the speeches made by his colleagues knowing well that it failed to reflect the company’s financial status. The defendant was considered ignorant of the fact that he could not notice the fraudulent act of company’s expanding high exposure loan procurement which was stated as subprime in their internal operations. Cook, on the other side was at fault by giving a speech to investors in 2007, the17th of May supporting Syron’s report. As the chief business officer and executive vice president at that time, she told shareholders that the company was not under any circumstances exposed to risks related to subprime. The support that Cook provided to Syron’s report on information statements, its appendages and form 10Q certification was considered by the plaintiff as substantial. Certification of the form and approval of accuracy in information statements was part of Cook’s accountability. Evident by the reasons, Syron and Cook were alleged to have dishonored and Bisenious, Cook and Syron ministered and supported dishonoring of provisions laid by the laws of federal securities on reporting and anti-fraud. Sections 10b and 10b (5b) supported that Syron and Cook were directly or indirectly involved influencing purchase and sale of the company’s securities using interstate based instrumentalities. Others which were violated were section of the Acts of exchange which reflected; [15 U.S.C. § 78j(b)] and Rule lOb-5(b) thereunder [17 C.F.R. § 240.l0b-5(b)]. Effects The effects of fraudulent acts committed by these three former agents of Freddie Mac Company majorly affected investors and the company general profitability. The purchases and sales of securities made as a result of the report presented were based on falsified information and according to the law are also fraudulent. This led to lose of confidence to the company by most of its investors benefits attained by the company were ill based gains since it was as a result of fraud (Davidson, 2010). Another effect of such fraud is company charges for violation of enforce laws. SFAS laws section 133 was also violated relating to accounting of derivative instruments and fudging procedures. Underwriting standards for security in the company was compromised which result into penalty on the part of the company. This resulted to replacement of the involved personnel by a new team like David M Moffett who is the current Chief executive Officer at Freddie Mac. The company’s performance deteriorated further after the crisis. This led to general losses being experienced by Government Sponsored enterprises due to changing prices of the securities and market imbalance. According to Duhigg (2008), Freddie Mac was susceptible to collapse as a result of the fraud but was saved by the United States Federal Reserve and treasury department. Credit limits for the company were protracted and also though access to loans of lower interest in the Federal Reserve through ownership of securities by the treasury department revived the Freddie Mac. The fraud led to increase in taxes in order to increase tax payers’ contributions. Since Freddie Mac is a government sponsored enterprise, it is supported by the federal government to prevent its closure. Taxation is a major source of governments’ income. According to Davidson (2010), the United States government support for the company would involve a 154 billion dollars tax from taxpayers. As a result, the case ruling provided that Cook, Syron and Bisenious be subjected to pay fines as provided by section 20 d and 21 -d -3of the Acts of securities including 15 USC and 77t d and 15 USC & 78u-d-3. The defendants’ lost their jobs as representatives; officers or directors of th company Freddie mac or any other company issuing securities to other public. This was provided by section 20 c and 21 d 2 of the Acts of exchange including 15 USC & 77 -t-e and 15 USC 78 u-d-2. The major characteristic of companies that the three were barred from included those with section 12 and section 15 d of acts of exchange registered securities. Reasons for these actions were in order to prevent Syron and Cook from further violating the law mainly through fraud. It was also important that Bisenious was precluded from supporting any further fraudulent activities in the Company and others too. How it could be prevented The fraud that former executives of the company, Syron, Cook and Bisenious engaged in would have been prevented. First, this could have been prevented by adherence to mortgage laws as provided by the Securities and Exchange Commission. Employees are required to practice diligence and accountability on their part in carrying out company’s tasks. Exerting considerable pressure by government towards the management of GSE to increase profitability will reduce the pressure on their side for committing fraud. Freddie Mac management had the pressure of indicating the Company’s steady development and this was done through financial statement reports. Another way of preventing fraud is freezing the opportunity to commit fraud which is ability on the part of a participant to defraud. This should be done by the management which in the case of Freddie Mac Company encouraged fraud by boosting fraudulent report. The management controls staff and their activities within the organization and their efforts to discourage fraud are likely to be effective unlike in Freddie Mac where the executives were also involved in misrepresenting earnings. Complementary leaves could have prevented the fraud from amounting to the extent that it did. Immediately the Security Exchange Committee detected aspects of the company’s state on risky loans, it would have been better to offer leave to suspected staff and to allow for investigation in their absentia (Grynbaum & Jolly, 2008). Conclusion and remarks Fraud is a rising matter of concern among many American companies. Fraud in Freddie Mac could have been as a result of negligence on behalf of the management, an aspect of rationalization or simply informed fraudulent actions. It was a material kind of fraud and therefore involved financial losses. This as a result affected the parties involved, who were company’s executives, the company itself and its investors. However, there are preventive measures which if they were applied, could have prevented such occurrence of fraud in Freddie Mac Company. Companies should realize that the management will either encourage or discourage fraud in the organization. They are therefore entrusted with a major responsibility of controlling such incidences especially investor fraud. Accounting policies are also instituted for the same purpose to control and prevent accounting misappropriations and misstatements. Works cited Kerrl Ann Panchuk. Former Freddie Mac executives fail to escape subprime fraud case. (2013). Duhigg, Charles, "Loan-Agency Woes Swell From a Trickle to a Torrent", The New York Times, Friday, July 11, 2008 Davidson, Paul. "Fannie, Freddie bailout to cost taxpayers $154 billion". USA Today (2010-10- 22). Grynbaum, Michael and Jolly, David. "U.S. Takeover of Mortgage Giants Lifts Stock Markets". The New York Times (The New York Times Company). (September 8, 2008). Hilzenrath, David S.; Zachary A. Goldfarb . "Fannie Mae, Freddie Mac to be Put Under Federal Control, Sources Say". Washington Post. (2008-09-05). Read More