Mr. Fuld, Raise Your Right Hand and Repeat After Me

Reports that Lehman was effectively ‘cooking its books’ prior to its ultimate demise are not a surprise.

Reports that Dick Fuld, then CEO of Lehman, was not aware of the nature of this cooking are both ridiculous and pathetic.

The lifeblood of every financial institution on Wall Street is access to financing for its operations. That financing very often comes in the form of repurchase agreements (repo financing), in which the institution borrows funds while pledging assets. These short term loans, often overnight loans, are unwound at a preset date and preset prices. The rates borrowers have to pay for funds borrowed depend on the credit quality of the borrower itself and the quality of the assets pledged.

Auditors assess the health of the institution on a variety of a measures, but ultimately look at the amount of equity capital the institution holds relative to its assets so it can determine its overall leverage. As defined by Investopedia:

The amount of debt used to finance a firm’s assets. A firm with significantly more debt than equity is considered to be highly leveraged.

A firm such as Lehman would have to pay more to borrow funds to finance its operations if lenders determined it was overleveraged. This increased cost of borrowing would eat right into Lehman’s bottom line and if the lending dried up completely would cause the firm to go belly up.

Was Lehman overleveraged? A report released yesterday is extremely revealing and incriminating of what was truly going on at Lehman, not only in the midst of the crisis but going as far back as 2001.

Welcome to the world of repo financing on Wall Street!!

Bloomberg reports on just how Lehman ‘cooked its books,’ in writing, Fuld ‘Negligent’ as Lehman Hid Leverage:

Lehman Brothers Holdings Inc. used off-balance-sheet transactions to understate its leverage in late 2007 and 2008, deceiving shareholders about its ability to withstand losses, a bankruptcy examiner’s report said.

Then-Chief Executive Officer Richard Fuld was “at least grossly negligent” for letting Lehman file financial reports in which a key gauge of strength was “reverse-engineered” through transactions known as Repo 105s, bankruptcy examiner Anton Valukas said in a report yesterday. Lehman auditor Ernst & Young LLP could be accused of “professional malpractice,” he said.

Lehman moved assets off its balance sheets via Repo 105 transactions (pledging excess collateral in return for funding) and accounted for them as sales, not financings, so that the overall leverage of the firm was disguised.

Bloomberg writes that the independent investigation reveals:

“The balance sheet manipulation was intentional, for deceptive appearances, had a material impact on Lehman’s net leverage ratio” and caused financial reports to be misleading, Valukas wrote of the New York-based company. Higher leverage undermines a firm’s capacity to absorb financial shock.

Was Fuld aware of these transactions? Does a bear dump in the woods? Fuld’s attorney begs otherwise. As Bloomberg reports:

Fuld didn’t know what the Repo 105 transactions were, his lawyer, Patricia Hynes of Allen & Overy LP in New York, said in a statement. He “didn’t structure or negotiate them,” she said. “Nor was he aware of the accounting treatment.”

What does Fuld’s right hand man, Bart McDade, have to say about this financing operation and Fuld’s knowledge?

The bank, which had been using the repos since 2001, ramped them up in mid-2007, breaching internal limits, the report shows. Lehman’s former president, Herbert “Bart” McDade, commented on them in an April 2008 e-mail exchange, after he was asked whether he knew about their effect on the balance sheet, Valukas said. “I am very aware,” McDade wrote back. “It is another drug we r on.”

Fuld, 63, received a presentation referencing Repo 105s in March 2008, and McDade, 50, recalled discussing the transactions with the CEO in June of that year, according to the report.

“Fuld knew about the accounting of Repo 105,” McDade said in an interview with Valukas on Jan. 28 this year.

What regulatory authority was charged with overseeing Lehman during this period? The NASD, which then became FINRA in 2007. Recall that FINRA’s oversight (or lack thereof) of Lehman and others is addressed in the Amerivet Securities v FINRA complaint.

In regard to Dick Fuld, his career on Wall Street started as a commercial paper trader (another form of short term borrowing). To think he was not fully cognizant of the Repo 105 transactions is beyond absurd.

Where should this Lehman situation go now? Let’s start with the following, in the appropriate halls of justice: ”Mr. Fuld, raise your right hand and repeat after me…..”

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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