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Repo 105: No Laughing Matter

Lehman used the so-called Repo 105 tactic to remove $50 billion in debt from its balance sheet.

The SEC is investigating whether other Wall Street firms employed the deceptive accounting practice, used by Lehman Brothers in 2007 and into the second quarter of 2008, to mask its financial condition, according to a DealBook report in the New York Times.SEC Chairman Mary Schapiro confirmed on Wednesday that the regulator is looking more broadly beyond Lehman into other firms that may have used the same tactics, reported the NY Times. Lehman used the so-called Repo 105 tactic to remove $50 billion in debt from its balance sheet, at the end of the financial quarter to make its leverage level look lower, according to a bank examiner's report. Then Lehman reportedly brought the assets back onto its balance sheet after it issued the earnings report. But some pundits are skeptical that the SEC will find anything. There is even skepticism over whether Repo 105 is really a revelation. To me it sounds like déjà vu.

Repo 105 first came to light last week when a court appointed bankruptcy examiner Anton R. Valukas, issued a 2,200-plus report exposing the deceptive accounting technique. But perhaps the larger revelation is what it cost to do this report.

An ex-Lehman executive (total of three) anonymously quoted in a New York Observer article yesterday said the Repo 105 technique, which existed since 2001, "was an open secret at the firm, and if it was a secret at all." One of the ex-Lehman executives said Valukas was looking for "a smoking gun" to justify the $38.3 million cost of writing the report. (DealBook reported the Observer story, "Ex-Lehmanites: Repo 105 Outrage Inspires Giggles."

Here's a key graph from The Observer article, "The Repo Mens New Lehman Shrug":

"The trick was to make Lehman look healthier than it was. It started with a repurchasing agreement-normally a humdrum tool to raise money by selling assets that are quickly bought back. Under accounting rules, the temporarily sold assets stay on a firm's books. But because Lehman arranged to be paid about $100 for every $105 of assets, thus its name, it counted Repo 105 as a true sale. That meant it could shovel off billions from its balance sheet."

Because Lehman couldn't find a U.S. law firm to sign off on the technique, it shipped its repo technique to England where Linklaters, a prestigious law firm, deemed it legal under British law, the Observer reported.

The ex-Lehman executives maintain Repo 105 was not a big deal to professionals inside the firm, and suggest it's being blown out of proportion by the bankruptcy examiner. One executive said financial firms do things to lower their balance sheet at quarter end. "The market understands it, and they don't really care," the ex-Lehman source is quoted saying. The sources suggest people want to be mad and outraged at something so they are picking on this aspect.

One of the ex-employees quoted by the Observer contends that $50 billion that was shuffled during Q2 08 was a small number and didn't topple the firm, since Lehman's balance sheet was a huge $700 billion. It would seem this is a symptom of a larger problem, accounting gimmickry and huge amounts of cash being moved around to manipulate the balance sheet and hide the true financial condition from investors, hedge funds and other counterparties. And what about Ernst & Young, the audit firm that signed off on Lehman's quarterly reports?

Meanwhile, the idea that regulators are investigating this further is not comforting. Examiners from the SEC and the Federal Reserve Bank of New York were camped out at Lehman's offices in the spring of 2008 at a point when investors were nervous about the firm's complex debt holdings and valuations. Regulators probed Lehman's books, but didn't find anything. Now Congress (Republican Rep. Spencer Bachus of Alabama) is calling for an inquiry into the regulator's failure to detect Lehman's Repo 105 chicanery.

The one thing we can all count on is that this will be expensive. Surely, there must be a cheaper way to conduct all these studies. Hasn't Congress heard of outsourcing?Lehman used the so-called Repo 105 tactic to remove $50 billion in debt from its balance sheet. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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