Source: The Sunday Times

In May 2008, as the world span towards the worst financial crisis in living memory, Matthew Lee, a senior vice-president at Lehman Brothers, the American investment bank, decided to make a stand.

After 14 years with the firm, the New York-based Edinburgh University graduate was convinced the bank was heading for disaster. He wrote a memo to senior management detailing his concerns.

Lee’s warning contained several allegations, all of which proved horribly prescient. Lehman had “tens of billion of dollars of unsubstantiated balances, which may or may not be ‘bad’ or non-performing assets or real liabilities,” said Lee.

He was worried that the bank had failed to value tens of billion of dollars of assets in a “fully realistic or reasonable way” and did not have staff and systems in place to cope with its rapid growth.

Lehman’s auditors, Ernst & Young, were worried. “We are also dealing with a whistle-blower letter, that is on its face pretty ugly and will take us a significant amount of time to get through,” William Schlich, a former lead partner on E&Y’s Lehman team, wrote in a June 5, 2008, email to a colleague.

Time was not on E&Y’s or Lehman’s side. By September, the 158-year-old bank was bust, thousands of people had lost their jobs and the world’s economy had been pitched into a black hole from which it is still struggling to emerge.

Lee’s warning forms a key part of a damning 2,200-page report into the bank’s collapse released last week by Anton Valukas, the court-appointed bankruptcy examiner. He found Lehman used accounting jiggery-pokery to inflate the value of toxic real-estate assets it held, and chose to “disregard or overrule the firm’s risk controls on a regular basis”.

His most juicy finding was Repo 105, which the report alleges was used to manipulate the balance sheet to give the short-term appearance of reducing assets and risk. Not since Chewco and Raptor — Enron’s “off balance sheet vehicles” — has an accounting ruse been so costly.

Valukas won’t judge. His brief from the court was to determine only what happened. But he does highlight “colourable claims” — ones that could potentially lead to legal action. And the report looks set to pour petrol on a raging fire.

Questions have emerged over the way banks including JP Morgan and HSBC put the squeeze on Lehman in its dying days, although both argue they were simply acting to protect their own interests.

Lehman’s collapse is already subject to numerous legal actions and government inquiries. E&Y is in the line of fire. Linklaters, the London law firm, has been forced to defend the advice it gave Lehman.

Then there are Lehman’s senior staff.

Dick Fuld, Lehman’s former chief, and finance chiefs Christopher O’Meara, Erin Callan and Ian Lowitt “certified misleading financial statements,” according to Valukas.

The US Justice Department is all over Lehman and this report will provide plenty of new avenues for investigation.

Reached at his Brooklyn home last week Lee told reporters he had not yet read the report and wouldn’t comment until the Lehman litigation was settled.

“I have a lot to say, but unfortunately it is going to have to wait,” he said.

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