The End of Lehman, Part 3: Repo 105 and the Legacy of Lehman

Ben Hallman is a staff writer at The Center for Public Integrity, a nonprofit investigative news organization in Washington, D.C. Financial Reform Watch, a blog tracking accountability news and analysis about the implementation of Dodd-Frank, is his latest project.

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For parts one and two of CPI’s three-part series marking the anniversary of the fall of Lehman, please click here and here.

re: The Auditors will continue to cover Lehman, Repo 105, Tony Valukas, and the bankruptcy examiner’s report, as well as related topics. For more, start herehere, here, and here.

This article is reprinted here by permission.

The End of Lehman, Part 3

Repo 105 and the Legacy of Lehman

Financial Reform Watch blogger Ben Hallman looks at how Lehman Brothers was a leader in disguising its losses—and how a government investigation into Lehman’s practices could offer federal authorities their best, and possibly last, chance to hold individuals responsible for the crisis personally accountable.

In February of 2009, Anton Valukas, a former U.S. attorney in Chicago, was appointed by the bankruptcy court to examine the failure of Lehman Brothers. Fourteen months later, after an exhaustive — and expensive — effort by his law firm, Jenner & Block, Valukas made public his findings in a 2,200-page report.

The report did what journalists and federal investigators had so far failed to do: produce convincing, prosecutable evidence that senior Lehman executives were culpable in the bank’s downfall. In the months before Lehman collapsed like a Jenga tower at a preschool, the investment bank used a dodgy accounting maneuver called Repo 105 to hide as much as $50 billion from its balance sheet in an attempt to look less leveraged than it actually was.

According to a recent Wall Street Journal report, Repo 105 is now at the center of the Securities and Exchange Commission’s investigation. Former Lehman chief executive Richard Fuld Jr., and two former Lehman chief financial officers are in the agency’s crosshairs, the paper said.

I recently interviewed Valukas and his team of investigators for a story for the September issue of The American Lawyer magazine. It was the first time they have spoken publically about the investigation. They shared new details about their discovery of Repo 105 and what it might mean for prosecutors seeking to hold Lehman executives accountable.

Valukas and his team first learned about Repo 105 from a Lehman whistleblower named Matthew Lee. In the spring of 2008, Lee wrote a letter to senior Lehman executives spelling out his concerns. He later met with several Lehman officials and with representatives from Lehman’s outside auditor, Ernst & Young. Nothing was done.

It wasn’t the last time that Lee told his story and was ignored. Before the examiner’s lawyers interviewed Lee, Robert Byman, who served as Valukas’s chief of staff for the investigation, called an assistant U.S. attorney who was investigating Lehman. It was standard protocol at that point to clear interviews with the office.

Go ahead if you want, Byman said he was told, but the U.S. attorney’s office added that it viewed Lee as a “kook.”


Repurchase agreements are common, but typically an entity must keep the underlying asset on its balance sheet. Repos act as secured loans, a way for a bank to raise quick cash, with the underlying security as collateral. For example, I might give my colleague, Michael Hudson, my bicycle, which is worth $120, in exchange for $100 in cash. I would use that cash to pay off — again, just for example — my very angry bookie. When I got my next paycheck, I would return the $100 plus interest, and get my bike back. (Everyone is happy, and I keep my knee caps).

Lehman, though, booked the repo transactions as a sale. Near the end of a financial quarter, Lehman’s European unit would “sell” securities to a counterparty and would use the money to pay down other short-term liabilities, so it could report quarterly leverage numbers low enough to satisfy the ratings agencies, and thus investors. A few days after the quarter end, Lehman would repay the cash, plus a hefty interest, and get its securities back.

This trick gave the illusion that Lehman was less leveraged than it actually was. Dozens of rank-and-file employees told the examiner that they were under tremendous pressure to make the Repo 105 deals, especially as Lehman’s financial position got increasingly shaky.

Lehman’s own executives described the maneuver as a “gimmick” and, in an email, as “another drug we r on.”

In the end, the numbers were huge. As Lehman was forced to announce a quarterly loss of $2.8 billion at the end of the second quarter of 2008, it sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio to less than 12.5 and that it had reduced the net assets on its balance sheet by more than $50 billion. Lehman did not disclose, however, that it had used Repo 105 to temporarily remove the assets.

