Lehman examiner's report puts 'face' on financial crisis and it looks like Fuld, Callan, O'Meara

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March 18, 2010, 4:53 p.m. EDT
Lehman examiner's report puts 'face' on financial crisis
Harsh light falls on Fuld, Callan, O'Meara; but criminal charges may be difficult
By Alistair Barr, MarketWatch


SAN FRANCISCO (MarketWatch) -- Most of the markets-jarring scandals of the past decade had culprits. The Enron scandal had Kenneth Lay and Jeffrey Skilling. WorldCom's $11 billion fraud put Chief Executive Bernie Ebbers in prison, where former Tyco International CEO Dennis Kozlowski also resides.

But 18 months after Lehman Brothers (OTHER:LEHMQ) collapsed, triggering the worst global financial crisis since the Great Depression, few top Wall Street executives have been charged or held responsible for the carnage.

A 2,200-page report on why Lehman failed, unsealed March 11, may change that, legal experts said this week.

"Since this crisis began, we have failed to put a face on it," said James Cox, a law professor at Duke University. "We don't have a Skilling or a Ken Lay for the crisis. This could be it."

Cox read the report and found it very different, he said, from similar reports into other alleged wrongdoing, such as options backdating.

"They were scrubbed by the lawyers of anything definite or condemning. You never find out it was Mr. Mustard in the library with the candlestick," Cox said. "This guy wrote a very different report. It has specific facts linked to specific people and supports findings with lots of documents.

"In the U.S. attorney's office or the state attorney's office in New York, why wouldn't I want to talk to some of these witnesses and find out if there's been a criminal violation?" Cox added. "There's enough to pique the interest of prosecutors."

Soon after Lehman's bankruptcy, the Department of Justice subpoenaed at least a dozen of the firm's executives, including Richard Fuld, the former chief executive, and former Chief Financial Officers Erin Callan and Ian Lowitt, according to a Wall Street Journal report. Since then, no government prosecutions or lawsuits by regulators have been filed. A spokeswoman for the Justice Department declined to comment Wednesday.

The Securities and Exchange Commission, which regulated Lehman and has the power to file civil rather than criminal lawsuits, is reviewing the firm's activities during the critical period before it collapsed, Chairman Mary Schapiro said Wednesday.

"Our review of activity during this period is taking us down a broad path," she added. An SEC spokesman declined to comment on whether the SEC is investigating Lehman or any former executives.

If regulators aren't investigating, the Lehman bankruptcy report by Valukas, chairman of the Chicago law firm Jenner and Block and a former U.S attorney, should quickly change that, Duke's Cox and other legal experts said this week.

"Prosecutors will go through this with a fine-tooth comb because it will alert them not only to potential avenues of prosecution but also to the defenses likely to be raised," said Chris Bebel, a former federal prosecutor with the U.S. attorney's office in Minneapolis and a former SEC attorney.

Bebel said he reckons there's enough evidence in Valukas' report for Fuld and possibly other former Lehman executives to be criminally prosecuted.

Repo 105 program

Such charges would likely focus on an alleged accounting maneuver Lehman used, called "Repo 105," and whether executives knew that it made the firm look financially stronger than it actually was.

Lehman introduced its Repo 105 program in about 2001. The firm couldn't get a U.S. law firm to sign off on the accounting for the transactions, so it ran them through its London-based brokerage unit and got a legal opinion from the U.K. law firm Linklaters, according to Valukas' report.

The deals temporarily removed billions of dollars of assets from Lehman's balance sheet, but the accounting made it look as if the transfers were sales. That made Lehman look less leveraged than it really was. Read about how Repo 105 works.

In 2006, senior Lehman management set a $17 billion limit on these transactions, but the firm then blew through them. By the second quarter of 2008, when investors were watching Lehman's leverage like hawks, the firm temporarily shifted as much as $50.38 billion of assets off its balance sheet in this manner, the report said.

In April 2008, Anuraj Bismal, a senior vice president at Lehman, emailed Bart McDade, then head of equities, to ask whether he knew about the use of Repo 105 to cut the size of the firm's balance sheet.

"I am very aware ... it is another drug on," McDade replied in an email, according to Valukas' report.

A week earlier, McDade recommended to Lehman's executive committee that the firm set a cap on the use of Repo 105 transactions, according to an interview Valukas conducted with McDade. At the time, this committee included Fuld, Callan and Chief Operating Officer Joseph Gregory.

In May 2008, Ryan Traversari, senior vice president for external reporting at Lehman, emailed the firm's chief risk officer, Christopher O'Meara, to point out that Repo 105 transactions made the firm's balance sheet larger at midmonth and smaller at the end of a month. Valukas has said that Lehman used such transactions to cut assets at the end of quarterly reporting periods, only to buy them back again soon afterward. O'Meara was replaced as CFO by Callan in October 2007.

Michael McGarvey, a senior member of Lehman's finance group, called the Repo 105 program "window dressing," in a July 2008 email obtained by Valukas.

Murtaza Bhallo, a former Lehman employee, said the transactions were an "accounting gimmick" in a September 2009 interview with Valukas.

Valukas said such evidence shows that four Lehman executives -- Fuld, Callan, O'Meara and Lowitt -- breached their fiduciary duty to tell investors and the firm's board such important information as that surrounding the Repo 105 program.

"There's a remarkable amount of clarity about these transactions, which is very unusual for these types of reports," Cox said. "The reference to them as gimmicks is very damning. If I were one of these executives, I would have a distinct sinking feeling."

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