Opinion

Felix Salmon

Was MF Global brought down by an accounting play?

Felix Salmon
Nov 2, 2011 18:40 UTC

Bethany McLean has a theory: that accounting helped to sink MF Global, and that the $6.3 billion long position in European debt was made “for an accounting play”.

The key part is that for accounting purposes, MF Global’s filings say the transaction was treated as a sale. That means the assets and liabilities were moved off MF Global’s balance sheet, even though MF Global still bore the risk that the issuer would default; that means the exposure to sovereign debt was not included in MF Global’s calculation of value-at-risk, according to its filings. And that also means MF Global recognized a gain (or loss) on the transaction at the time of the sale. The filings do not say how much of the gain was recognized upfront. But if it were a substantial portion, then these transactions would have frontloaded the firm’s earnings. That, in turn, may have helped cover the fact that MF Global’s core business was struggling.

Moving assets and liabilities off your balance sheet to make yourself look less risky? That’s a very Lehman move, redolent of the notorious “repo 105” trades.

But I’m not convinced by this story.

Firstly, the debt of Italy, Spain, and Belgium might be getting a lot of headlines right now, but in terms of price action it’s not actually as volatile as you might think. These assets weren’t actually significantly more volatile than the rest of MF Global’s balance sheet, and so including them on the balance sheet would not have increased MF Global’s value-at-risk very much. In fact, it might have reduced it.

Now that doesn’t mean, of course, that the assets weren’t riskier than most of the rest of the balance sheet. They were. They were sovereign bonds being held to maturity, in most cases at the end of 2012. And a lot can happen between now and then. That’s what the markets were worried about, rather than any immediate mark-to-market losses on the bonds. In fact, it’s not clear that there were mark-to-market losses on the bonds. But if you’re holding a bond to maturity, that’s an inherently much riskier position than if your prop desk is holding it as part of a bond position which it can sell at any time.

Secondly, it’s extremely unlikely that MF Global recognized a gain on this transaction at the time of sale. The bank bought this debt on the open market, and then immediately put the bonds up as collateral, getting cash in return. We don’t know who lent MF Global the money, taking the bonds as collateral. But whoever it was had no reason whatsoever to value the bonds at more than their market price. So there’s really no way that MF Global could have recognized a gain on the sale: much more likely, in fact, that it would have registered a modest loss. (In a repo transaction, it doesn’t matter if you sell the bonds for less than they’re worth, since you also contract to buy them back at a pre-set price later. So long as the repurchase price is also low, it’s fine if the initial sale is done at a low price too.)

And finally, there’s no indication that taking this trade off balance sheet helped to significantly hide the size of MF Global’s assets, or to understate its actual leverage. Here are the numbers from MF Global’s quarterly filings:

mfglobal2.jpg

What I’m charting here is the total size of MF Global’s assets, in green; its equity, in blue; and the ratio between the two, in red. Obviously, the leverage ratio is ludicrously high: there are more than $40 billion of assets being supported by just $1.2 billion of equity.

But can you see, in this chart, where Jon Corzine joined the company? (It was in March 2010.) And can you see where MF Global brought the European sovereign bonds back onto its balance sheet? (It was in the final numbers, for September 2011.)

The fact is that MF Global’s leverage ratio — and its total balance sheet — was higher before Corzine arrived than it was at any time afterwards. And that when the European sovereign-bond trade was brought back onto MF Global’s balance sheet, the total size of that balance sheet actually fell.

In other words, the trade which brought down MF Global, even if it had been on the balance sheet all along, would never really have been visible on the balance sheet, or in the leverage ratio, or in the value-at-risk figures. I’m not clear on why the trade was moved off balance sheet in the first place. But I think it’s a stretch to say that accounting brought down the bank.

COMMENT

Am I the only person that thinks this is Refco Part 2. Moving debt around to fool investors. And doesn’t MF’s executive team have some former Refco executives? Did we really get scammed again by the same people at the same game?

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The impunity of the Big Four auditors

Felix Salmon
Oct 28, 2011 16:05 UTC

Are the big four auditors too big to fail? Agnes Crane makes a strong case that they are, in the wake of a very tough report from the Public Company Accounting Oversight Board about Deloitte. The problem is that the PCAOB has no real teeth: with the number of auditors already far too low, at four, no one can afford a potentially-fatal attack on any of them. And that gives each of the Big Four effective impunity when it comes to mistakes and lack of professionalism.

