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Freddie Mac Board Told to Remove CEO

Regulators Cite Parseghian's Role in Improper Accounting; Directors' Response Is Unclear

Aug 22, 2003 | Washington Post

Federal regulators have told Freddie Mac's board of directors it must replace Gregory J. Parseghian as the company's chief executive because of his involvement in improper accounting practices at the mortgage-lending giant during the past three years, sources said.

Regulators from the Office of Federal Housing Enterprise Oversight told the new board chairman, Shaun O'Malley, and at least one other director, George Gould, at a meeting Wednesday that Parseghian, whom the board promoted in June in a management shakeup, had to step down.

"I can confirm that we have met with Freddie Mac and those discussions include discussions about current management," an OFHEO spokesman said last night, declining to comment further.

Meetings between the regulators and the company's board continued yesterday and more are set for today, as they discussed possible replacements for Parseghian and what, if any, role he could continue to play at the company, sources said.

It was unclear whether the board will accede to OFHEO's demand or fight it. The regulators believe they have the authority to remove an executive. As they debated whether to resist the order, some company officials acknowledged that a public fight with its regulator would hurt the company.

Sources say the board might name Paul T. Peterson, who was promoted to chief operating officer in June, as interim chief executive while a search for a permanent replacement is conducted. Others say O'Malley might serve that role. Also being discussed is the possibility that Parseghian could stay on as the acting CEO until a replacement is found.

Freddie Mac spokesman David R. Palombi said last night: "We have been meeting with OFHEO Director [Armando] Falcon to learn his views, including concerns about members of current management as well as management structure. We are discussing ways to accommodate his concerns as well as the needs of Freddie Mac and its constituents. Beyond that, speculation as to the nature or timing of resolving OFHEO's concerns is absolutely premature, as discussions are ongoing."

OFHEO has been under criticism from Congress for failing to uncover the accounting problems that led to the ouster of Parseghian's predecessor, Leland C. Brendsel, and two other top executives in early June. Bush administration officials are pushing to move oversight of Freddie Mac and its larger rival, Fannie Mae, into the Treasury Department, an effort that has gained bipartisan support in Congress.

Parseghian, 42, has generated controversy among some investors since he was elevated to the top spot because of his role in approving and implementing some of the transactions that led to accounting errors of as much as $4.5 billion at the McLean-based mortgage-funding giant.

A report to the board last month by the law firm Baker Botts LLP said Parseghian was one of the executives who approved trading strategies that were designed to obscure the effect of an accounting rule and to meet expectations of what was known as "steady Freddie" earnings growth.

The board of directors has backed Parseghian. "The Board made a sound and informed decision to select Mr. Parseghian: He is absolutely the right leader to fix the problems of the past and guide the company into the future," O'Malley said in a letter on the company's Web site.

Parseghian, who has been defending his reputation in a series of meetings with stock analysts around the country, has said repeatedly that as the head of the company's investment and trading division he had relied on the company's auditors and lawyers for advice that the complicated transactions followed accounting and disclosure rules. But regulators, who interviewed Parseghian for more than 12 hours last week, concluded that his record was one of sufficient involvement in the accounting errors that it would not be in the mortgage finance company's best interest for him to continue at its helm, sources said. In the end, OFHEO concluded that he was too much a part of the Freddie old guard.

Pressure to remove Parseghian comes after a difficult nine months for Freddie Mac, which has promised to operate more openly as it fights to restore its credibility. In January the company announced it would have to restate earnings for the past three years, prompting investigations by OFHEO as well as by the Securities and Exchange Commission and the Justice Department.

In June the company's board ousted Brendsel and two other top executives in connection with the accounting problems. A few weeks later the company said the restatement might be by as much as $4.5 billion. Then in late July the board released the Baker Botts report, which detailed the accounting problems and the role top executives, including Parseghian, played in them.

The report concluded that Freddie Mac's effort to "smooth" earnings and its failure to alert investors to the strategy, created "a pattern of financial accounting and disclosure practices that fell below the standards required of a registered public company."

The report said Freddie Mac "devoted considerable resources," including Parseghian and many senior people in his investment division, to finding ways to minimize the effect of a new accounting rule on how to value complex financial contracts called derivatives that it used to minimize risk in its mortgage-funding business.

In November, the company estimated that the rule change would cause profits to increase on paper by $700 million, the report said. To spread those gains out into future earning periods, it said, the company executed a series of trades totaling $30 billion that created a $726 million "loss."

Parseghian was among top company executives who signed a memo approving the trading strategy. By December, the projected profit increase had grown to $1.4 billion, and the company set out to produce a second large loss. On Jan. 2, Parseghian approved a policy to change the way the company valued a pool of assets known as "swaptions." The change created another paper loss that eliminated $731 million of the increase essentially canceling out the rest of the increase. Then, on Feb. 5, Parseghian approved a reversal of the new valuation policy.

The report criticized that transaction as being "reverse engineered" and said it wasn't adequately disclosed to the public.

On another occasion, Parseghian presented a $5 billion deal to the board that the report says was in fact part of a larger, $30 billion deal that wasn't fully disclosed to the board.

Parseghian declined to be interviewed yesterday. He has declined repeated interview requests since the release of the report.

The Washington Post reported Saturday that Parseghian made a profit of more than $17 million from selling all the company stock he could in early 2001, soon after he helped implement the change in valuation strategy criticized by the report. In a statement about the trades, he said, "I have nothing to hide" and that he sold the stock because "I believed this to be a prudent strategy to diversify my financial position." The statement said that he remained heavily invested in the company and that all his stock sales were in accordance with the company's trading policies and were reviewed by Freddie Mac's lawyers.

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