Freddie Mac Retirement Plan Comes Under IRS Scrutiny

October 22, 2003 ( - Questions surrounding Freddie Mac's tax treatment of linked swaps in its retirement plan could hit the federal mortgage broker with a $750 million tax bill, plus interest.

This comes after the company disclosed that both the Internal Revenue Service (IRS) and the Department of Labor (DoL) were looking into the treatment of these derivative transactions.   The disclosure was made in an information supplement to its annual financial statements in which it was stated the IRS is looking at the company’s tax returns for prior years, “some of which relate to matters connected with the restatement,” according to a Dow Jones report.

“Freddie Mac has reported and paid tax treating each pair of linked swaps as a single integrated transaction for federal income tax purposes,” the company went on to state. “There is a risk, however, that the Internal Revenue Service (IRS) could challenge Freddie Mac’s tax treatment of the linked swaps and make an adverse determination relating to this tax treatment ” – an “adverse determination” that could end up costing the company $750 million, plus interest.  

However the company does not believe the outcome will end up costing it the full amount, as the disclosure also said Freddie Mac has not allocated any money for any of the potential tax issues surrounding the linked swaps.   Rather, Freddie Mac sees the potential that if the IRS pursues the maximum penalties and additional tax liability against the company, that could have an adverse impact on Freddie’s earnings “in the quarter in which it was recognized.”

Linked Together

The transactions in question occurred in the latter part of 2001, when company executives executed the linked swaps that an internal report prepared for the company’s board of directors said “had minimal business justification other than the shifting of operating earnings.”   In fact, the transactions were being executed to offset a surge in Freddie Mac’s earnings and generated an estimated $420 million loss in the last half of 2001. That was then accounted for as an increase in earnings of the same amount in 2002 and beyond.

Freddie Mac has come under intense scrutiny for its practices of managing its books to keep period-to-period earnings steady.   These financial actions resulted in a restatement of the company’s earnings that added up to $4.5 billion to profits reported earlier in the year.  

In the wake of this disclosure,theWest Virginia Investment Management Board and the Central State Teamster Fund filed suit in the US District Court for the Southern District in Manhattan on Friday.  The two West Virginia suits, which were combined into a class action, contend Freddie Mac’s accounting skullduggery cost the Investment Board $1.8 million and the Teamster’s Fund $8.2 million.   Likewise, Ohio Attorney General Jim Petro filed a suit later in the day in the US District Court in Cincinnati, seeking damages related to losses suffered in the State Teachers Retirement System (STRS) and Public Employees’ Retirement System (PERS) as a result of accounting issues and a subsequent management shakeup at Freddie Mac (See  Freddie Mac Under Pension Fund Lawsuit Fire ).