Not to mention the fact that the PCAOB itself is horribly conflicted, as Jon Weil has discovered:

Three of its five board members had recused themselves from participating in meetings or discussions this year concerning Deloitte, because of past or current ties to the firm…

You have to wonder how good a job this board can do when a majority of its members can’t make decisions about one of the largest firms it oversees. No agency’s ties to the industry it regulates should run this deep.

Weil also points out that the PCAOB hasn’t even attempted to explain why it took 41 months to disclose its Deloitte evaluation; he might have added that we have no idea how many other, similar evaluations might be in the works.

I’m reminded of Jed Rakoff’s pointed questions for the SEC: what’s the point of regulating a company if you have no way of enforcing those regulations?

The dynamics at both the PCAOB and the Big Four are horrible. The incentive at the Big Four is to keep prices down to the point at which it’s impossible for a new entrant to break into their charmed group; after all, if it means they end up cutting corners, the worst that happens is that they get gummed by the toothless PCAOB. Even if they get broken up so that their consulting arms are spun off from their auditing arms, that still leaves only four auditors for most of the world of big business.

Is there a way of fixing this mess? Not an obvious one. Agnes says that “the only way to increase competition in the industry is for the incumbents to break into pieces”. But they’ll never do that voluntarily. And it’s very hard to see who’s going to force them.

COMMENT

In terms of who can break them up .
Surely “we the people” can do it ?

Maybe the occupy wall street people need to add this to their agenda

Maybe the rest of us should not give up on democract and wring out hands in anguish

If we really think that breaking them up is important to a vibrant capitalist system we do have the power

d

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Accountants in the firing line

Felix Salmon
Dec 23, 2010 15:40 UTC

As Caleb Newquist notes, most financial reporters cover the accountancy industry “once in a lunar eclipse on the winter solstice.” So it’s fantastic to see Bloomberg’s Jonathan Weil coming out with two incisive, hard-hitting columns in succession on the subject.

Last week, Weil drew a bead on PricewaterhouseCoopers, which has signed off on a $2.2 billion accounting benefit at MBIA. That number represents “estimated recoveries,” most of which are due to come from Bank of America; they’re essentially bonds which MBIA is allowed to put back to the lender because they didn’t conform to the lender’s own representations and warranties.

At the same time, however, PricewaterhouseCoopers is also happy signing off on Bank of America’s accounts, which include no liabilities to MBIA at all.

Weil concludes:

The job of an independent auditor should be to ensure that the numbers make sense.

At MBIA and Bank of America, they don’t.

Is this illegal? Probably not. But this week, Weil comes out swinging at Ernst & Young, dismissing its defense against Cuomo’s charges as “insane” and “nonsense,” and placing it in the broader context of E&Y’s corporate culture:

Allegations of misconduct at E&Y have become such a routine part of the firm’s business that they’ve come to be expected…

E&Y had established itself as a repeat offender long before Governor-Elect Cuomo filed his suit. In recent years we’ve seen four former E&Y partners sentenced to prison for selling illegal tax shelters, while other partners have been disciplined by the SEC for blessing fraudulent financial statements at a variety of companies, including Cendant Corp. and Bally Total Fitness Holding Corp.

(Note Weil’s mastery of the hyperlink: would that all journalists were as good.)

Weil effortlessly dismantles E&Y’s statement that “there is no factual or legal basis for a claim to be brought against an auditor in this context where the accounting for the underlying transaction is in accordance with the generally accepted accounting principles,” by pointing out that Cuomo’s whole case is based on the assertion that the transaction was not in accordance with GAAP:

In the footnotes to its audited financial statements, Lehman said it accounted for all its repurchase agreements as financings. This was false, because Lehman accounted for its Repo 105 transactions as sales, a point the Valukas report chronicled in exhaustive detail.

As any freshman accounting major can tell you, it’s a violation of GAAP for a company to tell investors it’s using one type of accounting treatment when it’s actually using another, especially when the method it’s secretly employing makes its balance sheet look stronger.

Meanwhile, Francine McKenna is doing sterling work on this case as well, pointing to the parts of the Valukas report where E&Y comes off as particularly obstructionist:

I think the NY AG’s investigators questioned EY and its partners first as part of building a case against Lehman executives. When EY was as difficult and non-cooperative as they seem to have been with Valukas, the NY AG decided to redirect their energies to the auditors. They had the Lehman Bankruptcy Examiner’s report as a road map, an almost-ready for prime-time template for a complaint against the auditors.

