Fannie, Freddie Probes Widen as SEC Seeks Documents

Fannie, Freddie Probes Widen as SEC Seeks Documents

Sept. 29 (Bloomberg) -- Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government, said federal prosecutors issued subpoenas for documents related to their accounting, disclosure and corporate governance.

Fannie and Freddie were notified on Sept. 26 that the U.S. Attorney for the Southern District of New York and the Securities and Exchange Commission are seeking documents, the companies said in separate statements today. The companies and the government wouldn't say specifically what information is being sought.

Reviews of Fannie and Freddie's books in the weeks leading up to the Sept. 7 takeover found that some accounting methods the companies were using obscured the ``low quality'' of capital reserves. The Federal Bureau of Investigation has already begun looking into possible accounting misstatements at Fannie, Freddie and 24 other companies in a probe of the subprime-mortgage market collapse, a senior law-enforcement official said this month.

``Given the mood of the country and the pressure on the FBI, the SEC and Justice Department to hold people responsible, the officers, directors and employees at Fannie and Freddie may have many sleepless nights in the future,'' said Frank Razzano, a former federal prosecutor and SEC trial attorney now at Pepper Hamilton LLP in Washington.

Freddie said the latest inquiry by the SEC and a federal grand jury subpoena seeks papers dating back to Jan. 1, 2007. Both Freddie and Fannie, which are operating under a government- led conservatorship, said they will cooperate. Stefanie Mullin, a FHFA spokeswoman, said that the regulator ``will work with the companies to assure a smooth and efficient process.''

What Executives Knew

Former SEC enforcement attorney Bryan Sillaman, now at Hughes Hubbard & Reed LLP, said investigators will be scrutinizing what executives knew about the value of the Fannie and Freddie's assets and what they told investors about the companies' overall health.

``They'll check whether those were consistent with what they were communicating,'' said Sillaman, who worked on the SEC's previous probe of Fannie's accounting practices, which resulted in a record $400 million fine in 2006. Freddie paid a $125 million fine to its regulator in 2003 and $50 million to the SEC last year to settle separate accounting fraud charges.

Rebekah Carmichael, a spokeswoman for U.S. Attorney Michael Garcia in New York, declined to comment. FBI spokesman Jim Margolin didn't immediately return a call. SEC spokesman John Nester declined to comment.

FBI Investigation

Federal agencies have come under pressure by lawmakers to hold companies responsible for the loan crisis that rocked Wall Street and led to the biggest housing slump since the 1930s. Financial companies worldwide have reported more than $500 billion in credit losses and asset writedowns stemming from the subprime-mortgage collapse that began to unfold in early 2007.

Though the cases will ``be highly complex and time consuming,'' Razzano said law enforcement agencies ``must prove that they were not asleep at the switch and that they can respond to and meet the citizenry's expectations that people will be held accountable.''

Securities firm Lehman Brothers Holdings Inc., which filed for bankruptcy protection this month, and insurer American International Group Inc., which was placed in a government-led conservatorship, are also part of the FBI's investigation.

FBI Director Robert Mueller, in congressional testimony this month, pledged to ``pursue these cases as far up the corporate chain as necessary to ensure those responsible receive the justice they deserve.''

Government Takeover

The Treasury Department and FHFA put the government- sponsored enterprises back under federal control for the first time in about 40 years after examiners working for the government agreed that the companies' accounting and their $14.9 billion in net losses threatened to further disrupt the housing market.

After looking through the finances, Fed examiners deemed their capital reserves too low, Dallas Fed President Richard Fisher said Sept. 8.

``We concluded that the capital of these institutions was too low relative to their exposure,'' Fisher said in response to an audience question after a speech in Austin, Texas. Further, ``that capital in and of itself was of low quality.''

Fannie counted $20.6 billion in so-called deferred tax credits toward its $47 billion of regulatory capital as of June 30, according to company disclosures. Freddie applied $18.4 billion in deferred-tax assets toward its $37.1 billion in regulatory capital in the second quarter.

Fannie and Freddie, created by Congress to boost homeownership, own or guarantee at least 42 percent of the $12 trillion in U.S. residential-mortgage debt outstanding. They make money by buying home loans and mortgage securities, profiting on the difference between their cost of borrowing and the yield on the debt. They also guarantee and package loans as securities.

BLOOMBERG