Closing the GAAP: FASB Addresses Apparent Loophole that Enabled the Lehman Repo 105 Fraud


As thoroughly detailed in the 2,200-page Examiner’s Report on the fraudulent accounting that was central to the Lehman Bros. failure, repurchase agreements ("repos") that should have been treated for financial reporting purposes as secured borrowing arrangements were improperly accounted for as sales transactions.

Now the Financial Accounting Standards Board ("FASB") has issued an amendment to the codified version of SFAS 140 that eliminates entirely the "transferor’s ability" criterion from the consideration of effective control for repos and other agreements that both entitle and obligate the transferor to repurchase or redeem financial assets before their maturity. In Accounting Standards Update 2011-03, it has concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, and not on whether the transferor has the practical ability to perform in accordance with those rights or obligations. Using the Lehman "Repo 105s" for reference purposes, Lehman’s borrowings of as much as $50 billion at any given financial reporting date contractually bound it to repay these loans, making them liabilities, and required that the collateral transferred be kept on Lehman’s balance sheets as its owned assets. Had this been done, even use of the proceeds to pay down other obligations (which was not, and will not be, prohibited) would not have resulted in the gross understatement of Lehman’s debt/equity ratio, as in fact regularly and increasingly occurred in the years leading up to its demise. Financial analysts, investors and other users would have clearly seen what financial maneuvers were being engaged in, which they may have then approved or challenged, being in possession of the information needed to respond wisely. Read the full story.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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