McKenna singles out this passage from Valukas:

Prior to this invitation and during [E&Y partner William] Schlich’s four‐day interview as an Ernst & Young representative, the Examiner invited Ernst & Young to opine on why Repo 105 transactions were proper and did not result in Lehman filing materially misleading financial statements…Schlich replied that the transactions were proper if they complied with Lehman’s self‐defined Accounting Policy. Despite an additional invitation from the Examiner, Ernst & Young has not offered any further explanation.

There are echoes, here, of the way in which Cuomo decided to file suit against Steve Rattner after being angered by his incomplete responses to initial questioning. It’s natural for individuals and companies not to want to incriminate themselves when being questioned by the attorney general. But when dealing with Cuomo, it seems that being as cooperative as possible as early as possible is the way to go. He hates being given incomplete information.

COMMENT

I agree with your general criticism that accounting firms need to work on their PR and that maybe more upfront cooperation with Cuomo would’ve yielded an ally further down the line.

But I have three disagreements with the above post;

1) The E&Y-Lehman suit was a foregone conclusion, even moreso after the Valukas report (which stated there was evidence of a colorable claim, which, in legalese, requires less presumption of wrongdoing than a civil or criminal charge). I have doubts that E&Y really could’ve avoided this lawsuit, and it is telling that only civil charges have been filed using expanded powers of the Martin Act.

2) The Main Stream Media’s coverage of accounting matters is, as you state, abysmal. But there is a reason why, accounting rules mirror those used in law, except tend to be more technical and thus, more boring. I see no attempt by the MSM to cover the particulars of accounting literature, or even the over-arching purpose – which is not to protect us from all failures or fraud, but to have some type of system of consistency in standards which is verified by an independant third party. E&Y will wage a losing battle trying to communicate this to the masses without assistence by an informed member of the MSM.

3) There are 4 major accounting firms auditing tens of thousands of companies and with 100k plus employees each. Cherry picking specific failures is no great accomplishment or evidence of general erosion of standards. In this case, the tax and audit divisions share little overlap in leadership or standards, and a couple failures are no implicit presumption to change the entire structure or internal workings of an organization.

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Cuomo lashes out at Ernst & Young

Felix Salmon
Dec 21, 2010 17:33 UTC

Say what you like about Andrew Cuomo, he gives good complaint:

E&Y substantially assisted Lehman Brothers Holdings Inc., now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public…

Not only were the transactions concealed, but Lehman’s financial statements affirmatively, and falsely, stated that the only securities subject to repurchase (“repo”) agreements were “collateralized agreements and financings” (i.e., loans), even though, as E&Y well knew, Lehman was treating the transfer of tens of billions of dollars of securities in Repo 105 transactions as “sales,” not “loans.” Rather than expose this fraud as auditors must, E&Y expressly “approved” this practice..

As the financial crisis deepened in 2007 and 2008 and Lehman’s liquidity problems intensified, E&Y was aware that Lehman was dramatically increasing the Repo 105 transactions in a desperate effort to stave off collapse. At a time when it was critical for investors to make informed decisions as to whether to keep or buy Lehman stock, E&Y assisted Lehman in defrauding the public about the Company’s deteriorating financial condition, particularly its leverage…

As the public auditor for Lehman, E&Y had the absolute obligation to ensure that Lehman’s financial statements complied with GAAP and did not mislead the public. Instead of fulfilling this obligation, E&Y gave a clean opinion each year, erroneously stating that Lehman’s financial statements complied with GAAP. E&Y sat by silently while Lehman deceived the public by concealing the Repo 105 transactions and misrepresenting the Company’s leverage. By doing so, E&Y directly facilitated a major accounting fraud, and helped Lehman mislead the public as to its true financial condition. E&Y, which reaped over $150 million in fees from Lehman, must be held accountable for its role in this fraud.

E&Y knew this was coming—we all did—but despite that fact, its only public reaction so far has been to refuse to comment. That doesn’t look good, and it forces us back to what the company said in the wake of the Valukas report—that its work as Lehman auditor “met all applicable professional standards,” whatever that’s supposed to mean.

If I had to guess, I’d wager that there will be a large settlement—more than $150 million, anyway—and that E&Y will avoid admitting blame and also avoid criminal prosecution. One notable thing about the complaint is that the only defendant is Ernst & Young LLP; there are no named individuals on the list. So E&Y’s partners are probably safe too. Sadly.

