SEC Giving Up On Lehman Probe, Won't Recommend Any Action


Lehman Brothers did nothing wrong when it booked billions of dollars in phony sales to disguise the true extent of its financial woes.

That, apparently, is the surprising conclusion reached by investigators for the Securities and Exchange Commission. On Thursday, Bloomberg News reported that SEC investigators concluded a three-year probe and determined that it will probably not recommend any enforcement action against Lehman or its former executives. Bloomberg cited an excerpt of an internal agency memo in its report.

An SEC spokesman, however, said the case remains under review. "As the Chairman said, it's still under review and no final decision has been made," John Nester said in an email.

The SEC's decision, assuming the internal report is accurate, comes just a few months after President Barack Obama announced the creation of a new task force to investigate the mortgage and banking industries that wrecked the economy. It's the latest disappointment for those waiting for prosecutors to single out the individuals and institutions that created, marketed and rated the financial products that nearly brought down the American economy.

"If, in fact, the SEC decides not to pursue even a civil money penalty action against any of the senior Lehman officers, that decision will be consistent with a highly regrettable pattern that we've seen ever since the financial crisis exploded in 2008," said Arthur Wilmarth, a banking law professor at The George Washington University.

It's been more than two years since Anton Valukas, an independent examiner appointed by a bankruptcy court to investigate the collapse of Lehman, determined that there were "colorable claims" against former Lehman CEO Dick Fuld, and Ernst & Young, the auditing firm that gave the green light to the fake sales.

Those sales were known as Repo 105. Near the end of a financial quarter, Lehman’s European unit would “sell” securities to a
counterparty and would use the money to pay down other short-term liabilities, so it could report quarterly leverage numbers low enough to satisfy the ratings agencies, and thus investors. A few days after the quarter end, Lehman would repay the cash, plus a hefty interest, and get its securities back.

This gave the illusion that Lehman was less leveraged than it actually was. Dozens of rank-and-file employees told the examiner that they were under tremendous pressure to make the Repo 105 deals, especially as Lehman’s financial position got increasingly shaky. Lehman’s own executives described the maneuver as a “gimmick” and, in an email, as “another drug we r on.”

In the end, the numbers were huge. As Lehman was forced to announce a quarterly loss of $2.8 billion at the end of the second quarter of 2008, it sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio to less than 12.5 and that it had reduced the net assets on its balance sheet by more than $50 billion. Lehman did not disclose, however, that it had used Repo 105 to temporarily remove the assets.

Typically, not disclosing to investors details as significant as a hidden $50 billion in assets -- probably toxic mortgage securities -- would count as a failure to disclose material information under U.S. securities law.

CORRECTION A previous version of this story incorrectly identified Arthur Wilmarth's academic affiliation. He is a professor at The George Washington University.

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