The Origins Of Lehman’s ‘repo 105’

At the time of insolvency, Lehman held $700 billion in assets and only $25 billion in equity. The bank held assets that had a maturity of over a year while its liabilities were mostly short-term, maturing in less than one year. That imbalance forced Lehman to borrow billions of dollars through the Repo market to pay its short-term debt obligations. The sales proceeds are used to pay down debts, enabling the company to temporarily reduce liabilities for the purpose of financial reporting. After the balance sheet is published, then the company borrows cash and immediately repurchases the assets. Prior to the bankruptcy, Lehman worked hard to make its financial condition look better than it was, the Valukas report says. A key step was to move $50 billion of assets off its books to conceal its heavy borrowing, or leverage.

repo 105

Repo 105 transactions used by Lehman were almost similar to ordinary repo transactions that banks use to borrow short-term loans – except that Lehman reported the transaction as a sale rather than as a financing transaction. Recording Repo 105 as a sale rather than as a financing transaction allowed the bank to remove debt from the balance sheet. SEC chairman, Mary Schapiro, indicated that the agency was trying to determine whether other companies used similar techniques as the “repo 105” used by Lehman Brothers.

Lehmans Defense Of Repo 105

With the initial hoopla over Lehman’s Repo 105, it’s time to get technical on the accounting “gimmick” Lehman Brothers used to move some $50 billion in assets off its balance sheet. The SEC has asked about 20 financial firms whether they used the Repo 105, the off-the-balance-sheet accounting method that Lehman Brothers used. And if they did, the SEC wants to know the business justification for using them. There was no agreement that required the transferor to repurchase the assets before their maturity or permitted the transferee to require the transferor to return specific assets. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. The examiner claimed that the management did not foresee the mortgage crisis.

repo 105

The law firm decreed in its briefs, at least as outlined in the 2006 iteration obtained by Mr. Valukas, that intent matters. If two parties intend to exchange assets for cash, and then later the party receiving the assets decides to hand back “equivalent assets rather than the very assets that were originally delivered,” that amounts to a sale. Unlike other repos, the value of the securities Lehman pledged in Repo 105 transactions were worth 105 percent of the cash it received. And when Lehman eventually repaid the cash it received from its counterparties, it did so with interest, making this a rather expensive technique. The Securities and Exchange Commission must’ve read the bankruptcy examiner’s report on Lehman Brothers, because now the regulatory agency wants to know if other banks pulled similar off-balance sheet accounting tricks. The manipulation of the balance sheet was neither made public to the company’s shareholders nor included in the financial report’s footnotes. The bank used the technique to make it look like it was less reliant on loans than it actually was.

Revisions To Accounting Standards After Mf Globals Bankruptcy

The borrower promises to pay back the short-term loan plus interest, and the collateral does not change hands. The collateral, usually a bond, is assumed to have been sold off and then bought back.

repo 105

Herring argues that as long as accounting firms are paid by the companies they audit, there will be an incentive to dress up the client’s appearance. This gap allowed the company to record the transaction as if it had been a true sale of the bond — despite the fact that, under the agreement, the company would repurchase the bond just a week or so after it had sold it. To make the loan safer for the big company, the bank “sells” the company some asset — like a bond. That way, if the bank goes bankrupt before it repays the loan, the big company can sell the bond and get its money back. The continued effects of the pandemic, along with the implementation of new accounting standards, have companies and their auditors confronting substantial change in year-end audits.

A new rule, FAS 166, replaces the 98%-102% test with one designed to get at the intent behind a repurchase agreement. The new rule, just taking effect now, looks at whether a transaction truly involves a transfer of risk and reward.

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Lehman and Linklaters refreshed their agreement multiple times, according to Mr. Valukas’s report. SEC Chairman Mary Schapiro has previously stated that her agency’s oversight of Lehman Brothers was “terribly flawed in design and execution.” If you’re republishing online, you must link to the URL of this story on, include all of the links from our story, including our newsletter sign up language and link, and use our PixelPing tag. The CPA Journal is a publication of the New York State Society of CPAs, and is internationally recognized as an outstanding, technical-refereed publication for accounting practitioners, educators, and other financial professionals all over the globe. Edited by CPAs for CPAs, it aims to provide accounting and other financial professionals with the information and analysis they need to succeed in today’s business environment. Lehman used this brief, but very specific, guidance to create agreements that would fall outside of FASB’s bright-line guidance for “substantially all” and therefore could be accounted for as sales. The assets to be repurchased were substantially the same as those that were transferred.

