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Lehman Brothers Post Mortem

by David Sack
Eyes On Wall Street |

On March 11, a court-appointed examiner released a 9-volume, 2,200-page report detailing the demise of Lehman Brothers, a Wall Street titan for more than a century. The report lays out how Lehman Brothers used misleading accounting techniques to conceal the bad mortgage holdings that led to its collapse.

Anton R. Valukas, chairman of the law firm Jenner & Block and a former prosecutor, authored the report. He found that Lehman Brothers used "materially misleading" accounting techniques to mask the perilous state of its finances. According to the report, just months before the Company imploded, Lehman Brothers executives used what amounted to financial engineering to temporarily shuffle $50 billion of assets off its books in an effort to conceal the Company's dependence on leverage, or borrowed money. Senior Lehman Brothers executives, as well as the bank's accountants at Ernst & Young, were aware of the moves, according to Mr. Valukas.

"Unbeknownst to the investing public, rating agencies, government regulators, and Lehman's board of directors, Lehman reverse engineered the firm's net leverage ratio for public consumption," Mr. Valukas wrote.

According to Valukas, Lehman Brothers executives engaged in what the report characterized as "actionable balance sheet manipulation," and "nonculpable errors of business judgment." While the report draws no conclusions as to whether Lehman executives violated securities laws, Mr. Valukas writes in the report that "colorable claims" could be made against some former Lehman executives and Ernst & Young, meaning that enough evidence existed that could lead to the awarding of damages in a trial.

A large portion of the nine-volume report centers on an accounting maneuver known inside Lehman as "Repo 105." Repo 105 involved transactions that secretly moved billions of dollars off Lehman Brothers' books at a time when the bank was under heavy scrutiny. According to Mr. Valukas, Mr. Fuld ordered Lehman executives to reduce the bank's debt levels, and senior officials sought repeatedly to apply Repo 105 to dress up the firm's results. Repos, short for repurchase agreements, are a standard practice on Wall Street, representing short-term loans that provide sometimes crucial financing. It appears that Lehman used especially aggressive accounting in its Repo 105 transactions: the Company seems to have structured transactions such that it sold securities at the end of the quarter, but planned to buy them back again days later. The effect of the accounting was to artificially and temporarily lower the firm's debt levels to hit certain targets, making the firm look healthier than it really was.