COMMENT

The core issue here is who pays for the audit. It’s the same issue as the credit rating agency mess.

The SEC should perform annual audits on all exchange listed companies and bill them for the time the same way the FDIC audits banks. If you are allowed to shop your audit around to the accounting firm most willing to bend the rules than you are always going to have Enron style blow-ups.

Even if a govemental agency did the auditing you would still have some problems… but I’d bet they would be more infrequent than under the current system where companies essentially pay a firm to swear to shareholders their annual reports aren’t works of fiction.

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Cuomo’s parting shot

Felix Salmon
Dec 20, 2010 13:51 UTC

Andrew Cuomo has decided, reports the WSJ, to file civil fraud charges against Ernst & Young in the waning days of his tenure as New York’s attorney general — news which has been received with delight by Yves Smith, on the grounds that it might strengthen a criminal case against Dick Fuld.

But what does this mean for E&Y, and for David Einhorn’s theory, as recounted to Andrew Ross Sorkin, that the government has held back on crisis-related prosecutions because of “an embedded belief that they did the wrong thing with Enron and with Arthur Andersen — the criminal prosecution, particularly of Andersen”?

One way of looking at the news is that Cuomo is stepping up where federal prosecutors fear to tread, and is filing the suit now precisely because he knows that if he doesn’t, the chances are that E&Y will suffer no consequences at all for the way that it signed off on Lehman’s books.

On the other hand, a civil fraud suit is not a criminal prosecution. Even if E&Y fights the charges and loses, it probably won’t find itself on the receiving end of the kind of criminal charges which brought down Andersen. Still, I’m sure that Cuomo’s office is doing nothing to downplay the contingent existential threat here, in its negotiations with E&Y.

So what happens once Cuomo moves to Albany? Will the U.S. attorney general, Eric Holder, pick up where he left off? It’s probably more likely that Cuomo’s successor, Eric Schneiderman, will take note of the way in which both Cuomo and his predecessor, Eliot Spitzer, used Wall Street prosecutions to boost their public profile in their quest to become governor. But in general, Cuomo seems to be by far the most zealous prosecutor out there. Without him, the number of crisis-related fraud charges is likely to dwindle sharply.

COMMENT

From experience…when the actions the government took caused the fall of ANDERSEN, many Partners and employees found other opportunities. However, the triage included those who “could not soldier on” because of age or health or previously retired.

Tragically, except for the individuals’ retirement funds that belonged to the individuals, the retirement funds administered by ANDERSEN were included in the windup of the residual organization.

The irony of the events…the Supreme Court of the U.S. overturned the decision against ANDERSEN. Now…the reputation of ANDERSEN must be restored.

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BNY Mellon’s massaged earnings reports

Felix Salmon
Dec 6, 2010 16:48 UTC

With Peter Eavis having left the WSJ, who will take on the job of poring over banks’ balance sheets to expose their crazy accounting? Aaron Elstein, that’s who! He pulls no punches today:

BNY Mellon spins the numbers to make its results look better.

Consider the way the company reports earnings. In quarterly releases, BNY Mellon prefers to highlight income from continuing operations, because it feels that’s the best way to show underlying performance. But its definition of “continuing operations” is always changing, according to a review by Crain’s New York Business of all the bank’s releases for the past three years.

BNY Mellon sometimes excluded investment write-downs from operating results or assessment fees imposed by the Federal Deposit Insurance Corp. At other times, it didn’t include certain taxes or the costs of settling a dispute with the IRS over leases. In one quarter, BNY Mellon excluded litigation reserves; in two others, it called them “special” litigation reserves.

Additionally, the 48,000-employee company routinely excludes costs associated with relocating staffers and merger-related items, even though it often moves people and does M&A deals—26 over the past three years…

“They’re definitely playing games, cherry-picking to inflate their numbers,” says Douglas Carmichael, an accounting professor at Baruch College and a former chief auditor of the Public Company Accounting Oversight Board…

Longtime banking analyst Nancy Bush of NAB Research says BNY Mellon’s frequent changes in defining earnings make it difficult for investors to figure out how well the bank is doing. “You never get the same figures twice,” she says. “It’s very frustrating.”

