Posted in: FINRA | Arbitrations | Ponzi Schemes | SEC | Risky Investments | Lehman Notes |
It took Anton Valukas, a court-appointed examiner, over a year to complete his report on whether Lehman Brothers acted improperly leading to their 2008 bankruptcy-the largest in American history. The highly-anticipated report discusses accounting gimmicks, which were “eerily reminiscent of how Enron tried to prop up its balance sheet back in 2001 before it collapsed,” said Peter Henning, a writer for the New York Times and editor emeritus of White Collar Crime Prof Blog.
The Wall Street Journal’s Jessica Papini believes Valukas’ report “could provide ammunition to some retail investors who bought Lehman Brothers principal protected notes.” Henning explains the Repo 105, which was utilized by Lehman Brothers to push billions of dollars around, and thus distorting their financial state to the SEC:
The examiner’s report gives us a new term for hiding problems on a corporate balance sheet that may become common parlance: “Repo 105.” Starting in 2001, Lehman Brothers engaged in repurchase agreements, called “repos,” which were described by DealBook as “what amounts to a short-term loan, exchanging collateral for cash up front, and then unwinding the trade as soon as overnight.” Repos are a common method for investment banks to finance their operations and are neither illegal nor questionable, at least when clearly accounted for.
Lehman Brothers went a step further by having the collateral exchange under the agreement worth 105 percent of the cash it received - hence, the “105” in the firm’s nomenclature. By doing so, that turned it into a sale for accounting purposes, so that the firm could move the assets it exchanged in the deal off of its balance sheet, at least for a short while.
At the end of 2007, Lehman Brothers used Repo 105 transactions to disguise assets, making the company appear more financially viable to the SEC and investors. While the public was investing in what they believed to be “principal protected” Lehman notes, without knowing the bulk of their investment was at risk.
The examiner’s report claims that three chief financial officers at the firm, and its former chief executive Richard S. Fuld Jr. most likely knew of the effect of the Repo 105 transactions between 2007 and 2008. With the timing and frequency of the transactions, these Lehman executives were aware they were misleading the public, as he explains in his report below:
Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former Global Financial Controller Martin Kelly, a careful review of Lehman’s Forms 10_K and 10_Q would not reveal Lehman’s use of Repo 105 transactions. Lehman failed to disclose its Repo 105 practice even though Kelly believed “that the only purpose or motive for the transactions was reduction in balance sheet”; felt that “there was no substance to the transactions”; and expressed concerns with Lehman’s Repo 105 program to two consecutive Lehman Chief Financial Officers - Erin Callan and Ian Lowitt - advising them that the lack of economic substance to Repo 105 transactions meant “reputational risk” to Lehman if the firm’s use of the transactions became known to the public. In addition to its material omissions, Lehman affirmatively misrepresented in its financial statements that the firm treated all repo transactions as financing transactions - i.e., not sales - for financial reporting purposes.
FINRA currently has a number of pending arbitration cases against UBS, and other broker-dealer firms that sold and marketed Lehman notes to its customers. If you purchased Lehman Brothers principal-protected notes between 2007 and 2008, or believe your account with Lehman Brothers was mismanaged, we urge you to contact us for a free consultation.
