Never underestimate the government’s capacity for incompetence when it comes to overseeing large financial institutions. The latest example: an ill-advised consulting contract between Freddie Mac’s outside auditor and the federal agency in charge of running the company.
Freddie Mac, the housing financier with a $2.1 trillion balance sheet that was seized by regulators in 2008, remains under the control of its conservator, the Federal Housing Finance Agency. Yet its shares and bonds are still publicly traded. And it continues to file reports with the Securities and Exchange Commission, which means it must follow the SEC’s rules.
Some of those regulations seem to have been ignored when the FHFA hired Freddie Mac’s auditor, PricewaterhouseCoopers LLP, in May to provide advice on managing the company. The firm’s work includes consulting services that are barred under the SEC’s auditor-independence rules, as far as I can tell. The agency and the accounting firm say they are following the rules. Their explanations aren’t convincing.
The contract came to light this week after the housing-finance agency released a copy to Vern McKinley, a consultant working with the Washington-based advocacy group Judicial Watch, in response to a Freedom of Information Act request. The agency hired Pricewaterhouse to create contingency plans that would be used if the government someday decides that Freddie Mac, Fannie Mae or any of the Federal Home Loan Banks should be taken into receivership and liquidated.
(Pricewaterhouse audits the 12 Federal Home Loan Banks, none of which is in conservatorship. Fannie Mae’s auditor is Deloitte & Touche LLP.)
The reason for having auditor-independence rules is to promote confidence in the integrity of companies’ financial statements. Auditors are supposed to be watchdogs for the public, not beholden to their clients. To be sure, the system is a bit of a charade. The client pays the firm for its audit, so there always are conflicts of interest.
The independence problem in this instance arises from the FHFA’s connection to Freddie Mac. In substance, the agency is Freddie Mac. Here’s how the company explained the relationship in its latest annual report:
“As our conservator, FHFA succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director thereof, with respect to the company and its assets,” the company said. “FHFA has delegated certain authority to our board of directors to oversee, and to management to conduct, day-to-day operations. The directors serve on behalf of, and exercise authority as directed by, the conservator.”
With that in mind, the auditor-independence problems become obvious. There are three main principles underlying the SEC’s rules: An auditor can’t function in the role of management. It can’t audit its own work. And it can’t serve in any advocacy role for an audit client.
The contract, under which Pricewaterhouse will receive about $757,000, calls for “providing general advice on receivership preparation, assisting the FHFA in developing pre-and post-receivership procedures, implementing those procedures,” and “assisting the FHFA in the operation and administration of a receivership.”
That means Pricewaterhouse is giving advice on how to run Freddie Mac, and even could be called upon to help operate the company at some point. The contract says the firm’s work includes making recommendations regarding “valuation services” and “human resources.” The SEC’s rules list those as services that auditors are prohibited from providing to audit clients.
Additionally, the contract calls for Pricewaterhouse to offer advice on “public relations,” which is an advocacy role. Other services include making recommendations on risk management, claims management, asset management, and securities management.
A Pricewaterhouse spokesman, Chris Atkins, released this statement: “PwC takes its auditor independence requirements very seriously. Our acceptance of the FHFA engagement was in consideration of the SEC’s auditor independence rules. The scope of services being performed for FHFA is consistent with those rules.” Asked to explain how, he declined to comment.
The housing-finance agency released a statement from its general counsel, Alfred Pollard. “This is not a contract for PwC to perform work for Freddie Mac or any other entity regulated by FHFA,” he said. Additionally, Pollard said “measures are in place to ensure against conflicts of interest and to maintain independence, including a process that prevents PwC employees working on this FHFA contract from working on contracts for a regulated entity.”
Nothing in his statement addressed the point that the agency, as Freddie Mac’s conservator, is standing in the company’s shoes, or that Pricewaterhouse is providing advice on how to manage the company’s affairs. A Freddie Mac spokeswoman, Sharon McHale, declined to comment.
The independence issues here were easily avoidable. There are plenty of firms the agency could have hired instead. Plus, Pricewaterhouse was the auditor for Freddie Mac when it was seized in 2008. The company has never acknowledged anything wrong with its books, even though its asset values obviously were overstated before it collapsed. There’s no good reason to hire Pricewaterhouse for this work.
In a world where rules were consistently enforced, the SEC would be cracking down. Of course, we know better than to expect the government to enforce rules against itself. Here’s what the SEC should be demanding that the housing-finance agency tell Pricewaterhouse: As Freddie Mac’s auditor, you’re fired.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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