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In Lehman’s Demise, Some Shades of Enron
Saturday, March 20, 2010
""Peter J. Henning follows issues related to white-collar crime for DealBook’s White Collar Watch.
The bankruptcy examiner’s report filed by Anton R. Valukas on the 2008 demise of Lehman Brothers discusses some accounting gimmicks that are eerily reminiscent of how Enron tried to prop up its balance sheet back in 2001 before it collapsed.
Both companies appear to have played right along the edge of properly accounting for transactions designed to make them appear much stronger than they turned out to be, becoming steadily more aggressive as they teetered on the brink of ruin.
Peter J. Henning, writing for DealBook’s White Collar Watch, is a commentator on white-collar crime and litigation. A former lawyer at the Securities and Exchange Commission’s enforcement division and then a prosecutor at the Justice Department, he is a professor at the Wayne State University Law School. He is currently working on a book, “The Prosecution and Defense of Publc Corruption: The Law & Legal Strategies,” to be published by Oxford University Press.
The examiner’s report discusses potential claims that the bankruptcy trustee can bring against Lehman’s former officers and outside advisers and does not mention potential government law enforcement action. Reading his report, however, gives strong indications that at a minimum the Securities and Exchange Commission is likely to pursue civil charges for securities fraud, and that criminal charges are certainly possible against Lehman’s former top executives.
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.
As explained by DealBook, “That meant that for a few days — and by the fourth quarter of 2007 that meant end-of-quarter — Lehman could shuffle off tens of billions of dollars in assets to appear more financially healthy than it really was.” By timing Repo 105 transactions to the end of a quarter, the reports filed with the S.E.C. and reviewed by investors looked much better than what was going to be the case just a short time later. Enron did much the same thing with some of its assets, such as its notorious Nigerian barge deal.
The examiner’s report goes into great detail in describing how the Repo 105 transactions allowed Lehman Brothers to portray itself much more favorably to investors and analysts by proclaiming that it was reducing its leverage, something very important as the real estate bubble was bursting in 2007. The report determines that Lehman Brothers ramped up its use of Repo 105 deals to reduce its leverage by $38.6 billion in the fourth quarter of 2007, by $49.1 billion in the first quarter of 2008 and $50.4 billion in the second quarter of 2008. The firm did not quite get to the end of the third quarter, filing for bankruptcy in September 2008.
And there is the root of the potential civil and criminal liability of Lehman’s executives. The report describes the use of Repo 105 transactions as a “material misrepresentation” of Lehman’s financial statements.
A second issue involves the firm’s claims that it had adequate liquidity to deal with the collapsing market in 2008. According to Mr. Valukas, that purported liquidity included assets that Lehman could not easily tap and investments that were far from liquid. Once again, the statements by corporate executives about the firm’s strength may well have been misleading.
The examiner’s report says Lehman’s three chief financial officers during 2007 and 2008 (the firm played musical chairs with its C.F.O.’s during the period) and its former chief executive, Richard S. Fuld Jr., most likely knew of the effect of the Repo 105 transactions. If the financial statements were false, then each could be prosecuted under a provision adopted in 2002 as part of the Sarbanes-Oxley Act (18 U.S.C. § 1350), which requires the chief executive and the chief financial officer to certify that the financial statements comply with all applicable statutes and rules.
Public statements about the liquidity issue and the leverage on the balance sheet could be the basis of a securities fraud violation, along with potential charges related to properly maintaining the company’s books and records and providing false information to the S.E.C.
The examiner’s report notes that each of the senior executives denied having any detailed knowledge of the Repo 105 transactions or their effect on the financial statements. It also identifies one potentially important witness, Lehman’s former chief operating officer, as stating that he spoke with Mr. Fuld about the transactions and that he understood the accounting treatment of them.
As in any securities case, the key issue would be intent if the government pursues charges against former Lehman executives. No one will dispute that the Repo 105 transactions occurred, or that public statements about the firm’s balance sheet and liquidity were made. Much as during the Watergate investigation, the issue will be what the executives knew and when they knew it.
