The story today about Lehman’s accounting manipulations can only be described as shocking. The details are to be found in the “Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report”. I am not an accountant, and based on a quick look at FAS 140 I do not understand why Lehman thought it could do what it did. But it seems to me that this case is a poster child for a change in accounting rules.
Lehman did the following (details are in the third volume of the Examiner’s report): Before the end of a quarter, they sold tens of billions of dollars worth of assets, simultaneously agreeing to buy them back after the quarter’s end. (This is called a repurchase agreement.) They would use the cash received from the sale to retire debt. Once the next quarter started, they would exactly reverse the transactions, issuing new debt to raise the money necessary to buy back the assets they had just sold.
Accounting for this as a sale left the appearance that Lehman had sold assets and reduced leverage. However, from an economic perspective, Lehman still owned the assets (they were going to possess them again in a few days so they cared about the value of the assets) and they still had indebtedness (they were committed to paying a fixed sum to buy back the assets, in other words they had debt).
The report does not mince words:
Lehman failed to disclose its Repo 105 practice even though [former Global Financial Controller Martin] 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…
And here is what the Examiner has to say about the propriety of these transactions:
“The Examiner concludes that colorable claims of breach of fiduciary duty exist against Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Ernst & Young.”
I confess that I had to look up “colorable”. It means what you think it means, and it is not good news for Mr. Fuld and colleagues.