(Discussion Board Post) (Original Content Only) (300 words) 1. The following di

(Discussion Board Post) (Original Content Only) (300 words)
1. The following discussion is found in the US Bankruptcy Report on Lehman Bros. Holdings dated March 22, 2010:
Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days… in late 2007 and 2008. Repo 105 transactions were nearly identical to standard repurchase and resale (“repo”) transactions that Lehman (and other investment banks) used to secure short-term financing, with a critical difference: Lehman accounted for Repo 105 transactions as “sales” as opposed to financing transactions…By recharacterizing the Repo 105 transaction as a “sale” Lehman removed the inventory from its balance sheet.
Lehman regularly increased its us of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transactions… Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios…A few days after the new quarter began, Lehman would borrow the necessary funds to repay the cash borrowings plus interest, repurchase the securities, and restore the assets to its balance sheet.
Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former Global financial Controller Martin Kelly, a careful review of Lehman’s Form 10-K and 10-Q would not reveal Lehman’s use of Repo 105 transactions.
Lehman filed to disclose its Repo 105 practice even though Kelly believed “that the only purpose or motive for the transactions was reduction in balance sheet:” felt that “there was no substance to the transactions:” and expressed concerns with Lehman’s Chief financial officers…advising them that the lack of economic substance to REpo 105 transactions meant “reputational risk” to Lehman if the firm’s use of the transactions became known to the public. In addition to its material omission, Lehman affirmatively misrepresented in its financial statements that the firm treated all repo transactions as financing transactions-ie not sales-for fiancial reporting purposes.
Starting in mid-2007, Lehman faced a crisis: market observers began demanding that investment banks reduce their leverage. The inability to reduce leverage could lead toa ratings downgrade, which would have had an immediate, tangible monetary impact on Lehman…In mid-to-late 2007, top Lehman executive from across the firm felt pressure to reduce the firm’s leverage for quarterly and annual reports…
By January 2008, Lehman CEO Fuld ordered a firm-wide deleveraging strategy, hoping to reduce the firm’s positions in commercial and residential real estate and leveraged loans in particular by half. IN the words of one internal Lehman presentation, “reducing leverage is necessary to remove refinancing risk and win back the confidence of the market, lenders, and investors.” Fuld recalled that Lehman had to improve its net leverage ratio by selling inventory… Selling inventory, however, proved difficult in late 2007 and into 2008 because, starting in mid-2007, many of Lehman’s inventory positions had grown increasingly “sticky” I.e. difficult to sell without incurring substantial losses… In light of these factors, Lehamn releid at an increasing pace on Repo 105 transactions at each quarter-end in late 2007 and early 2008…
Notably, during Lehman’s 2008 earnings call in which it touted its leverage reduction, analysts frequently inquired about the means by which Lehman was reducing its leverage… CFO Callan told analysts that Lehman… was reducing its leverage through the sal of less liquid asset categories but said nothing about the firm’s use of Repo 105 transactions.Is it ethical to keep the types of liablities discussed in this article off the balance sheet, or is this a type of financial statement fraud?
(Discussion Board Replies) (3 Replies) (150 words each) (2 APA citations) (in-text apa citations are a must)
1. The described actions by Lehman Brothers involving Repo 105 transactions raise significant ethical and legal concerns and can be considered a form of financial statement fraud. Here are some key points to consider:
Lehman Brothers intentionally misrepresented Repo 105 transactions as sales rather than financing transactions. This mischaracterization allowed them to temporarily remove securities from the balance sheet, providing a distorted picture of the company’s financial health. The lack of disclosure regarding the use and impact of Repo 105 transactions in periodic reports and financial statements constitutes a lack of transparency.
Lehman’s use of Repo 105 transactions was aimed at reducing its publicly reported net leverage ratios during critical reporting periods. This reduction was presented as a strategic effort to address market concerns and improve the firm’s financial position, but it was achieved through deceptive means.
Accounting principles generally require transactions to be recorded and presented accurately in financial statements. Lehman’s treatment of Repo 105 transactions as sales instead of financing transactions violates these principles.
