Ex-Lehman Brothers directors and their UK advisers could face a fresh blitz of civil and criminal charges following the publication on Friday of the explosive report into the collapse of the Wall Street bank which claimed it "misrepresented" its financial position.
According to US legal experts yesterday, the former Lehman boss, Dick Fuld, and other directors could be pursued by the Securities and Exchange Commission, the US watchdog, for civil charges of securities fraud. Other government enforcement agencies could also bring criminal charges. The 2,200-page report by Anton Valukas, appointed by a New York bankruptcy court, established that Lehman exploited a loophole between US and UK law which allowed it to keep $50bn (£33bn) of debt off its balance sheet, thus providing a better picture of its health. Mr Valukas described the use of the mechanism – a Repo 105 – as an "accounting gimmick" which led to a "material misrepresentation" to investors about the true state of its finances.
Civil charges are almost certain to be pursued by the SEC if the financial statements were false and directors could be prosecuted under the 2002 Sarbanes-Oxley Act which requires the chief executive and the chief financial officer to certify that the financial statements comply with all applicable statutes and rules.
One US lawyer said that provided Mr Fuld and Lehman's three chief financial officers during 2007 and 2008 knew of the effect of the Repo 105 transactions, criminal charges could also be brought. Any criminal prosecution would need the government to prove intent to defraud or knowledge that statements were false or misleading, he said.
Under the Repo 105 scheme, the bank would temporarily sell $105 of risky loans and investments to other institutions for $100 with a guarantee that it would buy them back a few days later. The 5 per cent difference meant that it could be classed as a proper sale, and not an accounting trick, and the result was that Lehman's balance sheet looked stronger because it had more cash.
The report also concludes there is credible evidence of professional malpractice against UK accountants Ernst & Young which advised Lehman's London subsidiary which carried out the Repo 105 transactions. These were based on an "opinion letter" from Linklaters, the law firm, which signed off on the deals claiming that they were sales and not financing arrangements. The report does not suggest Linklaters acted illegally although New York lawyers had refused to approve the procedure. Both E&Y and Linklaters have denied any wrongdoing.
At the heart of the Valukas review is the revelation that Lehman increased its use of Repo 105 transactions to reduce its leverage by $38.6bn in the fourth quarter of 2007, by $49.1bn in the first quarter of 2008 and $50.4bn in the second quarter of 2008. Lehman is said to have timed these deals to the ends of the quarter, allowing it to flatter its true financial position in its results.