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Lehman violated GAAP, says expert Print E-mail
Wednesday, 17 March 2010

By Ronald Fink

Lehman Brothers not only failed to properly disclose its use of repurchase agreements to make it look less highly leveraged than it really was, but also violated the accounting rules for such transactions, according to an accounting expert.

While the Lehman bankruptcy examiner's report issued last week found that the failed bank's lack of disclosure was "materially misleading," the report drew no conclusion as to whether the transactions, known as Repo 105, complied with the accounting rule known as SFAS 140.

But Charles Mulford, an accounting professor at the Georgia Institute of Technology and an advisor to CFOZone, contends that the way Lehman accounted for Repo 105 transactions was not consistent with its claims that the deals amounted to a sale, and thus did not comply with the requirements for removing the liabilities involved off of its balance sheet.

Over the year before it failed in September 2008, Lehman shifted as much as $50 billion of liabilities off of its balance sheet through such repurchase agreements before the end of each quarter, and then brought them back onto it a few days afterward. The bank had engaged in such balance sheet maneuvers since 2001.

To be sure, the 5 percent interest rate, known as a "haircut," that Lehman paid on the agreements was at least 3 percentage points more than guidelines issued by the Financial Accounting Standards Board say must be paid for repos to qualify as sales rather than financings.

"That seemed to fulfill the technical requirements of 140," Mulford acknowledged.

And Lehman got a UK law firm, Linklaters, to attest to the view that the transactions qualified as "true sales" after it could not find a US law firm that would do so.

But Mulford cited the examiner's finding that Lehman recorded the 5 percent haircut as an asset under a different account rule, known as SFAS 133, as inconsistent with such treatment. The accounting professor said that if the transaction were really a sale, Lehman should have recorded the haircut as a loss. But by instead treating the haircut as an asset, Lehman indicated that it still controlled the securities that collateralized the repos, and so did not comply with SFAS 140.

"Had they truly sold the securities and given up all rights to them, then the 5 percent haircut would have been recorded as a loss on sale," Mulford wrote in an email to CFOZone on Tuesday.

"That says to me that it really wasn't a sale," Mulford added in an interview on Wednesday. He said that he suspects that may be why no US law firm would sign off on the transactions. "They saw the substance of it," he said.

Mulford noted that he expected investigations by the Department of Justice and the Securities and Exchange Commission into Lehman's failure to examine this question more closely.

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