Lehman failed to disclose material information about the use of Repo 105 transactions, including the associated cash borrowings and their impact on the balance sheet. This omission deprived investors and other stakeholders of crucial information for assessing the company’s financial condition.
The internal recognition of the lack of economic substance to Repo 105 transactions, coupled with concerns about reputational risk if the practice became known, indicates an awareness of ethical issues associated with these actions.
While external pressures to reduce leverage existed, the use of deceptive practices to achieve this goal raises ethical questions. The decision to rely on Repo 105 transactions, despite internal acknowledgment of their lack of economic substance, adds to the ethical concerns.
In conclusion, the actions described in the report suggest a departure from ethical business practices and a deviation from accounting principles. Keeping certain liabilities off the balance sheet through deceptive means constitutes financial statement fraud, impacting stakeholders and undermining the integrity of financial reporting.
2. Lehman’s actions and accounting of the Repo 105 transactions are unethical. According to reports, Lehman would use the Repo 105 transactions immediately before issuing quarterly financials. After the company financials were published, Lehman would buy back the assets at 105% of their value. The impact of Lehman’s actions allowed it to remove billions of troubled assets and appear more valuable to the public. Lehman did not disclose any liabilities for the Repo 105 transactions. The transactions were accounted for as sales. The lack of disclosure of the Rep 105 transactions would have misled investors. Investors would not have known that Lehman was selling assets and reducing its balance sheet. By not disclosing its questionable accounting, the financials appear to have been created in a way with the intent to mislead investors and creditors and make the company appear more financially stable by lowering its leverage ratios (Wiggins, Bennett, & Metrick, 2019). The nondisclosure would be an omission of a material fact, which would be unethical (Jeffers, 2011). Ernst & Young provided services as an independent auditor for Lehman, and it appears that they were negligent in their duties performed for Lehman. As Lehman’s independent auditor, they should have raised questions about whether the financials were materially misleading. However, more research would need to be done on whether Ernst & Young could be held responsible and legal action taken against them for failure to find and report the questionable accounting of the Rep 105 transactions and whether or not Lehman acted under the advice of the auditor in the reporting method used (Wiggins, Bennett, & Metrick, 2019). As to whether or not Lehman committed fraud, I think the most crucial factor is that the transactions were reported with the intent to provide a false and misleading representation of the company’s overall health, which was used to gain investors and creditors. My opinion would be that Lehman’s actions are both unethical and fraudulent.
3. The Lehman Brothers’ use of off-balance-sheet devices, especially Repo 105 transactions, presents severe ethical and financial reporting issues. Financial statement fraud can happen when companies record transactions as sales rather than financing transactions and momentarily remove securities inventory from the balance sheet. Financial statement fraud includes any intentional alterations of financial statements to present a false picture of a firm’s financial standing (Baker, 2021). Lehman Brothers uses the Repo 105 transactions so that the picture of the company’s financial situation is false. In this context, Lehman did not reveal the essence and scope of these transactions, thereby understating its leverage ratios and overstating its total assets and liabilities, ultimately distorting the perception of its financial state (Reller, 2022). Therefore, making such liabilities outside the balance sheet can be considered unethical.
In the case of ethical accounting, transparency in financial reporting is one of the basic principles. Accurate and comprehensive financial information is critical for investors, creditors, and other stakeholders in making the right decisions (Baker, 2021). Lehman Brothers did not disclose the truth about Repo 105 transactions, which tainted their financial reports. Additionally, the intentional drive to cut down leverage ratios in line with market demands and to avoid a credit rating downside using accounting devices is ethically questionable. It was a short-term approach aimed at financial disclosures, which created an illusion to external parties regarding the company’s risks. To conclude, creating liabilities outside the balance sheet, mainly if it involves a deliberate intention to deceive stakeholders, is often viewed as unethical and financial statement fraud. Lehman Brothers committed fraud in this matter as no aspect of ethics is present where ethical financial reporting demands transparency, truth, and an accurate picture of a company’s affairs.