Leehman Brothers

Introduction
Lehman Brothers was founded by German immigrants Henry Lehman and his brothers in the
1850s. The company first traded cotton, before with banking and securities trading, eventually
becoming an investment bank. Lehman Brothers expanded and became one of the world’s
largest investment banks.

Modern investment banks like Lehman are complex institutions with advanced and opaque
structures, with daily transactions of several billion of dollars. The main business areas of
Lehman before the collapse was typical investment banking as well as equities, fixed income,
capital markets and investment management. Their investment banking business provided
financial services such as mergers and acquisitions, underwritings and issuing securities. In the
other business lines, the equity part of Lehman invested in equity around the world while the
fixed income, capital markets and investment management parts concerned various services
and wealth management. Their main revenues came from fees derived from the size of the
transactions or services provided.

Prime Culprit
In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five mortgage
lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialized
in Alt-A loans (made to borrowers without full documentation).

The Scandal
 Hid over 50 Billion in loans by placing them under assets as sales
 They did this so the capital of the company increases and the liabilities decreases,
allowing the company to look less dependent on loans then it truly was
 They did this to trick investors
 There auditor, Ernst & Young was able to manipulate the books by using “Repo 105”
 Repo 105: An accounting trick in which a company classifies a short term loan as a sale
and subsequently uses the cash proceeds from said sale to reduce its liabilities
 Lehman used Repo 105 and Repo 108 to temporarily remove securities inventory from
its financial statements for a period of seven to ten days. The manipulation would then
portray a misleading picture of the bank’s financial position to its investors, board of
directors, and the rating agencies. Repo 105 transactions used by Lehman were almost
similar to ordinary repo transactions that banks use to borrow short-term loans – except
that Lehman reported the transaction as a sale rather than as a financing transaction.
Recording Repo 105 as a sale rather than as a financing transaction allowed the bank to
remove the transaction from the balance sheet.

Violated IFRS Rules

1. The Business entity concept
- It is reported that former CEO kept his personnal assets very close to the business
2. Principal of Conservatism
- Leehman overstated liquid assets and understated illiquid assets
3. The cost principle
- Assets were not recorded at the correct historical value
4. The Continuing Concern Concept
 - This states that investors have to assume that a business will continue to operate
until it says otherwise

Ernst & Young

 The only third party privy to the happenings at Lehman Brothers, failed to reveal the
extensive steps taken by executive leadership to conceal financial problems.
 Responsible for gross negligence and lack of corporate responsibility.
 As an accounting firm, Ernst & Young is charged with certifying that companies
deliver accurate and reliable information to shareholders.

Conclusion
Lehman brothers affected many shareholders and financial institutions around the world. Their
leadership failed to uphold their mission statement and the financial rewards for themselves
undermine their decision-making process. Self-interest led them to make decisions that were
extremely risky than their own internal controls were designed to control, and top executives
received high compensation for taking such risks. They did everything that was bad for the
business, and tried very hard to cover it up until the very end.

Recommendation
 Policy makers such as the International Financial Reporting Standards, Securities and
Exchange Commission, must commence tough policies to address the Lehman failure to
prevent some future episode.
 Firms are required to fuse with high-quality corporate governance practice to restore
investors’ confidence via ethical practices and standards.
 To require banks to hold more capital to raise the bank’s capacity to absorb losses and
makes them more flexible against sudden shocks

References:
1. https://www.omicsonline.org/open-access/what-caused-the-failure-of-lehman-brothers-
could-it-have-beenprevented-how-recommendations-for-going-forward-2472-114X-S1-
002.php?aid=77283
2. https://sevenpillarsinstitute.org/case-studies/the-dearth-of-ethics-and-the-death-of-
lehman-brothers/
3. https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp
4. https://prezi.com/bjsnixf97qf8/lehman-brothers-scandal/