Defaulting banks - where will it stop?

[Peter Lemkin]

Lehman Brothers' former heads criticised for lapses [BBC]
Lehman Brothers collapsed in September 2008
A report into the collapse of Lehman Brothers criticises senior executives and auditor Ernst & Young for serious lapses that led to the firm's collapse.

The report says Lehman was insolvent for weeks before it went bankrupt, sparking a global financial meltdown.

It accuses management of "actionable balance sheet manipulation" and using accounting tricks to hide debts.

Ernst & Young said that its last audit of Lehman was "fairly presented" according to accounting rules.

The collapse of the 158-year-old investment bank in September 2008 was the world's largest bankruptcy.

Wall Street, the City of London, and the US and UK governments tried to organise a rescue, fearing - rightly - that Lehman's failure would set off a chain reaction around the globe.

Possible claims

Friday's 2,200-page forensic analysis into what went wrong says there could be grounds for legal action against former executives.

Lawyer Anton Valukas, who led the inquiry, stops short of saying that there was systematic wrong-doing at the firm.

And he pointed out that senior executives had used their business judgment and were largely not liable for the firm's collapse.

Nevertheless, Mr Valukas said creditors could have grounds for legal action for negligence or breach of fiduciary duty against its former chief executive Dick Fuld and chief financial officers Chris O'Meara, Erin Callan and Ian Lowitt.

Mr Valukas said there was also sufficient evidence to support a possible claim that Ernst & Young had been "negligent" and that Lehman's liquidators could pursue claims against the firm for "professional malpractice".

Much of the report, which took evidence from all the major parties involved in Lehman's collapse and attempts to rescue the firm, contains allegations about an accounting "gimmick" known as "Repo 105".

This is a legal accounting device that involves shifting around assets to reduce the size of a company's balance sheet, and effectively give the appearance that debts have been cut.

It was a gimmick that Lehman used increasingly as its problems mounted.

Mr Valukas said Repo 105 was used to "give the appearance that Lehman was reducing its overall debt" levels in 2008 when in reality it was not.

The report estimates that Lehman used the practice to temporarily remove $50bn of assets from its balance sheet in 2008 alone.

Lehman began using Repo 105 in 2001, but the practice was "dramatically" ramped up from late 2007, the report said.

An e-mail from Bart McDade, former head of equities, suggested Lehman was addicted to Repo 105. "I am very aware... it is another drug we're on," he wrote.

London appears to have played a key role in approving Lehman's use of Repo 105. The report says Lehman at first tried to find a US law firm that would approve its shifting around of assets.

Unable to get US clearance, Lehman turned to London law firm Linklaters, which advised that the practice was allowed under UK law.

So, assets Lehman wanted to "hide" were transferred to the London operation, which would "conduct the [Repo] transaction on their behalf," the report said.

Wall Street's role

The report says that Lehman had received warnings about the accounting device from Martin Kelly, the firm's former global financial controller.

Yet, "certain of Lehman's officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports, and Ernst & Young was professionally negligent in allowing those reports to go unchallenged," the report said.

An attorney for Mr Fuld said on Thursday that the former Lehman boss "did not know what those [Repo] transactions were".

"He didn't structure them or negotiate them, nor was he aware of their accounting treatment," his attorney Patricia Hynes said.

Ernst & Young said in a statement: "Our last audit of the company was for the fiscal year ending November 30, 2007. Our opinion indicated that Lehman's financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view."

A Linklaters spokesperson said: "The US Examiner's report into the failure of Lehman Brothers includes references to English Law opinions which Linklaters gave in relation to a number of Lehman transactions.

"The Examiner - who did not contact the firm during his investigations - does not criticise those opinions or say or suggest that they were wrong or improper. We have reviewed the opinions and are not aware of any facts or circumstances which would justify any criticism."