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March 31, 2010
SEC Widens Inquiry into Pre-Crash Accounting by Financial Firms
    by Robert Kropp

As criminal charges against Lehman Brothers are contemplated, the SEC Division of Corporation Finance requests accounting information from other companies.

Earlier this month, Anton Valukas issued his 2,200-page report on the 2008 collapse of Lehman Brothers, an event that was central to the financial crisis that soon engulfed the global economy. In his investigation, Valukas found that Lehman had utilized an accounting device to reduce its leverage by $39 billion in the fourth quarter of 2007, $49 billion in the first quarter of 2008, and $50 billion in the second quarter of 2008, by categorizing transactions known as repurchase agreements as sales.

Repurchase agreements are generally categorized as loans. By removing assets from its balance sheet, Lehman managed to reduce its leverage, which at the time consisted of $25 billion in capital supporting $700 billion in assets. Lehman's reduction in leverage was designed to improve its credit rating.

In his report to the bankruptcy court, Valukas wrote that the balance sheet manipulation was "exacerbated by Lehman executives, whose conduct ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation; by the investment bank business model, which rewarded excessive risk taking and leverage; and by government agencies, who by their own admission might better have anticipated or mitigated the outcome."

The impact on investors of Lehman's balance sheet manipulation was pronounced, as it has been reported that the company sold $12 billion worth of stock during this time.

What SEC Chairman Mary Schapiro hopes will amount to a "culture change" at the Commission was illustrated by a letter sent to upwards of 20 financial firms from the Commission's Division of Corporation Finance, asking them to provide information to the Commission regarding "accounting for certain of your repurchase agreements, securities lending transactions, or other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets."

The SEC also asked that if the companies "did not provide disclosure of those transactions in your Managementís Discussion and Analysis, please advise us of the basis for your conclusion that disclosure was not necessary and describe the process you undertook to reach that conclusion." The letter gave the companies ten days to respond.


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