Yes, BNY reports GAAP figures—but at banks, GAAP figures tell you very little, and it’s crucial that the reported numbers allow analysts to make apples-to-apples comparisons. Bank earnings are extremely opaque at the best of times, which is one of the reasons that banks tend to trade at lower multiples than other industries: no one really knows what might be buried within them. And as a rule, the more that senior management is spinning its earnings rather than reporting them as transparently as it can, the less trust that markets will have in the bank.

I do wonder, though. Is this a tactical decision by BNY’s Bob Kelly? Has he calculated that the boost in share price he gets from reporting artificially-rosy earnings is greater than the decline in share price he gets from leading analysts on a wild goose chase every quarter to try to work out what he’s doing? Does he reckon that analysts’ opinions don’t actually matter that much, and that his shareholders—including Warren Buffett—would rather just see something pretty and massaged?

Or is it simply that once he started down this road he couldn’t stop? It might make sense to switch to a more transparent and consistent set of reporting standards, but that would mean reporting lower earnings, and it’s hard for any CEO to admit that prior earnings figures were massaged in any way. So we might have to wait for a new BNY CEO before we see any changes on this front. After all, the chairman of the board—one Robert Kelly—is not about to rock the boat at all.

Marking bank loans to market

Felix Salmon
May 28, 2010 17:47 UTC

Should banks mark their loans to market? The issue — which flared up briefly at the height of the financial crisis, when everybody was wondering whether many of America’s largest banks were insolvent — is back in the headlines, thanks to FASB’s proposed rule change, which Tracy Alloway calls “mark-to-mayhem”.

Cue the predictable response from the American Bankers’ Association:

If implemented, the proposal would greatly undermine the availability of credit by making it difficult to make many long-term loans, the value of which, even if performing perfectly, would likely be reduced on the day a loan is made.

As a curio, before the financial crisis, banks’ fair value numbers were generally above book value. At that point no one really seemed to care about the discrepency, or mark-to-market, for that matter.

It’s not obvious just how much mayhem the proposed rule change would cause, since Businessweek’s Michael Moore says that “changes in the fair value of loans probably wouldn’t show up in banks’ earnings”. But I’m not completely convinced that this is a good idea.

In general, I’m all in favor of transparency in the reports of public companies in general, and banks in particular. So if banks are forced to reveal the true value of their assets, that’s good. But it’s not good if it just results in effective bank runs, where banks with low-value loans found themselves shut out of the repo markets, for example.

It’s certainly true that when any individual bank — like Goldman Sachs, for example — starts marking its assets to market, that imposes a very useful discipline and can help that bank avoid large losses: when the loans start dropping in value, they get dumped sharpish.

But that’s much easier for Goldman Sachs than it is for commercial banks with enormous long-term loan books and valued relationships with their borrowers. What’s more, it would be disastrous if every bank in America started dumping its loans every time they fell in value — given that they would all be sellers rather than buyers, the value of the loans would plunge enormously overnight, and then they really would all be insolvent.

My feeling is that so long this is just an extra reporting requirement, and it doesn’t show up on the income statement or the balance sheet, we’re probably fine. Banks should certainly be marking their loans to market internally, and if they’re doing that it makes sense to ask them to report those marks to their shareholders on a quarterly basis. But there is a real risk here, if those shareholders start to panic when they see the marks.

COMMENT

@MarkWolfinger: Yes, at least some banks will respond internally to internal valuations.

Felix, part of the trouble here has been where banks attempt to hedge their credit risk in the CDS market, where they are required to mark the CDS to market but not the loan it was supposed to be hedging. There has at various times in the last several years — they seem to change these rules from time to time — been an option to designate certain positions as hedges, in which case they don’t have to be marked to market. This naturally opens up some room for shenanigans, but so does treating economically equivalent (or very similar) positions differently.

There’s a continuum of different degrees of liquidity and transparency in market prices. I know that DE Shaw and Goldman have both owned wind farms at various times in the last five years; those are hard to get market prices for. If you’re hedging them with more liquid instruments, those are easier to get prices for, but the whole point is that the value of those instruments should correlate negatively with the value of the illiquid asset; your net worth is less volatile than would be suggested by marking the liquid assets to market and not the illiquid ones. This leads you, eventually, to more of a mark-to-model, where your model assumes that things that correlate negatively will continue to do so. So the only definite conclusion I can give is that you’re not going to find a system that’s perfect; hopefully you can formulate a system with enough of these problems in mind that it doesn’t make any of them too bad.

