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WASHINGTON – Initiatives may be stalled in the House and Senate to tighten the regulation of the housing Government Sponsored Enterprises. Meanwhile the Office of Federal Housing Enterprise Oversight is moving ahead with its own agenda and recommendations for improving the regulation of the GSEs. Armando Falcon Jr., director of the Office of Federal Housing Enterprise Oversight (OFHEO) on Jan. 21, testified before the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises Hearing on the agency’s December Report on the Special Examination of Freddie Mac and told the Subcommittee members that, “Until remediation efforts have taken full effect, Freddie Mac remains exposed to substantial management and operations risk.” In summarizing the key findings of the report which is based on a special examination Falcon ordered of the circumstances that led to the accounting failures and management changes at Freddie Mac last year, he told the Subcommittee the report concluded that “OFHEO must ensure that Freddie Mac has established an adequate remediation plan and is allocating the necessary resources to establish a new corporate culture that rewards integrity and the acceptance of responsibility, and that penalizes failure to meet appropriate standards of conduct. Remediation must also eliminate existing accounting and control weaknesses, including infrastructure planning for future growth and a dedication to adequate management of operations risks.” Falcon explained he ordered the special examination of Freddie Mac because, “I believed that the removal of three members of the management team only went part of the way toward correcting serious problems with management practices and controls. Among the findings of the examination, said the director, “Freddie Mac used means that failed to meet its obligations to investors, regulators and the public. The company employed a variety of techniques ranging from improper reserve accounts to complex derivative transactions to push earnings into future periods and meet earnings expectations. Freddie Mac cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth.” OFHEO’s examination not only found Freddie Mac executives at fault, but also the GSE’s board of directors. “For the most part, the same long-tenured shareholder-elected Directors oversaw the same CEO, COO, and General Cousel of Freddie Mac from 1990 to 2003. The non-executive Directors allowed the past performance of those officers to color their oversight. Directors should have asked more questions, pressed harder for resolution of issues, and not automatically accepted the rationale of management for the length of time needed to address identified weaknesses and problems.” OFHEO’s report detailed several specific actions Freddie Mac should take. Among them: * Freddie Mac should separate the functions of the Chief Executive Officer and the Chairman of the Board; * impose strict term limits on Directors, and require that the Board meet more frequently; * OFHEO establish a materiality standard for the provision of sufficient information by management to the Board; * to address Freddie Mac’s “general neglect” of operations risks and compliance issues, the GSE should establish a formal compliance program and a position of Chief Risk Officer who reports directly to the CEO, with explicit responsibility for operations risk, credit and market risk; * Freddie Mac’s Internal Audit Department should be strengthened so that it can play a more effective role; * OFHEO should consider requiring a periodic change of external audit firms. Freddie Mac should document the legitimate business purpose of every significant business transaction. “Freddie Mac needs to establish and maintain superior accounting controls and prevent undue reliznce on its external auditor,” the report stated; * to address inappropriate managerial incentives, Freddie Mac should refocus its compensation program more on long-term goals, not short-term earnings; * until remediation efforts have occurred, OFHEO should consider requiring Freddie Mac to hold “significant” regulatory capital surpluses, “at least until it can produce timely and GAAP-consistent financial reports”; * OFHEO should implement regulations that provide for mandatory disclosure and build staff resources necessary to oversee compliance if Congress does not repeal the exemptions of the GSEs from securities law; * OFHEO should expand its capacity to detect and investigate misconduct by including more substantive tests of the internal control frameworks at the Enterprises, including procedures to identify pressure to commit fraud and opportunities to carry it out; * OFHEO should conduct a special examination of the accounting practices of Fannie Mae. Martin Baumann, chief financial officer for Freddie Mac, also testified before the Subcommittee and emphasized that the GSE is “implementing a corporate-wide remediation program to ensure that the accounting and financial control issues that led to the need for the restatement will never happen again.” On Dec. 9, 2003 – the same day OFHEO released its special examination report of Freddie Mac, the GSE entered into a Consent Order and Settlement with OFHEO. Under the terms of the Consent Order, Freddie Mac agreed to undertake remedial actions concerning corporate governance, internal controls, internal audit, internal accounting capabilities, risk management transaction, public disclosures, and regulatory reporting. “The goals of Freddie Mac’s remediation program are to ensure that we have the highest level of accounting expertise, compliance with generally accepted accounting principles and regulatory reporting, and fully accurate, timely, and transparent financial reporting,” said Baumann. -

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