March 13, 2010 in Business

Probe finds accounting ruse hid Lehman’s fragile status

Marcy Gordon Associated Press
File Associated Press photo

Lehman Brothers Holdings Inc. chief executive Richard Fuld, front center, is heckled by protesters Oct. 6, 2008, as he leaves Capitol Hill in Washington after testifying before the House Oversight and Government Reform Committee on the collapse of Lehman Brothers.
(Full-size photo)

WASHINGTON – An accounting gimmick called “Repo 105” provided financial relief for Lehman Brothers in the months before its spectacular collapse, an autopsy of the once-venerable Wall Street house has found. The question now is whether the trickery spells legal jeopardy for executives of Lehman or its auditors Ernst & Young.

The implosion of Lehman Brothers Holdings Inc. into the biggest bankruptcy in U.S. history in September 2008 precipitated the financial meltdown that plunged the economy into the most severe recession since the 1930s. How did it happen?

After saddling itself with tens of billions of troubled assets that couldn’t easily be sold, Lehman masked its debt and perilous financial condition by using the accounting artifice, an examiner appointed by the bankruptcy court found in a 2,200-page report on a yearlong investigation.

The examiner, Anton Valukas, discovered that Lehman put together complex transactions that allowed the firm to sell “toxic,” mostly mortgage, securities at the end of a quarter – wiping them off its balance sheet when regulators and shareholders were examining it – and then to quickly buy them back. Thus, the “Repo,” meaning repurchase.

“It’s a very damaging report and certainly is something that is going to be carefully scrutinized by federal prosecutors,” said Robert Mintz, a former Justice Department prosecutor who is a private defense attorney.

Now, thanks to the work by Valukas, Repo 105 has entered the pantheon of names of vehicles for accounting chicanery, along with Enron’s Jedi, Chewco and Raptor partnerships and the “Buco Nero” (black hole) offshore account stashed away by the fallen Italian dairy giant Parmalat. In the sagas of those two companies, the role of the accounting firms was central.

Did other companies engulfed by the financial meltdown deploy similar accounting tricks?

“I think what Lehman was doing was way out there and quite misleading, and against the financial reporting and accounting rules,” said Lynn Turner, a former chief accountant at the Securities and Exchange Commission. “I don’t think there were many others, if there were others at all, that were doing this. I think the rules Lehman violated are straightforward.”

Even members of Lehman’s accounting staff, in e-mails unearthed by the examiner, called the Repo 105 concoctions an “accounting gimmick” and “a lazy way of managing the balance sheet as opposed to legitimately meeting … targets at quarter end.”

Valukas’ report doesn’t reach a conclusion on whether executives violated securities laws. It does say that the executives’ decision not to disclose the effects of its business judgments “does give rise to colorable claims against the senior officers who oversaw and certified misleading financial statements.”

Colorable claims means there appears to be sufficient evidence to support the awarding of civil damages in a trial.

The executives named by the report include former CEO Richard Fuld and three chief financial officers. Fuld has denied knowing what the transactions were or the accounting for them.

The report says there also are colorable claims against the outside auditors, Ernst & Young, for “its failure to question and challenge improper or inadequate disclosures” in Lehman’s financial statements.

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