Monday, March 15, 2010

A Few Notes on Lehman

The bankruptcy report for Lehman was a very damning document. For me, here are the points that really stood out.

1.) Lehman's former executive Fuld is going to claim he didn't know anything about the Repo transactions. This is not going to fly. The law imposes on all executives a "duty of care." Essentially, all executives must be pro-active in the management of their company. They can't wait for people to bring them information. Fuld's arguments/claims don't begin to hold legal water and his lawyer knows it. My guess (and this is just a guess) is Fuld's legal team is trying to deflect criminal liability

2.) Why wouldn't any US firm sign off on the Repo transactions? All transactions must -- from a tax perspective -- have "substance." This means they must be what they are claiming to be. A repo transaction is a standard financing transaction -- if it is used a short-term financing transaction. But that is not what Lehman was doing. As such, it had no tax substance and would therefore be challenged by the IRS. The fact no one would sign off on it should tell you a great deal about the substance of Lehman's actions.

3.) The big accounting firms suck - plain and simple. E and Y is the third accounting firm in the last 15 years to demonstrate pure incompetence in their job. There is no way they could have let the "repo" transactions pass. They should have raised questions. Instead, they will argue they were nothing more than bean counters and were not supposed to question the transactions. Personally, I think this is where the real crime lies -- the fact that a financial audit was pure crap.

Here is some relevant information on possible legal liability:

Lehman Brothers may have collapsed a year and a half ago, but fallout from its demise has created a potential legal liability for its former accounting firm, Ernst & Young.

A 2,200-page report by a court-appointed examiner, Anton R. Valukas, on Lehman’s collapse has plenty of criticism for various players involved with the investment bank. But some of his harshest words are reserved for Ernst & Young and the accounting maneuvers it permitted.

Mr. Valukas writes that he found enough evidence to support at least three claims against the accounting firm for not looking more closely into Lehman’s use of questionable accounting. Lehman used the tactics, known inside the bank as Repo 105, to hide as much as $50 billion off its balance sheet to temporarily reduce its debt levels.

His report concludes that sufficient evidence exists to bring claims of malpractice against the accounting firm on the grounds of failing to disclose or investigate the technique. Legal and accounting experts say that Ernst & Young could now face potentially damaging civil litigation by private plaintiffs or the Securities and Exchange Commission — or even criminal charges by the Justice Department.

In short, Lehman was run by idiots.