What led to the demise and failure of Lehman Brothers? This is the precise question that Anton Valukas, a partner in the New York office of the venerable law firm Jenner & Block, was appointed in January 2009 by the U.S. Bankruptcy Court for the Southern District of New York to answer. Indeed, Lehman Brother’s bankruptcy, which was filed on September 15, 2008, is the largest Chapter 11 bankruptcy filing in history. Many would argue that the Lehman collapse has contributed greatly to our current financial crisis—The Great Recession—one of the worst since The Great Depression. Yesterday, Valukas issued a 2,200-plus page Report detailing the failure of Lehman Brothers.
Valukas indentified a number of failures in corporate governance and auditing and financial controls. Valukas observed that Lehman Brothers “repeatedly exceeded its own internal risk limits and controls.” According to Valukas, Lehman’s management made a number of terrible decisions that ultimately led to Lehman’s collapse. Commenting on Lehman’s executives, Valukas noted that conduct “ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation.” Valukas indicated that Lehman Brother’s attempted to forestall its ultimate demise by misleading investors about its true financial picture.
Perhaps most damning, Valukas discloses Lehman’s use of “Repo 105” a financial accounting device to “cook” or alter its balance sheet. Using Repo 105, Lehman shifted $50 billion of toxic assets off its balance sheet during the first and second quarters of 2008, instead of selling and reporting these toxic assets at a loss. Through a loophole and gap, accounting rules allowed Lehman to treat Repo 105 transactions as sales instead of financings. Lehman’s chief financial officer was implicated in emails that indicated that Repo 105’s chief purpose was to reduce liabilities on the balance sheet.
Valukas found that Repo 105 was not disclosed to government regulators, rating agencies, investors, or to Lehman’s board of directors. Lehman apparently did not act alone. Valukas discovered that Ernst & Young, Lehman’s auditor, was made aware of Repo 105 and did not challenge the use of this questionable accounting practice. Repo 105 led to the repossession of billions of taxpayer dollars and investment and retirement funds!!!
We passed Sarbanes-Oxley in the wake of the Enron scandal to try to root out financial and accounting irregularities. How could similar irregularities occur at Lehman Brothers? History has a way of constantly repeating itself. One thing is for certain, the civil lawsuits, and hopefully criminal charges and indictments, will flow shortly. I will do my best to keep you posted in the coming weeks and months.