Nowadays, companies face more and more pressure to be at the top of their game; companies want to report high earnings to attract investors and attention to the financial standing of their organization. According to an article by Bob Jensen titled History of Fraud in America, "The majority of investor fraud is rooted in false and misleading financial performance reports of corporations." In the beginning of the millennium, the biggest accounting frauds in history emerged left and right. This doesn't go to say that accounting fraud started out at the beginning of the millennium- one of the first and most notorious white collar crime was the Ponzi Scheme of 1920 (History of Fraud in America). From year 2000 to 2002, more than 20 corporate accounting scandals came to surface with most involving billions of dollars (Accounting Scandals of 2002); the Federal Home Loan Mortgage Corporation, also known as Freddie Mac is a housing/mortgage cooperation that in 2002 was involved in one of many accounting scandals (Accounting Scandals of 2002).
Freddie Mac was created in 1970 by Congress in order to buy mortgages and sell them as mortgage backed securities to the investing public (Freddie Mac Clears Stock Sale, 1988). Freddie Mac's way of making money was by keeping the fee it charged on loans by promising that those securities purchased by investors will be paid whether or not the borrower defaulted (The Fall of Fannie and Freddie, 2008). In 2003, Freddie Mac became involved in one of many accounting frauds; while companies tend to overstate earnings, Freddie Mac's earnings were understated by about $ 5 billion (Fannie Mae and Freddie Mac Failing Their Mission, 2003). According to the SEC's complaint filed against Freddie Mac, the company misstated true financial performance mainly because the corporation's culture placed "great emphasis on steady earnings". The 47 pages long report stated that the company ignored true impact of changes in GAAP, shifted income from current periods into future periods thus showing a smooth growth pattern in earnings and failed to inform their investors of the changes in accounting regulations thus concealing the significance of their transactions. Freddie Mac was able ignore true impact of changes in GAAP by specifically having an accounting purpose that minimized those impacts and specifically violate SFAS 133. In 2003, Freddie Mac restated earnings from year 2000 to 2003 which showed to what extent the company went to smooth earnings. In 2000 net income was reported as $2.5 billion when it should have been 3.6 billion and in 2001 net income was reported at $4.1 billion which when restated was $3.1 billion; what the company did was simply add some of the income it should have reported in 2000 in 2001's earnings. Finally in 2002, when income should have been $10.1 billion, it was reported as $5.7 (SEC Complaint, 2007).
The company's fraudulent reporting was not only facilitated by their accounting purpose, but also by the company's president and two senior vice presidents that have been accused of participating and/or directing the conduct. From the SEC Complain, "The most senior management of the company, including its Chief Financial Officer, constantly pressured the company to undertake to report smooth and dependable earnings growth and to present to investors with the image of a company….positioned to generate predictable and growing earnings." Due to their purpose, the company violated SFAS 133 which has to do with accounting for derivative instruments and hedging activities. Derivatives are defined as financial instruments such as future contracts whose value depends on the value of another underlying security or asset. Freddie Mac, and other companies such as it, use derivatives to manage interest rate and other risks. The standard as of 2001, allowed holders of such derivatives to account for such assets at fair value. Due to this, Freddie Mac would have had to report a large one time gain because the fair value of its assets way exceeded the book value. The company was so affected by this new standard that it formed a team which main purpose was to find ways to reduce the gain (SEC Complaint, 2007). Upon discovery and investigation, Freddie Mac was only fined $50 million for having manipulated earnings for three years (Freddie Mac, SEC settle accounting fraud charges, 2007).
Three elements must be present in order for fraud to occur: pressure, opportunity and rationalization. In Freddie Mac's case the pressures for committing the fraud are simple, the company's purpose was to show steady growth and the financial statements had to report steady growth. Opportunity is the ability to commit the fraud; the opportunity was created when management itself encouraged the fraudulent reporting. It was not a question of hiding something an employee had done; everyone including management at Freddie Mac worked toward misstating earnings. As for rationalization, although one was not offered, it would be fair the assume that the company thought it was not really committing fraud. When they had income they reported some of it, and when income was a litter lower they had a reserve to make up for the shortfall (Study Finds Extensive Fraud at Fannie Mae, 2006).
Fraudulent accounting reporting only accounts for only 8% of accounting frauds but the greater amount of dollar losses which is at about $ 1 million (Accounting Information Systems). Following the scandal, Freddie Mac managed to stay in business and is still around today while other companies that have undergone accounting scandal around the same time frame have not been so lucky. No matter how good one covers his/her track, fraud is eventually discovered; keeping this in mind, employees and companies as well should think twice about committing fraud.
