In the 1984 film, Repo Man, actor Tracey Walter observed that “the life of a repo man is always intense.” The same could have been said of the life of a Repo Man at Lehman Brothers. Although instead of repossessing cars, the Lehman Repo Men hawked securities and deceived investors through the use of an accounting gimmick called “Repo 105.”

Repo 105 transactions were repurchase agreements. A repurchase agreement is a type of short term financing transaction where party “A” sells securities to party “B” in exchange for cash. Party “A” then agrees to repurchase the securities from “B” at a later date for a specific price. According to the court appointed bankruptcy Examiner “Lehman used the cash from the Repo 105 transaction[s] 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.” Had Lehman properly accounted for the transaction, a liability would have remained on the books indicating the obligation to repurchase the securities.

The essence of the Lehman subterfuge involved treating Repo 105 transactions as sales rather than financing transactions, which is how they must be reported according to U.S. accounting principles. But Lehman’s American Lawyers were of no help to the Repo Men. Lehman’s own accounting policies stated that “repos generally cannot be treated as sales in the United States because lawyers cannot provide a true sale opinion under U.S. law.” However, under English law, you can get such an opinion provided the buyer resides in a jurisdiction covered under English law. And this is exactly what Lehman Brothers did.

But there’s more. After recording the improper sale, Lehman continued to report income from the securities which were reported as sold – that is – Lehman Brothers reported income from assets it did not own. Even your normal, bonus loving banker can spot the flaw in that logic.

And where were the regulators? The Examiner’s report notes…

Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.

Now remind me…the point of monitoring is what exactly?


And Then There Were Three…
Most damaging to Lehman Brother’s auditor, Ernst & Young (one of the “final four” large accounting firms), is the Examiner’s statement that “a trier of fact could find that Lehman’s use of tens of billions of dollars of Repo 105 transactions at quarter-end in late 2007 and early 2008 rendered the firm’s financial statements and related disclosures materially misleading.” Ernst & Young’s own work papers define materiality “as any item individually, or in the aggregate, that moves net leverage by 0.1 or more.” The Examiner reports that “Repo 105 moved net leverage not by tenths, but by whole points.” This is a textbook example of the case where an omitted disclosure causes financial statements to be materially misleading.

Will Lehman Brothers be Ernst & Young’s Waterloo like Enron was for Arthur Andersen?


The source of the information for this blog is the Report of Anton R. Valukas, Examiner, In re Lehman Brothers Holdings Inc., et al., for the United States Bankruptcy Court, Southern District of New York, dated March 11, 2010…and, of course, Repo Man.