Finally, the assets returned to the transferor at the settlement date do not have to be the same assets that were originally transferred. The Valukas report also shows the need for better risk-management assessments by firm’s boards of directors, Herring says. The IASB and FASB, senior bodies responsible for setting accounting standards, met in April 2010 to review the accounting treatment for such repo transactions.

The Origins Of Lehmans repo 105

Under the previous accounting rules, whether a repo was reported as a sale or financing depended in part on whether a company kept effective control over the transferred assets. Effective control in turn depended on the company’s ability to buy the assets back. Judgment is needed to interpret the term substantially all and other aspects of the criterion that the terms of a repurchase agreement do not maintain effective control over the transferred asset. The Board believes that other collateral arrangements typically fall well outside that guideline.

First, the transferee actually acquires title to the securities on the trade date and has the authority to sell or pledge the assets to another party during the term of the agreement. In addition, if the fair value of the asset declines, the agreement may give the transferee the right to demand more collateral.

The whole point of GAAP is that it allows an outsider to look at the balance sheet and draw conclusions regarding the health of a company. We have seen this with Enron, with Lehman, with Greece, however, nothing beats Federal Government’s budget, the King of pretending trillions of liabilities not existing. Marian Wang was a reporter for ProPublica, covering education and college debt. As business reporters sniff through Anton Valukas’ 2,200-page “coroner’s report” on Lehman, here’s a look at all the people who’ve denied they knew anything about the “Repo 105” scam. Free Financial Modeling Guide A Complete Guide to Financial Modeling This resource is designed to be the best free guide to financial modeling!

What is term repo?

Repo is a money market instrument, which enables collateralised short term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate.

I’m sure Geithner and Paulson new of the technique and so did their staff auditors. Why weren’t they more proactive in requiring full disclosure for all financial institutions they were monitoring. This just shows how much damage can be unleashed when regulators don’t regulate. In short like the government cooking the books has become the American way of doing business.

Concealing Financial Distress With Repo 105

What a surprise,” They made money the old fashion way, they moved it to another column on the ledger” . No surprise that fraud is involved in the failure of another investment banking business. Oh, sorry, it’s Legal Fraud, there is a disclaimer, somewhere in the file cabinet. Perhaps we read different articles Doctor, but not one US law firm signed off on this practice. Perhaps we read different aricles Doctor, but not one US law firm signed off on this practice.

What happened to Bear Stearns and Lehman Brothers?

Lehman’s stock fell sharply as the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds. During that month, the company eliminated 1,200 mortgage-related jobs and shut down its BNC unit. 5 It also closed offices of Alt-A lender Aurora in three states.

The housing market continued to decline, and in the second quarter of 2008 Lehman reported its first loss since going public in 1994. Banks refused to extend lines of credit, and, without cash, Lehman was unable to continue operating and filed for bankruptcy on September 15, 2008. The Repo 105 and 108 transactions were not the sole cause of the bankruptcy; however, they helped disguise the actual financial position of the company for over a year. Anton Valukas, the court-appointed bankruptcy examiner, stated in his 2010 report that it was clear that the executives engaged in these transactions for the sole purpose of improving the balance sheet and leverage ratios.

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Since the bankruptcy, Linklaters has also advised PricewaterhouseCoopers in its administration of Lehman’s international arm. You may change your billing preferences at any time in the Customer Center or call Customer Service. In our experience, when queried about Repo 105, banks aren’t exactly forthcoming. If you share republished stories on social media, we’d appreciate being tagged in your posts. We have official accounts for ProPublica and ProPublica Illinois on both Twitter (@ProPublica and @ProPublicaIL) and Facebook. Any website our stories appear on must include a prominent and effective way to contact you.

History shows, though, that if a loophole exists, eventually someone will find and exploit it. Only time will tell whether replacing the exploited brightlines with more principles-based guidance will solve the underlying problems or merely open the door to new ones. By early October 2011, these RTMs had produced $124 million in upfront gains. MF Global was still responsible, however, for covering the margins for any declines in the market value of the securities. As fears of default increased, the required margins also increased, and MF Global had to find additional sources of cash to meet them. This need for cash ultimately resulted in the misappropriation of millions of dollars from customer accounts, and the company filed for bankruptcy on October 31, 2011. FAS 140 allowed the pooled securities to be moved off the issuing firm’s balance sheet, protecting investors who bought the securities in case the issuer ran into trouble later.