The examiner’s report goes into great detail regarding e-mail messages exchanged by various Lehman executives about the nature and effect of the Repo 105 transactions, with one describing them as “window dressing.” But e-mail alone does not make either a civil or criminal case. The recent prosecution in Brooklyn of two former Bear Stearns hedge fund managers, with a trial ending in their acquittal, showed how difficult it was for the government to prove a case based only on what the defendants wrote or received electronically. Words are rarely precise, and inferring knowledge from e-mail traffic can be difficult.
The Repo 105 transactions were not objected to by Lehman’s outside auditor, Ernst & Young, and the British law firm Linklaters provided an opinion letter under British law that they were sales and not mere financing arrangements. For a criminal prosecution especially, a defense of reliance on experts can undermine the government’s proof of intent to defraud or knowledge that statements were false or misleading.
As in the Enron prosecution, to make a securities fraud case against any Lehman executives the S.E.C. and Justice Department will need cooperating witnesses who can explain the underlying transactions and provide testimony about what was said and understood at the time. In the Enron and WorldCom prosecutions, the chief financial officers of the two companies — Andrew Fastow and Scott Sullivan, respectively — were crucial witnesses against the chief executives, Jeffrey K. Skilling and Kenneth L. Lay of Enron, and Bernard Ebbers of WorldCom.
The offices of the United States attorneys for the Southern and Eastern Districts of New York have been investigating the collapse of Lehman Brothers for months, along with the S.E.C. The government has access to the same documents as those discussed in the examiner’s report. As a former United States attorney, Mr. Valukas must have been keenly aware that his conclusions about the Repo 105 transactions being materially misleading and discussions about the basis for finding the executives were knowledgeable about Lehman’s financial difficulties would serve as a type of road map for potential government enforcement proceedings in addition to private lawsuits.
Will the government take action against any Lehman Brothers executives? I think a civil action by the S.E.C. is likely because of the importance of the Repo 105 transactions and the effect of the statements about liquidity on the market. The burden of proof in the civil case is much lower, requiring a preponderance of the evidence. And the commission may well bring a case against the outside auditors in addition to individuals at Lehman Brothers.
The canary in the coal mine for whether there will be a criminal case is if we see any executives from just below the executive suite agreeing to plead guilty and cooperate. Prosecutors work from the lower levels of management and then work their way up the chain. A criminal case will need cooperating witnesses to flesh out what happened because the documents and e-mail alone will not be enough to prove intent.
Accounting fraud cases generally take at least 18 to 24 months to develop, at which point the government will decide to proceed or allow the investigation to lapse. We are almost to that point, so the next few months will be crucial to seeing whether any criminal charges emerge from the collapse of Lehman Brothers. As the TV announcer says, “Stay tuned.”
– Peter J. Henning"
Source
http://dealbook.blogs.nytimes.com/2010/03/12/in-lehmans-demise-some-shades-of-enron/
Lehman accounting tricks possibly illegal - Lehman Brothers Bankruptcy - Lehman Brothers Whistleblower
Friday, March 19, 2010
"" NEW YORK – A Lehman Brothers whistleblower warned his bosses that accounting gimmicks the bank used before its collapse may have been illegal, his lawyer said Friday.
Matthew Lee, a former Lehman senior vice president, was fired days after questioning the accounting tricks in a letter to his superiors, attorney Erwin Shustak said. Shustak gave a copy of the letter to The Associated Press.
Lehman Brothers Holdings Inc. imploded in September 2008, becoming the biggest corporate bankruptcy in U.S. history. The collapse sent financial markets across the globe into a free-fall and prompted a massive bailout of the U.S. banking system.
An examiner appointed by the bankruptcy court said in a 2,200-page report last week that Lehman hid its debt and perilous financial condition by using an accounting gimmick called Repo 105. The report revealed Lee's warnings to the bank, though his letter makes public the first internal assessment of the legality of Lehman's bookkeeping.
