Report escalates Lehman ineptitude to new level
The forensic autopsy of Lehman Brothers appears to have found the many causes of death. The examiner for the bankruptcy court, Anton Valukas, portrays the investment bank’s chief Dick Fuld and his lieutenants as more hubristic and inept than first thought. The scathing report also details a series of balance-sheet shenanigans that could land the former top brass and their auditor, Ernst & Young, in court.
Among the toxins discovered was something called Repo 105. This accounting gimmickry masked the size of Lehman’s balance sheet as the pressure grew for investment banks to reduce their leverage at the end of 2007 — which Lehman also was doing at the time.
Even if Repo 105 wasn’t lethal it was certainly poisonous. Lehman had been abusing it as far back as 2001, using repurchase agreements to finance assets but, unlike with typical repo transactions, treating them for accounting purposes as sold. This enabled Lehman to cover up its true leverage, making it seem lower than it actually was. Lehman even needed its overseas subsidiary to make it work sometimes. Bart McDade, the Lehman executive in charge of shrinking the balance sheet disparagingly referred to Repo 105 as “another drug we r on.”
That sounds like a breach of fiduciary duty — although Valukas doesn’t think it was. He does, however, reckon there is a strong case — or a “colorable claim” as he calls it — against Fuld and the firm’s three finance chiefs in its final 12 months: Chris O’Meara, Erin Callan and Ian Lowitt. What’s more, Ernst & Young could be on the hook for professional negligence for allowing the trades to pass muster. Through his lawyer, Fuld has disavowed knowledge of Repo 105 or how it worked.
The 2,292-page report is a page-turner even without this damning revelation. It paints a far more detailed picture than previously available of senior management believing their own hype, ignoring growing risks, and their deputies’ concerns, as they built up bigger positions in illiquid assets like commercial real estate and private equity. They overrode the bank’s own risk limits on a regular basis and didn’t include these positions in stress test scenarios.
Whether or not Fuld and his associates end up on trial, Valukas has at least drafted a fantastic management guide. It’s the best document yet from this crisis on how to prevent future failures. It should be mandatory reading for current and would-be bank chiefs — and their regulators.
– The findings of court-appointed examiner, Anton Valukas, chairman of law firm Jenner & Block, charged with investigating the collapse of Lehman Brothers in September 2008, were unsealed on March 11. The report is 2,200 pages long.
– Among the findings, the report details Lehman’s use of an accounting device, known as “Repo 105,” to temporarily remove $50 billion of assets from the firm’s balance sheet in 2008. The device lowered Lehman’s net leverage — a measure closely monitored by rating agencies — to 12.1 from 13.9 in the second quarter of 2008.
– The examiner said there were “colorable claims” against bank executives Richard Fuld, Christopher O’Meara, Erin Callan, and Ian Lowitt “in connection with their failure to disclose the use of the practice” as well as against the firm’s auditors “Ernst & Young for its failure to meet professional standards in connection with that lack of disclosure.”
– Examiner’s report: http://r.reuters.com/vyq73j