Lehman Brothers Hid Up to $50 Billion in Debt Every Quarter With a Trick No US Law Firm Would Approve. It Found One in London Instead.

On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection with $639 billion in assets and $619 billion in debt — the largest bankruptcy filing in American history, and one nobody at the firm had publicly forecast even weeks earlier. Eighteen months later, a court-appointed examiner explained one of the ways the firm had kept up appearances: a $50 billion accounting trick that no law firm in the United States would put its name on.

Lehman found one anyway. It just had to cross an ocean to get it.

What Repo 105 Actually Did

The trick was a variation on an ordinary repurchase agreement, or "repo" — a short-term loan in which a firm sells securities and agrees to buy them back shortly after, usually at close to the same price. Lehman's version, internally called Repo 105, exploited a quirk in accounting rules: if a firm handed over securities worth at least 105 percent of the cash it received, the transaction could be booked as a genuine sale rather than a loan. That meant the securities — and the debt used to finance them — could disappear from the balance sheet for a few days, right around the moment Lehman reported its results to the public.

• Bankruptcy examiner Anton Valukas found Lehman used Repo 105 to move up to $50 billion off its balance sheet at the end of a single quarter.
• At the end of Q1 and Q2 2008, the technique moved a combined $100 billion, temporarily improving Lehman's reported leverage ratio from 13.9 to 12.1 — a healthier-looking number for a firm that was, in reality, more leveraged than that.
• Days later, once the quarter had closed and the numbers had been reported, Lehman routinely borrowed the cash back and reversed the trades, restoring its real balance sheet.
• The transactions were signed off under CFO Erin Callan and certified, as required by law, by CEO Richard S. Fuld Jr.

The Opinion No One in New York Would Sign

Booking a repo as a sale rather than a financing arrangement requires a "true sale" legal opinion — a law firm's written judgment that the transaction really does transfer ownership. According to the Valukas report, Lehman could not find a single U.S. law firm willing to issue one for Repo 105. It found a willing signatory in London instead: Linklaters, Lehman's outside counsel for its European broker-dealer subsidiary, issued a true-sale opinion under English law, addressed only to that London entity and covering only transactions executed under English-law repurchase agreements. Lehman then ran the U.S. balance sheet's Repo 105 trades through that same European subsidiary, so the one opinion no American firm would write could still be applied to the American books.

The Auditor Who Saw It Coming

Lehman's outside auditor, Ernst & Young, signed off on the firm's financial statements throughout this period. The Valukas report found E&Y was aware of the Repo 105 practice and its roughly $50 billion scale, and had been alerted directly by a Lehman senior vice president, Matthew Lee, who raised the accounting as improper roughly a month before the collapse — after which Lee was fired.

• In December 2010, New York Attorney General Andrew Cuomo's office sued Ernst & Young, alleging it helped Lehman deceive investors and regulators through Repo 105.
• In April 2015, E&Y settled with the New York Attorney General's office for $10 million, without admitting wrongdoing.
• Separately, E&Y paid $99 million to settle a related class-action suit brought by Lehman investors.

Everyone Kept Their Freedom

No criminal charges were ever filed against Fuld, Callan, or any other Lehman executive over Repo 105 or the firm's collapse. Fuld told Congress he had no knowledge that the transactions were being used to manage the firm's reported leverage, and no U.S. prosecutor built a criminal case that concluded otherwise. Fuld went on to found a boutique advisory firm; as of the most recent public reporting, he has never expressed regret for his role in Lehman's failure.

The largest bankruptcy in American history produced a 2,200-page federal court report identifying exactly how the numbers were faked, exactly who signed off on faking them, and exactly which firm made the fakery technically defensible. It produced two settlements, paid by the accountants who checked Lehman's math, not the executives who told them what math to check. It did not produce a single conviction.

Filed from public reporting:

• Wikipedia — Repo 105
• U.S. Senate Committee on Banking — Statement by Anton R. Valukas, Examiner, Lehman Brothers Bankruptcy
• Knowledge at Wharton — Lehman's Demise and Repo 105: No Accounting for Deception
• ProPublica — Lehman Brothers Autopsy: Repo 105, and Why Auditors Have Some Explaining to Do
• ABA Journal — Lehman Used Linklaters Opinion to Justify Aggressive Accounting, Report Says
• Yale Journal of Financial Crises — Managing the Balance Sheet Through the Use of Repo 105
• New York Attorney General — A.G. Schneiderman Announces Settlement With Ernst & Young Over Auditor's Involvement in Alleged Fraud at Lehman Brothers
• Forbes — Ernst & Young Settles With New York Over Lehman Brothers Repo 105 Deals
• Institutional Investor — Examiner's Report Highlights Lehman's Controversial 'Repo 105' Accounting
• Yahoo Finance — CEO Behind Lehman Collapse Isn't Sorry: Dick Fuld, Five Years Later