By Mandy Moody, CFE
ACFE Social Media Specialist
Lehman Brothers: a name synonymous with bankruptcy and the worst financial crisis since The Great Depression. Founded in 1850 as a small cotton trading business by a German immigrant and his two brothers, Lehman grew into one of the largest investment banks on Wall Street. Its reputation, however, far exceeded what hid behind a dark veil of altered quarterly and annual filings. As Bruce Dubinsky, CFE, CPA, CVA, Managing Director of Duff and Phelps, LLC, and ACFE Regent, conveyed today, “It’s not about what you can actually see on the page; it’s about what’s not there.”
So, how did this once 42-time “Best in Class” award-winner for excellence in prime brokerage and the No. 1 prime broker in Japan and Europe end up filing for Chapter 11 bankruptcy protection? Dubinsky explored this question and Lehman’s hard fall from grace in his breakout session, “Repo 105/108 Transactions: The Anatomy of Accounting Deception.”
“Lehman recognized a loophole in the accounting standard language regarding repurchase agreements (repos) and took advantage of it,” Dubinsky said. “Liabilities were not recorded for these asset transactions, but rather assets were taken off its balance sheet and the cash received was then used to repay other debt, effectively lowering its leverage.” Repos are agreements where one party (the transferor) transfers an asset to another party (the transferee) as collateral for a short-term borrowing of cash, while concurrently agreeing to repay the cash plus interest and take back the collateral at a specific point in time. Essentially, they were low-risk, short-term loans that were used all of the time.
Dubinsky pointed out that these repos, Repo 105 and 108 specifically, gravely distorted Lehman’s leverage and even reduced it because it was paying off debt at the end of every quarter. However, consumers, the SEC and shareholders were unaware of the actual state of the company because they didn’t see the money that was paid back for the repurchase agreements at the beginning of every quarter, increasing their debt and leverage.
Lehman Brothers was able to complete their due diligence by finding a legal firm that would give the okay to these sales despite the accepted accounting standards in the U.S. “No law firm in the U.S. wanted to give an opinion on what they wanted, so Lehman’s went opinion-shopping," Dubinsky said. "They traveled across the pond and found a U.K. law firm to provide the opinion letter they needed.”
Once they received the sign-off from a law firm, Lehman began to accumulate a massive amount of debt. It didn't take long for it to add up when they were selling securities valued at 105 percent and 108 percent for only 100 percent of the price. According to Dubinsky, in May of 2008 alone Lehman Brothers sold $50 billion worth of repos. It is no surprise that when they declared bankruptcy only months later they were $615 billion in debt.
So, what happened, you may wonder? Lehman was one of the largest bank not bailed out by the U.S. government and after the accounting examinations, the Securities and Exchange Commission decided not to indict anyone. But, according to Dubinsky, the takeaways are clear. “To say that there were mistakes made would be easy as, ‘Hindsight is 20/20.’ However, we can hope that executives, auditors and regulators alike will learn from Lehman’s example and apply this insight going forward to whatever accounting issues and market conditions come next.”