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SEC Probes Lehman-Like Accounting

April 21, 2010

SEC Chair Mary Schapiro told the House Financial Services Committee that the SEC’s Division of Corporate Finance plans to use the results of its letter-writing campaign to banks and insurance companies to gauge how much use they are making of the kinds of repurchase agreements that were identified as hiding large debts on Lehman Brothers’ balance sheet.

Last month the Division of Corporation Finance sent letters to various public companies requesting detailed information about their use of repurchase agreements or similar transactions involving the transfer of assets where they have an obligation to repurchase them, she noted. Among other things, the letters ask companies to describe their accounting for these transactions, their business purpose for engaging in them, and their impact upon liquidity; as well as provide detailed information about the financial statement impact of these transactions throughout each quarter; and discuss how that impact differed from that presented at each quarter end.

“Not only will this information enable us to better evaluate each company’s disclosure, it will help us understand whether companies are complying with our current requirements, and whether changes to current requirements should be made,” said Schapiro in her prepared testimony Tuesday. “Where we find that companies are engaging in financial transactions that are inconsistent with their publicly reported financial condition, we will take appropriate action.”

The Financial Accounting Standards Board also plans to use some of this same information in re-examining the accounting rules for repurchase agreements, such as the Repo 105 and Repo 108 transactions that Lehman used to shift $50 billion temporarily off its balance sheet at the end of the first and second quarters of 2008. In the meantime, though, FASB is withholding judgment.

“At this point in time, while we have read the report of the Lehman Bankruptcy Examiner, press accounts, and other reports, we do not have sufficient information to assess whether Lehman complied with or violated particular standards relating to accounting for repurchase agreements or consolidation of special-purpose entities,” said FASB Chairman Robert Herz in a letter to House Financial Services Committee Chairman Barney Frank, D-Mass. “Furthermore, we do not know whether other major financial institutions may have engaged in accounting and reporting practices similar to those apparently employed by Lehman. In that regard, we work closely with the SEC. We understand that the SEC staff is in the process of obtaining information directly from a number of financial institutions relating to their practices in these areas. As they obtain and evaluate that information, we will continue to work closely with them to discuss and consider whether any standard-setting actions by us may be warranted.”

To provide the committee with background ahead of Tuesday's hearing, Herz then went on to describe two of the relevant accounting rules, mainly FAS 166 and 167. Interestingly, though, in his prepared testimony before the committee, former Lehman CEO Richard Fuld cited a different accounting rule, FAS 140, as the justification for the repo transactions used at the defunct investment bank (see Lehman Ex-CEO Blames Accounting Rules).

"Another piece of misinformation was that Repo 105 transactions were used to hide Lehman’s assets," he said. "That also was not true. Repo 105 transactions were sales, as mandated by the accounting rule, FAS 140."

Herz's letter only mentions FAS 140 in a footnote, and only because it is part of the title of an AICPA Auditing Interpretation.

Apparently there are loopholes all over U.S. GAAP for misusing repo transactions. Closing them up may require not only closer examination and outreach to financial companies that may have been taking advantage of them, but also a lot of imagination.

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