Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and

Question

Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days… in late 2007 and 2008. Repo 105 transactions were nearly identical to standard repurchase and resale (“repo”) transactions that Lehman (and other investment banks) used to secure short-term financing, with a critical difference; Lehman accounted for Rep 105 transactions as “sales” as opposed to financing transactions…By recharacterizing the Rep 105 transaction as a “sale”. Lehman removed the inventory from its balance sheet.   Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction…Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.. A few days after the new quarter began, Lehman would borrow the necessary funds to repay the cash borrowing plus interest, repurchase the securities, and restore the assets to its balance sheet.

Is it ethical to keep the types of liabilities discussed in this article off the balance sheet, or is this a type of financial statement fraud?

Explanation / Answer

Lehman customarily expanded its use of Repo 105 transactions within the days prior to reporting periods to slash its publicly pronounced internet leverage and steadiness sheet. Lehman's periodic reports did not disclose the cash borrowing from the Repo one zero five transaction i.E., despite the fact that Lehman had in influence borrowed tens of billions of greenbacks in these transactions, Lehman didn't disclose the recognized obligation to repay the debt.2851 Lehman used the money from the Repo 105 transaction to pay down different liabilities, thereby lowering each the total liabilities and the complete property reported on its balance sheet and decreasing its leverage ratios. As a consequence, Lehman's Repo 105 apply consisted of a two step process: (1) mission Repo 105 transactions followed by (2) the use of Repo one hundred and five cash borrowings to pay down liabilities, thereby lowering leverage. A few days after the new quarter began, Lehman would borrow the critical dollars to repay the money borrowing plus interest, repurchase the securities, and restore the assets to its balance sheet.
Lehman in no way publicly disclosed its use of Repo 105 transactions, its accounting medication for these transactions . . .
You will see that why Repo a hundred and five could be a tempting thing in the course of a brewing financial challenge.

Leverage had end up a focus of the scores groups and was once commonly thought to be a hallmark of financial institution threat, which supposed Lehman would were hell-bent on lowering its leverage at least publicly.

Whilst costs for matters like CMBS and subprime loans have been falling and/or illiquid Lehman might no longer have decreased its stability sheet quite simply by selling things off without incurring massive losses.

Therefore the Repo, which the bank more and more used between 2007 and 2008 even breaching its possess interior cap on the Repo's use (about $22bn as of summer 2006).

The Examiner concludes that there is adequate proof to aid a colorable declare that: (1) special of Lehman's officers breached their fiduciary duties by exposing Lehman to competencies liability for filing materially misleading periodic studies and (2) Ernst & younger, the organizations external auditor, used to be professionally negligent in allowing those experiences to move unchallenged. The Examiner concludes that colorable claims of breach of fiduciary duty exist against [former CEO/CFOs] Richard Fuld, Chris O'Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of authentic malpractice exists against Ernst & younger.

In a statement, Mr Fuld's attorney wrote: Mr Fuld didn't recognize what those transactions were he didn't constitution or negotiate them, nor used to be he aware of their accounting cure, his lawyer wrote in a assertion.
furthermore, the proof on hand to the examiner shows that the Repo one hundred and five transactions have been done based on an inside accounting policy, supported the legal opinions and accepted by way of Ernst & younger, Lehman's impartial external auditor.
E&Y said in a statement: Our opinion indicated that Lehman's financial statements for that yr were particularly presented in response to generally accepted Accounting standards (GAAP), and we remain of that view.
Mr Lowitt's attorney stated in a announcement: in the three months during which he held the job, Mr Lowitt labored diligently and faithfully to discharge all of his tasks as Lehman's CFO, Any advice that Mr Lowitt breached his fiduciary tasks is baseless.
Mr O'Meara would no longer be reached for comment. A attorney representing Ms Callan declined comment

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