Aug. 19 (Bloomberg) -- Freddie Mac, the second-largest U.S. mortgage finance company, said it may face civil action by the Securities and Exchange Commission, which began an investigation after the company restated earnings last year by $5 billion.

The SEC is probing possible violations of a regulation prohibiting fraud and deceptive practices and may impose a fine and a permanent injunction, McLean, Virginia-based Freddie Mac said in a statement.

The prospect of SEC sanctions jars a turnaround effort by Richard Syron, who, since joining Freddie Mac as chief executive in January, has tried to revive investor confidence by recruiting top executives and overhauling the accounting division, said Kevin Jackson, a senior mortgage analyst at RBC Dain Rauscher Inc. in Chicago.

Freddie Mac stock has risen 16 percent this year compared with the 1.5 percent decline in the Standard & Poor's 500 Index. The company released its statement on the SEC probe yesterday after the official close of U.S. exchanges.

``It's up to Freddie Mac to show they are moving past'' disclosures last year of bookkeeping errors and findings by the company's federal regulator, the Office of Federal Housing Enterprise Oversight, that the accounting division lacked expertise and leadership, Jackson said.

`Staying Away'

The SEC notice makes Freddie Mac ``even more unattractive,'' said Akira Takei, who helps oversee about $9.2 billion in Tokyo at Fuji Investment Management Co., a unit of Japan's biggest bank by assets. ``I'm staying away from investing in U.S. agency debt.''

The restatement by the government-chartered company prompted a $125 million federal fine last year and fueled a Bush administration effort to create a stricter regulator for Freddie Mac and Fannie Mae, its larger rival.

Jackson predicted the setback from the probe will be short- lived. ``Syron is going to pull the organization through,'' he said. ``He's been moving in that direction in cleaning house.''

Syron on Aug. 5 announced the appointment of Eugene McQuade as president and chief operating officer, the same titles he held at FleetBoston Financial Corp. while negotiating the bank's merger with Bank of America Corp. McQuade in June resigned as president of Bank of America.

While at Fleet, McQuade cut the bank's losses from Argentina's debt default in 2002, reducing expenses and writing off loans. He also managed the closing in 2002 of investment- banking arm Robertson Stephens Inc., which was hurt by the collapse of technology stocks beginning in 1999.

Syron last month hired Patricia Cook from J.P. Morgan Fleming Asset Management to manage the company's $630 billion mortgage and investment portfolio. Earlier this year he tapped Ralph Boyd as general counsel and Catherine Dondzila to oversee investment and capital markets accounting.

Wells Notice

``Unfortunately, there is nothing we can do that will change our image overnight,'' Syron said in a June 14 interview.

Freddie Mac yesterday received a so-called Wells Notice from the SEC, spokeswoman Sharon McHale said in a telephone interview. She declined to comment beyond the company's statement, including the time frame of any possible violations.

SEC spokesman John J. Nester declined to comment. A Wells Notice indicates that SEC staff members have completed a review of the case and may recommend action by the full commission.

Freddie Mac ousted its top executives in mid-2003 for involvement in accounting errors from 2000 to 2002 that resulted in the earnings restatement in November. The company said it underreported income to hide earnings volatility from investors.

Two U.S. representatives wrote a letter to SEC Chairman William Donaldson last year, urging an investigation of share sales by five current and former Freddie Mac officials.

Injunction

The restatement also sparked a probe by U.S. Attorney Paul J. McNulty in Alexandria, Virginia, who could bring criminal charges related to the matter. Freddie Mac in June said it was cooperating with the SEC and U.S. Attorney's investigations.

An injunction prohibits a company from engaging in specific activities following an accusation of violations of SEC regulations. The prohibition typically remains in effect until the completion of an inquiry.

Ofheo, Freddie Mac's regulator, on Dec. 10 ordered the company to pay $125 million for sidestepping accounting rules. On Jan. 29 the agency ordered Freddie Mac to keep 30 percent more capital on reserve than previously required.

The restatement and the ouster of three top officials, including 18-year Chief Executive Officer Leland Brendsel, have intensified scrutiny by lawmakers and the Bush administration.

Government Charter

Freddie Mac was chartered by Congress in 1970 to make money more widely available for home loans. The company went public in 1989. Under the charter, Congress has exempted Freddie Mac and Fannie Mae from state and local income taxes and authorized Treasury to buy $2.25 billion in each of their securities in the event of possible default.

Freddie Mac and Fannie Mae own or guarantee about half of the $7.3 trillion U.S. mortgage market. They make money on the difference between the interest cost of debt they sell and the return received from home mortgages they buy from lenders. They also profit from their investments in bonds backed by pools of mortgages.

To contact the reporters on this story: James Tyson the Washington newsroom at jtyson@bloomberg.net Al Yoon in New York at ayoon@bloomberg.net

Last Updated: August 19, 2004 00:43 EDT