Updated from 8:03 a.m. EDT

Freddie Mac ( FRE) will upwardly restate its past three years of earnings by as much as $4.5 billion, saying its audit staff was overmatched by derivatives accounting and supervised by weak managers.

"The information we are disclosing today reflects poorly on Freddie Mac's past accounting, control and disclosure practices," said Gregory Parseghian, Freddie's new chief executive officer and president.

The restatement, which has been in the works for months and has spawned a series of criminal and regulatory investigations, reflects reclassification of part of the company's derivative portfolio as "cash market instruments" -- bets on interest rate movements. The derivatives had previously been treated as offsetting hedges to other assets intended to protect the company against rate fluctuations.

(Some experts say telling the difference shouldn't be that hard.)

"A majority of the corporation's derivatives in 2001 and 2002 will not qualify as accounting hedges," said Freddie in a press release. Although the changes will boost past earnings results, Freddie said, the new accounting will lead to "significant volatility" in its reported earnings in the future.

Crime and Punishment

In a conference call, Freddie executives offered a "robbing Peter to pay Paul" analogy for the accounting mess.

While the restatement could add anywhere from $1.5 billion to $4.5 billion in earnings to past results, there will be more volatility in future quarters and earnings in those periods may be lower than expected.

In early trading, shares of Freddie were trading higher, up $1.73, or 3.5%, to $51.76.

The company's comments appear to confirm speculation that Freddie had engaged in a form or earnings management by trying to smooth out its quarterly results and delay the recognition of income from some of its derivatives transactions by inappropriately labeling them as accounting hedges.

Indeed, the company said that its lawyers found "certain capital market transactions and accounting policies had been implemented with a view to their effect on earnings in the context of Freddie Mac's goal of achieving steady earning growth."

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