In a letter dated May 18, 2008, Lee wrote that he discovered that the bank had been underreporting its debt by about $5 billion at the end of each month.
Lee, a 14-year Lehman veteran, wrote that he felt compelled to report the "discrepancies" under the firm's code of ethics, saying he believed they "possibly constitute unethical or unlawful conduct."
"I believe the manner in which the firm is reporting these assets is potentially misleading to the public and various governmental agencies," Lee wrote. "If so, I believe the firm may be in violation of the code."
Days after sending the letter, the firm told Lee he was being terminated as part of a general layoff, Shustak said. After his firing, Shustak wrote a letter to the bank saying that Lee "believes he has been the victim of retaliation for bringing what he believed, in good faith, to have been ethical and securities law violations by Lehman."
Lee, 56, later reached a severance agreement with Lehman, however, he stopped receiving payments after the firm's collapse, Shustak said. He has filed a claim with the bankruptcy court to recover the unpaid amount.
The bankruptcy examiner's report and Lee's letter could provide a framework for any future legal action against Lehman executives.
Senate Banking Committee Chairman Christopher Dodd on Friday called for Attorney General Eric Holder to investigate the circumstances that led to Lehman's collapse. A Justice Department spokeswoman said the department would review the request.
The examiner, Anton Valukas, discovered that Lehman put together complex transactions that allowed the firm to sell "toxic," mostly mortgage-backed, securities at the end of a quarter — wiping them off its balance sheet when regulators and shareholders were examining it — and then quickly buy them back.
His report doesn't conclude whether executives violated securities laws. It does say that the executives' decision not to disclose the effects of its business judgments appears to be sufficient evidence to support the awarding of civil damages in a trial.
The executives named by the report include former CEO Richard Fuld and three chief financial officers. Fuld has denied knowing what the transactions were or the accounting for them.
Securities and Exchange Commission Chairman Mary Schapiro said Wednesday that the agency is investigating several companies' actions in the run-up to the financial crisis of 2008. Without naming Lehman or other banks, Shapiro said the bankruptcy examiner's report raised "some very interesting points" and will be helpful to the SEC probe. ""
Source
http://news.yahoo.com/s/ap/20100319/ap_on_bi_ge/us_lehman_brothers_whistleblower
Lehman’s Hidden Leverage ‘Shenanigans’ May Haunt Fuld
Wednesday, March 17, 2010
"" By Joshua Gallu and David Scheer
March 13 (Bloomberg) -- Lehman Brothers Holdings Inc.’s Richard Fuld exuded confidence as he briefed analysts on June 16, 2008, four days after demoting his firm’s finance chief in the wake of a $2.8 billion quarterly loss.
“I am the one who ultimately signs off and I’m comfortable with our valuations at the end of our second quarter,” then- Chief Executive Officer Fuld said on the conference call. “We have always had a rigorous internal process.”
The rigor was based on a shaky foundation, according to a 2,200-page report about the firm’s demise by Anton Valukas, the examiner for the bankrupt firm. Lehman Brothers “reverse- engineered” a key measure of stability, masking the firm’s true financial condition, Valukas said. Some asset valuations were also “unreasonable,” he said.
Keen to show that it had reduced leverage, a gauge of a company’s ability to withstand losses, Chief Financial Officer Ian Lowitt said on the June 16 call that the firm had shrunk its net leverage ratio to 12 times from 15.4 in the second quarter.
It accomplished the feat by reducing net assets by $70 billion, said Lowitt, who had just replaced Erin Callan in his post. “We’re going to operate conservatively,” he said.
Unbeknownst to shareholders, the firm was hiding $50 billion in assets through off-balance-sheet transactions known as Repo 105s that temporarily removed holdings until days after the quarter closed, according to Valukas. In the first quarter, the firm had used the same strategy to hide $49 billion in assets, he said in the report.