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The Repo 105 list

Felix Salmon
Apr 5, 2010 19:51 UTC

As the SEC investigates the question of just how many banks were abusing Repo 105, Vipal Monga today points out that abusing Repo 105 is exactly the same thing as using Repo 105: there’s no conceivable innocent use of this particular part of the accounting-standards rulebook.

The rule in question is SFAS 140, and as Vipal says, the only reason for the rule to exist is so that it can be abused, Lehman-style:

The simple fact that FASB set a bright line acted as an invitation to exploit it. Put another way, FAS 140 seems to officially sanction such treatment. “The only reason to have the rule is to give sale treatment to a borrowing,” Willens says. He adds that Ernst & Young LLP, the auditor that signed off on Lehman’s accounting, was acting “well within the accounting guidelines,” which says something about the rule itself.

It’s pretty much inconceivable that SFAS 140 would have been implemented without a lot of support from people intending to use it. What’s more, we know that the people who used it didn’t disclose that fact — no disclosures surrounding Repo 105 have been made in any financial institution’s filings.

So if and when the list of Repo 105 abusers is finally revealed, expect it to be a long one. And expect to see the ABA’s Ed Yingling out there earning his $2.29 million salary trying to justify the unjustifiable.

E&Y tries to defend itself

Felix Salmon
Mar 25, 2010 06:44 UTC

Contrarian Pundit has a letter being sent out by Ernst & Young “to address certain media coverage and commentary on the Examiner’s Report that has at times been inaccurate, if not misleading”.

It’s pretty obvious why the letter isn’t being sent to the media outlets in question: it’s hilariously disingenuous, and anybody reading it side-by-side with, say, this piece at ZeroHedge will find it simply laughable. For instance:

Because effective control of the securities was surrendered to the counterparty in the Repo 105 arrangements, the accounting literature (SFAS 140) required Lehman to account for Repo 105 transactions as sales rather than financings.

For one thing, it’s jolly good that E&Y is so clear about this now, after the head of its Lehman team, Hillary Hansen, told the examiner that she had no idea what Repo 105 even was as late as June 2008. And more to the point, the examiner never says that the accounting treatment of the Repo 105 transactions was wrong; he says that the disclosure surrounding those arrangements was clearly inadequate. To which E&Y responds that “the 2007 audited financial statements were presented in accordance with US GAAP, and clearly presented Lehman as a leveraged entity operating in a risky and volatile industry”.

Well, yes. Which makes it all the more important that off-balance-sheet sources of leverage and risk should be clearly disclosed, no?

The letter continues in this vein for two pages, denying allegations which haven’t been made while stepping gently around the ones which have. Even if you haven’t seen things like the ZH report, the tone of the letter is decidedly weird. If you have seen things like the ZH report, the letter will only serve to make your opinion of E&Y even worse. If I was on the audit committee which received this letter, I would certainly be shopping my account right now. And if this is the best defense that E&Y can muster, they really are in for a world of Lehman-related pain.

COMMENT

Although the Examiner’s Report expressly declined to take a position on the issue, it seems quite unlikely that Lehman’s repo 105 program in fact met the standards required by FAS 140 for off-balance sheet treatment. In particular, LBIE (Lehman’s UK entity) apparently repo’d two different “buckets” of securities in the UK: (i) securities that were already owned LBIE, and (ii) securities transferred to LBIE from U.S. Lehman entities. With respect to the second category, the means of transfer was a repo between the U.S. Lehman entity and LBIE. That repo between the U.S. Lehman entity and LBIE, however, would not be characterized as a true sale for U.S. bankruptcy law purposes; indeed, the very impetus for the repo 105 structure was Lehman’s inability to obtain a true sale opinion from a U.S. law firm for repos transacted by U.S. Lehman entities. And there lies the problem: the transfer of securities from U.S. Lehman entities to LBIE, and the characterization of such transfer for U.S. bankruptcy law purposes, were not addressed in the Linklaters UK legal opinion upon which Lehman depended for FAS 140 purposes (and one might conjecture that Lehman probably never informed Linklaters of the specific providence of the securities). Instead, the Linklaters UK legal opinion simply included an express assumption that there were no provisions of foreign law that would have any effect on the opinion. Accordingly, it is hard to imagine that Linklaters would still have been able to provide its UK legal opinion if there had been an explicit statement of the fact that certain of the securities that were repo’d in the UK by LBIE were first acquired by LBIE from U.S. Lehman entities in repo transactions that did not constitute true sales for U.S. bankruptcy law purposes.

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