Welcome to the
February 2010
edition
of the International Association of Risk and
Compliance Professionals (IARCP) newsletter
Dear
Member,
Download the 190 pages e-book: "Discover 100 Job Descriptions in
Risk and Compliance Management and what it takes to get hired. Which
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It is a great reference book, developed in 2010, free to all
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Contents
1.
Risk
Professionals
2.
Compliance
Professionals
3.
Sarbanes Oxley
Professionals
4.
Basel ii
Professionals
5.
Solvency ii
Professionals
6.
Hedge Funds
Professionals
7. Members of the
Board of Directors
Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s
Report
Jenner & Block is providing links to the Report of the
Examiner in the Chapter 11 proceedings of Lehman Brothers
Holdings Inc. The Examiner’s report is divided into nine
volumes, which are reproduced below in individual Adobe Acrobat
PDF files.
The Examiner in this matter was Anton R. Valukas, Chairman of
Jenner & Block. Please direct any inquires regarding the below
report to: lehmaninquiry@jenner.com.
REPORT OF ANTON R.
VALUKAS, EXAMINER
March 11, 2010
Jenner & Block LLP
INTRODUCTION
On January 29, 2008, Lehman Brothers
Holdings Inc. (“LBHI”) reported record revenues of nearly $60
billion and record earnings in excess of $4 billion for its
fiscal year ending November 30, 2007.
During January
2008, Lehman’s stock traded as high as $65.73 per share and
averaged in the high to mid-fifties, implying a market
capitalization of over $30 billion.
Less than eight
months later, on September 12, 2008, Lehman’s stock closed under
$4, a decline of nearly 95% from its January 2008 value.
On September 15, 2008, LBHI sought Chapter 11 protection, in the
largest bankruptcy proceeding ever filed.
There are many
reasons Lehman failed, and the responsibility is shared. Lehman
was more the consequence than the cause of a deteriorating
economic climate.
Lehman’s financial plight, and the
consequences to Lehman’s creditors and shareholders, was
exacerbated by Lehman executives, whose conduct ranged from
serious but non-culpable errors of business judgment to
actionable balance sheet manipulation; by the investment bank
business model, which rewarded excessive risk taking and
leverage; and by Government agencies, who by their own admission
might better have anticipated or mitigated the outcome.
Lehman’s business model was not unique; all of the major
investment banks that existed at the time followed some
variation of a high-risk, high-leverage model that required the
confidence of counterparties to sustain.
Lehman
maintained approximately $700 billion of assets, and
corresponding liabilities, on capital of approximately $25
billion.
But the assets were predominantly long-term,
while the liabilities were largely short-term.
Lehman
funded itself through the short-term repo markets and had to
borrow tens or hundreds of billions of dollars in those markets
each day from counterparties to be able to open for business.
Confidence was critical. The moment that repo
counterparties were to lose confidence in Lehman and decline to
roll over its daily funding, Lehman would be unable to fund
itself and continue to operate.
So too with the other
investment banks, had they continued business as usual. It is no
coincidence that no major investment bank still exists with that
model.
In 2006, Lehman made the deliberate decision to
embark upon an aggressive growth strategy, to take on
significantly greater risk, and to substantially increase
leverage on its capital.
In 2007, as the sub-prime
residential mortgage business progressed from problem to crisis,
Lehman was slow to recognize the developing storm and its
spillover effect upon commercial real estate and other business
lines.
Rather than pull back, Lehman made the conscious
decision to “double down,” hoping to profit from a
counter-cyclical strategy.
As it did so, Lehman
significantly and repeatedly exceeded its own internal risk
limits and controls.
With the implosion and near collapse
of Bear Stearns in March 2008, it became clear that Lehman’s
growth strategy had been flawed, so much so that its very
survival was in jeopardy.
The markets were shaken by
Bear’s demise, and Lehman was widely considered to be the next
bank that might fail.
Confidence was eroding. Lehman
pursued a number of strategies to avoid demise.
But to
buy itself more time, to maintain that critical confidence,
Lehman painted a misleading picture of its financial condition.
Lehman required favorable ratings from the principal rating
agencies to maintain investor and counterparty confidence; and
while the rating agencies looked at many things in arriving at
their conclusions, it was clear – and clear to Lehman – that its
net leverage and liquidity numbers were of critical importance.
Indeed, Lehman’s CEO Richard S. Fuld, Jr., told the
Examiner that the rating agencies were particularly focused on
net leverage;18 Lehman knew it had to report favorable net
leverage numbers to maintain its ratings and confidence.
So at the end of the second quarter of 2008, as Lehman was
forced to announce a quarterly loss of $2.8 billion – resulting
from a combination of write-downs on assets, sales of assets at
losses, decreasing revenues, and losses on hedges – it sought to
cushion the bad news by trumpeting that it had significantly
reduced its net leverage ratio to less than 12.5, that it had
reduced the net
assets on its balance sheet by $60 billion,
and that it had a strong and robust liquidity pool.
Lehman did not disclose, however, that it had been using an
accounting device (known within Lehman as “Repo 105”) to manage
its balance sheet – by temporarily removing approximately $50
billion of assets from the balance sheet at the end of the first
and second quarters of 2008.
In an ordinary repo, Lehman
raised cash by selling assets with a simultaneous obligation to
repurchase them the next day or several days later; such
transactions were accounted for as financings, and the assets
remained on Lehman’s balance sheet.
In a Repo 105
transaction, Lehman did exactly the same thing, but because the
assets were 105% or more of the cash received, accounting rules
permitted the transactions to be treated as sales rather than
financings, so that the assets could be removed from the balance
sheet.
With Repo 105 transactions, Lehman’s reported net
leverage was 12.1 at the end of the second quarter of 2008; but
if Lehman had used ordinary repos, net leverage would have to
have been reported at 13.9.22
Contemporaneous Lehman
e-mails describe the “function called repo 105 whereby you can
repo a position for a week and it is regarded as a true sale to
get rid of net balance sheet.”
Lehman used Repo 105 for
no articulated business purpose except “to reduce balance sheet
at the quarter-end.”
Dear
members,
Thank you for reading
our newsletter.
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Best
Regards,
George Lekatis
President of
the International Association of Risk and Compliance Professionals
(IARCP)
General Manager and Chief Compliance Consultant,
Compliance LLC
1200 G Street NW Suite 800, Washington DC 20005,
USA
Tel: (202) 449-9750
Email:
lekatis@risk-compliance-association.com
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