‘Shenanigans’
Lehman Brothers actions amounted to no more than “shenanigans,” said Sanford C. Bernstein & Co. analyst Brad Hintz, a former Lehman chief financial officer. “If all you’re doing is hiding something behind the curtain, the financial strength isn’t there.”
The repos helped prop up Lehman’s credit rating, Valukas said. The off-balance dealings required more collateral than if Lehman had opted for ordinary transactions visible to shareholders, he said.
“Repos were just one of many ways to hide losses,” said Janet Tavakoli, president of Chicago-based financial consulting firm Tavakoli Structured Finance Inc. “All of the former investment banks used those techniques. All of them borrowed too much money and were overleveraged.”
Lehman Brothers bolstered capital by raising about $12 billion from investors during the first half of 2008, a time when Valukas said the New York-based firm’s financial statements were misleading.
‘Grossly Negligent’
Investors included Blackrock Inc., the largest publicly traded fund manager in the U.S., a venture run by former American International Group Inc. CEO Maurice “Hank” Greenberg, and New Jersey government retirees.
Fuld, 63, was “at least grossly negligent in causing Lehman Brothers to file misleading periodic reports,” Valukas said.
Fuld’s lawyer, Patricia Hynes, disputed the examiner’s conclusions.
“Mr. Fuld did not know what those transactions were -- he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” Hynes said in a statement. She also said none of Lehman’s senior financial officers, lawyers or outside auditors raised concern about the transactions with Fuld.
Robert Cleary, a lawyer for Callan at Proskauer Rose, didn’t return a call seeking comment. Callan, 44, who left Lehman in July 2008 to join Credit Suisse Group AG, stepped down from the Swiss bank Dec. 31, spokesman Duncan King said.
Real Estate Overvalued
Lewis Liman, a lawyer for Lowitt, 46, said in an e-mail that his client did nothing wrong. Lowitt is now chief operating officer at Barclays Wealth Americas, whose parent, Barclays Plc, bought Lehman’s North American brokerage for $1.54 billion.
In its final year, Lehman overvalued real-estate holdings, including a stake in U.S. apartment developer Archstone-Smith Trust, Valukas said. Lehman and Tishman Speyer Properties LP completed a joint acquisition of Archstone for $22 billion, including debt, in October 2007.
Lehman presented “unreasonable” valuations of its Archstone stake in the first three quarters of 2008, overvaluing the holding by as much as $450 million in the second quarter, the examiner wrote.
The bankruptcy case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).
--With assistance from Erik Schatzker and Christine Harper in New York. Editors: Alec McCabe, Dan Reichl.
To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; David Scheer in New York at dscheer@bloomberg.net. ""
Source of Post
http://www.businessweek.com/news/2010-03-13/lehman-brothers-shenanigans-on-hidden-leverage-may-haunt-fuld.html
Lehman Brothers and Proskauer Rose Connections
Peter Z. Sivere v. JP Morgan Chase - Department of Labor - OSHA - SEC - Canary Capital - Davis Polk - JPM Chase
Tuesday, March 16, 2010
August 2005 Archives
Inside the JP Morgan, Peter Sivere Whistleblower Case
"Civil Action to Protect Against Retaliation in Fraud Cases"
Lisa M. Wells - JPM Chase
Sarbanes - Oxley
Jamie Dimon
Davis Polk Investigations
When Loans were made and What We did about it...
JP Morgan provided a $150 Milloin Line of Credit to a Canary Entity Structured for Canary a series of short equity basket swaps that allowed Canary to hedge its long position in third party mutual funds.
Plaintiffs allege that JPM has liability as financier of some Canary Market timeing and late trading. ... Davis Polk seems to have claimed, in their investigation that JPM had no knowledge of late trading or improper timing...
Heritage Bank One ..
What are the Conflicts of Interest, Attorneys Protecting Each Other.. Isn't Davis Polk connected to Proskauer Rose Somehow??
Canary Capital Litigation
Investment Banking Exposure
TS&S / Investment Management Exposure
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