So the “intent” of this “aggressive accounting”/expensive repurchase agreement was to restate Lehmans’ income statement and the assets on the balance sheets at a specific time period, specifically the YEAR END 2007. For most repos, the economic substance of the transaction is similar to a secured loan. The cash received for the securities is less than the fair value of the asset and represents the principal of the loan. The difference between the fair value of the asset transferred and the cash received is referred to as the “haircut” in repo transactions. The securities transferred are the collateral, and the amount paid to repurchase the securities represents payment of the principal plus interest at the agreed-upon rate. If the transferor defaults and does not repur-chase the securities, the transferee can sell them to satisfy the obligation.

What Is Repo 105?

No American law firm would provide Lehman with such a statement; instead, it had to employ Linklaters LLP in London, which stated that the transaction represented a true sale only under English law. Therefore, the transactions had to be executed by Lehman Brothers International in Europe, with European banks as transfer-ees. The consolidated financial statements of Lehman Brothers Holdings Inc. that included these transactions were, however, filed in the United States. When the housing market began to collapse in 2007, Lehman and other similar firms recorded huge losses in write-downs of subprime mortgages. At the same time, investment banks, including Lehman, were advised to reduce their leverage to avoid ratings downgrades.

One executive email cited in the report described the program as just “window dressing.” But the company, which had international operations, managed to get a legal opinion from a British law firm saying the technique was legal. Lehman would take the money it got from selling the bond and pay off some of its debts. Then, after it had issued its quarterly report, the company would borrow more money to repurchase the bond.

Of those three questions, Audit Analytics found that the SEC most often inquired about the last one. When Jon Corzine became CEO of MF Global in 2010—after losing his reelection bid for New Jersey governor—the company had not shown a profit in over four years and had a credit rating only two steps above junk status. Rating agencies told Corzine that the company needed to increase revenues by at least $200 million or face further downgrades. MF Global had generated much of its revenue from interest income, and when the Federal Reserve dramatically cut interest rates in 2008, that revenue dropped sharply. Because revenue needed to be generated quickly, the trades were structured as repo-to-maturity agreements. Lehman’s use of Repo 105 was clearly intended to deceive, the Vakulas report concludes.

Lehman Brothers Autopsy: Repo 105, And Why Auditors Have Some Explaining To Do

Excessive short-term borrowing made lenders lose confidence in the bank’s ability to pay back loans. The bank turned to financial statement manipulation to hide its financial distress from the rating agencies and investors. In the opinion of the examiner, there was sufficient evidence to support legal action and recovery of losses from the bank’s executives.

  • Repurchase agreements, or repos, have existed since 1917 and play an important role in the short-term liquidity markets.
  • The CPA Journal is a publication of the New York State Society of CPAs, and is internationally recognized as an outstanding, technical-refereed publication for accounting practitioners, educators, and other financial professionals all over the globe.
  • So under accounting rules, the assets a bank uses in repo deals stay on the bank’s balance sheet.
  • The lender – the firm purchasing the assets – therefore demands a very low interest rate.
  • The IASB and FASB, senior bodies responsible for setting accounting standards, met in April 2010 to review the accounting treatment for such repo transactions.

While Lehman’s huge indebtedness and other mistakes have been well documented, the $30 million study by Anton Valukas, assigned by the bankruptcy court, contains a number of surprises and new insights, several Wharton faculty members say. Regardless, I’d suggest reading Audit Analytics report to get a sense of what has caught the SEC’s attention under FAS 140 in the past. Our second annual Cyber Risk & Data Privacy Summit is a virtual event wherein top-of-mind topics related to data privacy and cybersecurity will be examined by keynotes and panelists and best practices for compliance practitioners will be shared. When I acted as a corporate internal auditor, our accountants (Ernst & Young) requested that I prepare “Subsequent Transaction” schedules for their review.

Repos, as they are called, are used to convert securities and other assets into cash needed for a firm’s various activities, such as trading. “There are a number of different kinds, but the basic idea is you sell the security to somebody and they give you cash, and then you agree to repurchase it the next day at a fixed price,” Allen says. Suggests that the other firms participating in Lehman’s Repo 105 transactions must have known the whole purpose was to deceive. “I thought Repo 105 was absolutely remarkable – that Ernst & Young signed off on that. All of this was simply an artifice, to deceive people.” According to Siegel, the report confirms earlier evidence that Lehman’s chief problem was excessive borrowing, or over-leverage. He argues that it strengthens the case for tougher restrictions on borrowing. But when Lehman Brothers wanted to make it look like it wasn’t borrowing so much money, the company used a special technique to get around this rule.