Fraud 101 file: Lehman Brothers and Repo 105. Facts are from the Report of the Lehman bankruptcy examiner, Anton R. Valukas (11 March 2010) [1]. These are the examiner’s findings, not a court ruling. General information only, not financial advice.
Fifty billion dollars, off the balance sheet for a week.
That is the short version of Repo 105, the quarter-end technique Lehman Brothers used before it collapsed in 2008. According to the bankruptcy examiner, it removed as much as $50.38 billion from Lehman’s balance sheet in the second quarter of 2008 [1].
A loan that was booked as a sale
A normal repo (repurchase agreement) is a short-term loan backed by securities. You hand over securities, receive cash, and buy the securities back days later. The securities stay on your balance sheet, because economically you still own them. You’ve just borrowed against them.
The examiner found Lehman accounted for its Repo 105 transactions as “sales” [1]. So just before quarter-end the securities left the balance sheet, the cash was used to pay down other liabilities, and the balance sheet looked smaller and less leveraged. Then, “usually for a period of seven to ten days” later, the securities came back [1].
The examiner’s figures for the amounts moved at quarter-end [1]:
| Quarter | Repo 105 volume |
|---|---|
| Q4 2007 | $38.6 billion |
| Q1 2008 | $49.1 billion |
| Q2 2008 | $50.38 billion |
He concluded this created a “materially misleading picture of the firm’s financial condition” [1].
And inside the firm, people knew what it was. One Lehman executive wrote in an email quoted in the report: “it is another drug we r on” [1].
The auditor’s eye
Red flag: a “sale” that comes back in a week. If the seller is committed to buying the asset back a few days later, the risks and rewards of ownership never really moved. That’s a loan, whatever the paperwork calls it.
Three things an auditor would test:
- Quarter-end spikes. Compare balances on the reporting date with the days just before and after. A balance sheet that shrinks for the photo and grows straight back is a timing story, not a business story.
- The repurchase terms. Read the agreements, not the summary. Who is obliged to buy back, when, and at what price?
- Why now? Large deals concentrated in the last days of a quarter, with no clear business purpose beyond the reported numbers, deserve the hardest questions.
Should a deal that’s a loan on day one and back on day seven ever count as a sale? Tell us in the comments on the channel.
Watch the Short: Off Book Files on YouTube · Free download: 10 Accounting Red Flags, subscribe to the newsletter
Further reading
- A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. McDonald & Patrick Robinson
As an Amazon Associate, Off Book Files earns from qualifying purchases.
Sources
- Report of Anton R. Valukas, Examiner, In re Lehman Brothers Holdings Inc., Ch. 11 Case No. 08-13555 (Bankr. S.D.N.Y.), 11 Mar 2010, Vol. 3, Section III.A.4 (Repo 105): https://www.jenner.com/a/web/obFa233r8auoB6xdtZXE7C/4HRMZQ/VOLUME%203.pdf (index: https://jenner.com/lehman/)