Lehman examiner’s report: London was the ‘Guantanamo Bay’ of finance
March 12th, 2010
One of the most stunning revelations to come out of the Court Appointed Examiner’s Report into the bankruptcy of Lehman Brothers, published online last night, was that the New York-based investment bank was unable to find a US-based law firm prepared to sign off its at best deceptive and at worst fraudulent approach to accounting.
The 2,292 page report lifts the lid on Lehman Brothers’ use, at the end of each quarter, of Repo 105, an accounting ruse, in order to hide up to $50 billion of toxic loans without the need to declare these on its balance sheet. Lehman Brothers relied on this and other Enron-esque kidology to deceive investors and counterparties about its financial health — to dress up the ‘sow’s ear’ of its own profligate recklessness as the ‘silk purse’ of a prudently-managed bank.
The report’s author, Chicago-lawyer Anton Valukas, wrote:-
“Unbeknownst to the investing public, rating agencies, government regulators, and Lehman’s board of directors, Lehman reverse engineered the firm’s net leverage ratio for public consumption.”
But US-based lawyers refused to lend their name to the trickery. So where did the investment bank, led by CEO Dick Fuld (pictured above) go? Where could it be confident of finding a firm of lawyers willing to rubber stamp such underhand practices?
Naturally it came to London where “magic circle” law firm Linklaters was only too happy to oblige. One assumes that Linklaters’ hunger for fees had dulled any ethical antennae. It appears to have had fewer qualms about lending its name to such sophisticated swindling than lawyers across the pond (it’s also worth remembering that Linklaters was the principal legal adviser to Royal Bank of Scotland on its disastrous €71bn takeover of ABN Amro).
The same applied to Lehman’s use of Ernst & Young as its UK auditors. The “Big Four” accountancy firm was no less reluctant to lend its imprimatur to Lehman’s sleight-of-hand. No questions asked as long as the fees — $31bn in 2007 — were paid (for further analysis of the shamelessness of the ‘Big Four’ audit firms click here).
Lehman’s choice of jurisdiction is telling.
The 2000 Financial Services and Markets Acthelped institute a regulatory vacuum in the UK. It did this by, among other things, decreeing that the FSA “must consider the international mobility of the financial business” before taking enforcement action against financial institutions and “avoid damaging the UK’s competitiveness”. In other words, Tony Blair’s government created a regulator that was specifically asked to put the interests of the Square Mile above the rule of law. (I learnt this from Nick Cohen’s Observer article “Shock! City slickers are arrested“)
It was little wonder that in 2002-08 London became known as “Guantanamo Bay of finance” to US investment bankers. The FSMA ensured they were able to get away with things here that would have never got past regulators in America. It was for this that AIG chose the City of London as base for its disastrous “Financial Products Group” led by Joe Cassano, the “Man With a Three Trillion Dollar Price on his Head”.
Senior Lehman executives — presumably including Fuld — and E&Y were fully aware of the use of Repo 105 to fraudulently misrepresent the bank’s figures, according to the Valukas report, which has detonated a series of timebombs that will continue to reverberate across the financial landscape for months to come.
Valukas, senior partner of New York law firm Jenner & Block, suggested there are “colorable” claims (ones that would be plausible to a jury) against Fuld, Christopher O’Meara (Lehman’s head of risk), and two of Lehman’s former chief financial officers, Erin Callan and Ian Lowitt.
He also said there could be “colorable” claims against E&Y. “Colorable claims exist that E&Y did not meet professional standards, both in investigating [whistleblower Matthew] Lee’s allegations and in connection with its audit and review of Lehman’s financial statements,” Valukas said. If E&Y were to face claims for negligence and damages, there’s a chance it could implode like Arthur Anderson before it.
Lynn E Turner, a former SEC chief accountant, accused E&Y of abdicating responsibility by not presenting its concerns to Lehman’s audit committee. He told the New York Times.
“This is pretty aggressive and pretty abusive. I don’t know how under GAAP this follows the rules whatsoever. It reeks of an auditor who is beholden to management.”
Turner said he believes the SEC and Justice Department should follow up on Valukas’s findings.
Valukas’s also said there are “colorable” claims against nvestment banks JP Morgan Chase and Citigroup. Their demands for increased collateral and modification of agreements with Lehman sucked liquidity out of the weaker institution and precipitated its demise.
The report, which cost $38m to produce, says the conduct of Lehman executives “ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation.” Lehman chose to “disregard or overrule the firm’s risk controls on a regular basis,” even as the credit and property markets started to collapse.
Lehman used Repo 105 transactions from 2001 onwards to classify “repurchase” agreements as sales, keeping investors in the dark about its obligation to buy the assets back at a later date. Repo 105 enabled Lehman to remove problematic assets from its balance sheet, and provided cash with which it could temporarily pay down other liabilities. The ruse gave the impression Lehman was less dependent on leverage than it was.
In a string of emails cited by Valukas, one senior Lehman executive wrote of Repo 105: ”It’s basically window-dressing.” Another responded: ”I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the Street do it? Also is that why we have so much BS [balance sheet] to Rates Europe?” The first executive replies: ”Yes, No and yes.”
Fuld’s lawyer, Patricia Hynes, claimed Fuld:
”did not know what those transactions were — he didn’t structure or negotiate them, nor was he aware of their accounting treatment”.
Valukas was appointed in January 2009 to examine the causes of Lehman’s collapse by the US Bankruptcy Court for the Southern District of New York [continues after image].
Here’s my pick of the best of this morning’s coverage of the Examiner’s Report:-
- Examiner: Lehman Torpedoed Lehman Wall Street Journal
- The Genesis of Repo 105 FT Alphaville
- Repo 105 FT Alphaville
- Report escalates Lehman ineptitude to new level Breaking Views (via Daily Telegraph)
- Lehman Bosses Used Accounting Gimmick to Cover up Debts The Times
- Lehman’s Boesky, and why you can get away with anything in London Jeremy Warner’s blog
- Could Lehman’s Dick Fuld end up behind bars? The Guardian
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Short URL: http://www.ianfraser.org/?p=1040
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[...] Goodwin were able to straddle the global stage, and where deceptive accounting such as occurred at Lehman Brothers UK arm (and at plenty of other banks) was tolerated or [...]
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[...] 1997. As a result of this and other deregulatory measures, UK banking became a sort of wild west or Guatantanamo Bay of finance where recklessness and fraudulent practices (exacerbated by anaemic controls at banks such as HBOS) [...]
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