Big Four auditors Ernst & Young were “professionally negligent” in
allowing collapsed bank Lehman Brothers to use off balance-sheet devices in the
years before its collapse, a sensational report into the bank’s demise has
In a report prepared, for the United States Bankruptcy Court, examiner Anton
Valukas claims Ernst & Young, allowed key reports to go unchallenged as
senior executives channeled fund through an off balance sheet vehicle known as
In a statement reported on the BBC’s website the firm said: “Our last audit
of the company was for the fiscal year ending November 30, 2007. Our opinion
indicated that Lehman’s financial statements for that year were fairly presented
in accordance with US Generally Accepted Accounting Principles, and we remain of
According to the report, Lehman’s recorded Repo 105 transactions as sales
rather than financing transactions, which meant accounting rules did not require
Lehman to record the liabilities arising from the cash borrowings.
Valukas claims the transactions to temporarily remove securities inventory
from its balance sheet, usually for a period of seven to ten days, to create a
materially misleading picture of the firm’s financial condition in late 2007 and
Lehman’s net leverage ratio for November 30, 2007 was 16.1x. Without the
balance sheet benefit of Repo 105 transactions, Lehman’s net leverage ratio
would have been 17.8x, according to the report.
Repo transactions involve the owner of financial assets swapping them in
return for cash but with an agreement to buy them back at a future date. They
are a common way of raising short-term financing. The deals are classed as ”
financing” and therefore the assets remain on the balance sheet because the
owners are deemed to have retained control of them.
In Lehman’s case the repo deals were booked as sales because the bank could
claim to have lost control of the asset, even though they bought them back
Loss of control was based on the idea that Lehman took less cash than its
assets were worth (in Lehman’s case the bank offered assets worth 105% of the
cash it received , hence the name of the transaction – Repo 105). As a result
Lehman would not have enough money to buy the assets back on the open market.
Control of the asset is, therefore, lost and Lehman could take the assets off
the balance sheet until they were bought back.
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