Report faults executives with manipulating Lehman Brothers' balance sheet

Evidence exists that CEO Richard S. Fuld Jr. and his top lieutenants were "at least grossly negligent," according to the report.
Evidence exists that CEO Richard S. Fuld Jr. and his top lieutenants were "at least grossly negligent," according to the report. (Susan Biddle/the Washington Post)
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By Tomoeh Murakami Tse
Washington Post Staff Writer
Saturday, March 13, 2010

A high-profile report on Lehman Brothers raises fresh questions about whether senior executives at the failed Wall Street investment bank presented a misleading picture of its financial health and whether government regulators did enough to prevent the firm's sudden collapse.

The 2,200-page report, unsealed late Thursday, accuses top Lehman executives of manipulating Lehman's balance sheet, auditor Ernst & Young of potential malpractice and top regulators of inaction even as the firm failed multiple tests to assess its ability to withstand a run on the bank.

On Friday, Wall Street was abuzz with details of the document, filled with e-mails and interviews with top financial industry and government officials. Legal experts characterized the report as a "blueprint" for prosecutors and a "gift" to attorneys jostling on behalf of clients in bankruptcy court for a piece of Lehman's estate.

Various civil suits have been filed against Lehman executives, and federal prosecutors are investigating whether investors were misled. Enough evidence exists, the report said, that Richard S. Fuld Jr., chief executive of Lehman at the time, and top lieutenants were "at least grossly negligent," and could be subject to damages in a civil trial.

John D. Lovi, a securities lawyer with Steptoe & Johnson, said he was preparing to notify his clients -- a large Korean fund that has filed a claim before the judge overseeing Lehman's bankruptcy -- of the report's findings. He said they would consider going after individuals at Lehman and Ernst & Young to recoup losses incurred when the bank collapsed. "It changes our thinking," he said.

It was far from clear, however, whether criminal charges would result, as the government faces the difficult task of proving criminal intent, former prosecutors said. "There's no question that prosecutors and other attorneys will be scouring this report for information that could help them to build their cases," said Robert Mintz, a former federal prosecutor.

Lehman's bankruptcy filing in September 2008, the largest in U.S. history, helped spread fear through global markets and prompted the federal government to step in with a multibillion-dollar rescue package for the financial industry. The report identifies various factors that contributed to the 158-year-old firm's failure, including demands for collateral by rival banks such as J.P. Morgan Chase.

'Repo 105'

The report, conducted by a court-appointed examiner as part of Lehman's ongoing bankruptcy, said executives manipulated Lehman's balance sheet, using a "materially misleading" accounting trick to temporarily remove up to $50 billion of troubled assets at the end of each quarter.

Known as "Repo 105" within the firm, the move made Lehman's use of borrowed money appear significantly less than it was.

In an April 2008 e-mail cited by the report, Lehman's Chief Operating Officer Herbert McDade referred to the accounting moves as "another drug we r on." In an interview with the examiner, McDade, who says he tried to reduce their use, said he talked with Fuld about the maneuvers.

Fuld's lawyer, Patricia Hynes of Allen & Overy, said he was not aware of the accounting details. "At no time did Lehman's senior financial officers, legal counsel or Ernst & Young raise concerns about the use of Repo 105 with Mr. Fuld," she said.

The report also criticizes Ernst & Young for not taking any steps after another Lehman executive, Matthew Lee, raised questions about Repo 105 in June 2008. A day later, the firm met with the audit committee of Lehman's board but did not alert members to Lee's concerns, the report said.

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