Valukas also says that there are “colorable claims” against Ernst & Young for its role in allowing the transactions. Fuld, the Lehman executives, and Ernst & Young have denied any wrongdoing.

A Fuld prosecution may provide the SEC — and the Justice Department, if it follows on — the best chance to hold an architect of the financial crisis personally responsible. But the case isn’t a slam dunk.

What happened at Lehman with Repo 105 is simply not comparable to the fraud at places like Enron and HealthSouth. There was no cover up. It was used for nearly a decade, supported by the opinion of counsel at a law firm in London, and either ignored or tacitly approved by accountants at Ernst & Young.

“This was not a secret,” one of the Jenner & Block investigators told me. “It was widely discussed at all levels.”


Some senior Lehman employees vigorously defended the practice to the investigators. One executive, Kaushik Amin, the former head of liquid markets in Lehman’s fixed income division, got agitated when the investigators questioned him about Repo 105. “If the examiner thinks we were using Repo 105 to manipulate the balance sheet, he is smoking dope,” Amin said, according to the lawyers present at the interview.

Lehman executives also claimed that it wasn’t alone in classifying assets in this way, and the intervening months have proved them right. A few months ago, Bank of America said it wrongly classified $10.7 billion in repo agreements as sales, Citigroup said it misclassified $9.2 billion, and American International Group said it misclassified $2.3 billion.

Ultimately, the bankruptcy examiner opted not to inveigh on whether Repo 105 was itself a violation of accounting rules, a decision that likely saved executives like Amin from being fingered as individuals whose actions leave them vulnerable to civil prosecution. Instead, he focused on the sole issue of disclosure. Whatever the purpose of the transactions, Lehman had an obligation to tell investors what it was doing, Valukas said.


What government investigators might do with the evidence that the examiner turned up is anyone’s guess. The SEC, and, especially, the Justice Department, have struggled mightily thus far to win financial crisis-related cases. The highest profile case to go to trial involved two Bear Stearns hedge fund managers, who had had exchanged emails that suggested they thought what they were peddling was junk. Last November, a federal jury quickly acquitted both of criminal fraud charges.

The SEC has succeeded in wringing out some hefty fines from institutions — most notably $500 million from Goldman Sachs — but individuals have mostly gone unpunished. The SEC has a big one queued up, though: Angelo Mozilo and two other former Countrywide executives are set to go to trial on civil fraud charges beginning Oct. 19 in Los Angeles federal district court.

Accountability is a curious thing. Will Americans feel better about the government’s response to the financial crisis if the former chief executive of one bank is forced to pay a big fine? Add Mozilo and a handful of former chief financial officers to the mix. What if they have to surrender some of their fortune, too?

Put in a historical context, it doesn’t seem like much. Consider: in the wake of the savings and loan crisis 20 years ago, more than a thousand S&L insiders were convicted of felonies, including big names such as Lincoln Savings’ Charles Keating. Financial titans who served time behind bars as a result of the Wall Street scandals of the same era included junk bond king Michael Milken.

Another curious thing about accountability. A few years ago, the thought that a handful, at best, of the architects of the financial crisis would be punished would have seemed like the absolute least the government could do. Now, it is the most.

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Trackbacks & Pingbacks

  1. […] example of fraud and stronger support for claims of fraud regarding a crisis transaction than Repo 105, I don’t know what it is. Not only did Jenner & Block chairman, non-armchair prosecutor, […]

  2. […] Street Journal. Fraud charges against EY are expected to be focused on its role as enabler of theinfamous Repo 105 transactions that Lehman used to “window-dress” its balance […]

  3. […] charges against Ernst & Young are expected to be focused on EY’s role as enabler of the infamous Repo 105 transactions that Lehman used to “window-dress” its balance […]

  4. […] examiner’s report, issued in March 2010, is a 2,000-word work of compelling non-fiction.  Anton Valukas, the examiner, gave us a model by which all future examination documents will be […]

  5. […] the most notorious off-balance sheet strategy to come out of the crisis was Repo 105.  Start here for a set of links describing the technique and Ernst & Young’s response to the […]

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