Investigation Begins Into E&Y's Role In Connection With Lehman's Repo 105 Scam

Fox Business reports that the investigation around Lehman is intensifying. Surely the SEC, now generically equated with objects that float around in sewers in formal conversation, has realized it has to do something, anything, to find at least one scapegoat for the financial collapse. Which is why we read with little surprise Gasparino's report that "thee SEC has ramped up its inquiry into Lehman’s fall, particularly after court-appointed bankruptcy examiner Anton Valukas issued a lengthy report stating that Lehman’s top executives were “grossly negligent” in possibly hiding the risky nature of the firm’s finances during its final day." What we find much more interesting is that "yet another investigative agency, the Public Accounting Oversight Board -- created under the 1992 Sarbanes-Oxley law to investigate and discipline public accounting firms -- has launched an inquiry into the role of Lehman’s auditor, Ernst & Young, following the examiner’s report, which accused the big accounting firm of “professional malpractice,” for its work in approving accounting techniques Lehman used during its dying days in the summer of 2008." In the absence of any Wall Street villains, which it is now all too clear have endless diplomatic immunity from prosecution by the corrupt regulators, will the auditor, together with Dick Fuld, be made into the sacrificial lambs? Or will we continue the farce that anything even remotely related to capital markets integrity and reporting is real and valid? Judging by the nearly 60 days of no S&P downticks, the market has answered that question for us.

More from Gasparino:

It was the use of one of those accounting techniques, known as Repo 105, which appears to be at the top of the list of investigators, people with knowledge of the inquiry say. The use of the accounting technique, which is designed to temporarily lower the amount of “leverage,” or borrowing a firm uses to stay afloat thus lowering its risk levels, isn’t necessarily illegal. In fact, Lehman sought and received a favorable opinion from Ernst & Young to use the technique in 2008.

But what might fall afoul of the securities laws, according to people close to the inquiry, is if Lehman turned to the gimmick in a concerted effort to hide its risk level. One person with knowledge of the inquiry say investigators are looking at “the pattern” of Repo 105 usage, and if that pattern represents intent to deceive investors about the true nature of the firm’s finances.

Several large investors such as the state of New Jersey pension fund as well as money management powerhouse BlackRock (BLK: 206.93, 1.13, 0.55%), run by CEO Larry Fink, a friend of Fuld, as well as former AIG (AIG: 40.16, -0.73, -1.79%) chief Hank Greenberg (through his company CV Starr) all bought Lehman shares in the summer of 2008. After the purchase, Greenberg later told Dow Jones Newswires that "nobody can forecast what is to come, but I think on balance it is a very well-run organization…I think they raised enough capital” to survive.

In addition to the firm’s use or possible misuse of Repo 105, investigators are examining whether top officials properly marked to market the declining value of investments, such as the Archstone-Smith Trust, a massive real estate venture of apartment complexes that the firm bought at the top of the market in 2007, and whether the firm properly booked losses stemming from an alleged stock fraud scheme involving Japanese trading house Marubeni, these people say.

Another area of interest, according to people who have been interviewed by investigators, focuses on Lehman’s trading with various hedge funds it controlled or owned pieces of, and its use of off-balance sheet companies or so-called “qualified special purpose vehicles” that traded with Lehman during its final months as a firm.

One may question whether Louise Story's discovery of additional Lehman accounting gimmicks will be included in the "regulatory" probe. We are confident that the SEC will get right on it, just as the SEC will analyze why Ambac, which JPM notes has no value, is now the most actively traded stock in the market.