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Home > Blogs > Ian Fraser > Lehman Bros: Time for Sarbox to be rethought post-Valukas

Lehman Bros: Time for Sarbox to be rethought post-Valukas

Rethinking The Sarbanes–Oxley Act Ian Fraser

This is the first of a series of QFINANCE blog posts on the Anton Valukas’s report on the collapse of Lehman Brothers. See also: The auditor’s dilemma, part 1, by Anthony Harrington; Just an accounting gimmick? by Anthony Harrington; and Repo 105, the case for the defense by Anthony Harrington.

The time bombs detonated by the court-appointed examiner’s report into the collapse of Lehman Brothers have by no means all gone off. Indeed, further explosions are expected to continue to reverberate and echo around the financial and regulatory landscape for some years to come.

The report—a 2,200-page, nine-volume page-turner written by lawyer Anton Valukas—revealed that the failed investment bank continuously manipulated its accounts from 2001 until its September 2008 collapse in order to deceive investors as to its own financial health.

Above all else, the report has highlighted that the draconian Sarbanes–Oxley (Sarbox) approach to regulating financial institutions introduced by the government of George W. Bush following the collapse of Enron has failed.

The Valukas report suggests that Sarbox was what a lot of people have long suspected it was—too rules-based to stop the clever creative accountant or the would-be manipulator of financial reporting. It will probably come to be seen as a classic case of a US administration shooting itself in the foot with a kneejerk “something must be done” regulatory response to a crisis. Sarbox will almost certainly now have to be rethought.

The Valukas report has also prompted calls for a fundamental review of the corporate governance of so-called systematically dangerous institutions (aka “too-big-to-fail” banks) such as Lehman Brothers unfortunately was; of the audit industry (including of self-regulatory standard setters such as the IASB and FASB); and of course of financial services regulation.

One of the report’s most stunning revelations is the apparent complicity of Lehman’s primary regulator, the Federal Reserve Bank of New York, in maintaining the fiction that Lehman Brothers was a well-capitalized bank, whose assets were worth what was said on the tin, and which was awash with liquidity, even as it careered towards self-destruction.

Eliot Spitzer, the former New York attorney general, has shed light on the relationship between Lehmans and the NY Fed in an article in the Huffington Post, co-authored with Professor William K. Black.

Spitzer was a notorious crusader against fraudsters and white-collar criminals on Wall Street in the mid-Noughties but had to step down as governor of New York after a prostitution scandal. Well, Spitzer is now back and in this no-holds-barred piece has called for “an immediate Congressional investigation.”

Spitzer and Black are also calling on the NY Fed to release e-mail exchanges with Lehman executives and other documents that cover analyses of the failed bank’s financial soundness. Spitzer and Black write: “What downside can there possibly be in making these records available for public analysis and scrutiny?”

They point out that the Valukas report suggests that the NY Fed—which alongside the Federal Reserve in Washington and the SEC was admittedly walking a tightrope between maintaining financial stability and preventing deceptive accounting by SDIs in 2007 and 2008—was eager to maintain the fiction that their toxic and subprime tainted mortgage “assets” were simply “misunderstood” assets.

This apparently lay behind its decision to allow Lehman to continue to deceive both its investors and the general public and to keep the firm’s “smoke and mirrors” approach to accounting from the SEC and the public gaze.

Writing in ZeroHedge, Tyler Durden said: “The Fed basically lied to everyone, while behind the scenes allowing not just worthless collateral to be pledged, but worked in complicity with Lehman’s management to misrepresent the true state of the firm’s financial affairs.”

True to form, Spitzer wants to see some scalps. And he’s probably right. If bank executives and “Big Four” accountancy firms continue to imagine they can get away with the sort of calculated deceptiveness that has been revealed to have been perpetrated by Lehmans, it could take years before trust can be rebuilt in the banking sector and there is likely to be another crisis.

Spitzer and Black conclude:

“Three years since the collapse of the secondary market in toxic mortgage products, we have yet to see significant prosecutions of the kind of fraud exposed in the Valukas report. The SDIs, with Bernanke’s open support, exorted the accounting standards board (FASB) to change the rules so that banks no longer need to recognize their losses. This has made the SDIs appear profitable and allows them to pay their executives massive, unearned bonuses based on fictional profits.

“If we are to prevent another, potentially more devastating financial crisis, we must understand what happened and who knew what. Many SDIs are hiding debt and losses and presenting deceptive portraits of their soundness. We must stop the three card monte accounting practices that create the potential and reality of fundamental misrepresentation.”

Further reading on the Sarbanes–Oxley Act

Tags: capital adequacy , central banks , creative accounting , Lehman Brothers , regulation , Sarbanes–Oxley Act , Valukas report
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