Posts tagged ‘Enron’

Fishy Fuld Finances – Repo 105

The truth may set you free, or it may just send you to jail. Right now, Anton Valukas’s high profile 2,200 page report has unearthed a reeking stench surrounding a $50 billion fund shuffling scheme. Our legal system will ultimately determine the fate of Dick Fuld, former CEO of Lehman Brothers, and any potential co-conspirators. Anton Valukas, appointed by the U.S. bankruptcy court to get to the root causes of the largest bankruptcy in history (a 158 year old investment banking institution), spearheaded the year-long investigation.

While most observers have not shed a tear over the grilling of Fuld in the media, onlookers shouldn’t feel sorry for Valukas either. His firm, Jenner & Blocker, was paid $38 million for its troubles in researching the report through January of this year.

Completing the report was a Herculean task. Finishing the report involved narrowing down 350 billion pages of documents (spread across 2,600 systems) down to about 40 million pages, which were supplemented by interviews with more than 250 individuals, according to The Financial Times.

Repo 105 Crash Course

At the heart of the Valukas’s report is a unique accounting gimmick used by Lehman Brothers to conveniently shed billions in assets off its books at opportune times. The scheme distorted the firm’s financial position so Lehman Brothers could appear financially leaner than reality. This controversial practice is called Repo 105 (“repo” is short for “repurchase”). Here’s how it works:

a)      The Right Way: In a typical legitimate repurchase transaction, widely used in the banking industry, a financial institution transfers assets (collateral) to a counterparty in exchange for cash. As part of the transaction, the institution that transferred the assets for cash agrees to repurchase the collateral from the counterparty in the future for the original value plus interest. These repurchase agreements are completely valid and function as an excellent short-term liquidity tool for the financial markets. What’s more, the transactions are completely transparent with the associated assets and liabilities in clear view on the publicly distributed financial statements.

b)      The Crooked 105 Way: With toxic real estate values plummeting, and Lehman Brothers’ leverage (debt) ratios rising, Lehman executives became more desperate in hunting out more creative methods of hiding unwanted assets off the balance sheet. To satisfy this need, Lehman travelled across the Atlantic Ocean to court the legal opinion of a preeminent law firm, Linklaters, in order to have them sign off on the imaginative Repo 105 practice. Under Repo 105, Lehman pledged assets equaling 105% of the cash received from a counterparty. Based on the Repo 105 design, the transaction was considered a “sale” and therefore wiped Lehman’s balance sheet clean of the assets. Cash temporarily received by Lehman could then be used to pay down debt. Lehman conveniently used this strategy to pretty up the books (“window dressing”) around critical periods when financial results were shared with the public and investors. Shortly thereafter, Lehman would take back the discarded assets for a cash and interest payment (similar to the previously described repurchase agreement).

In a way, this Repo 105 transaction is like a teenage boy selling a Playboy magazine to his friend for cash right before his mom comes home, then agrees to repurchase the magazine from his friend as soon as the boy’s mom goes back to work. Sneaky, but effective…until you get caught.

Where are the Cops?

With the fresh corporate scandal wounds from the likes of Enron, WorldCom, and Tyco (TYC) still healing, a neutral observer might expect the auditors to more responsibly monitor the behavior of questionable client behavior. The death of accounting giant Arthur Andersen (former Enron auditor) was supposed to serve as a poster-child example of what can happen if irresponsible corporate behavior goes unchecked. Apparently Lehman Brothers’ “Big Four” auditor Ernst & Young didn’t learn a lesson from the carnage left behind by its deceased competitor. Not only did Ernst & Young sign-off on these transactions, but their neglect of whistle-blower allegations also serves to land E&Y in very hot water.

Frustratingly, this outcome wouldn’t be the first time a whistle-blower was ignored – Harry Markopolos the Bernie Madoff sleuth was rebuffed multiple times by the SEC (Securities and Exchange Commission) before Madoff confessed his illegal Ponzi scheme crimes. Although the SEC may feel some more heat relating to Lehman’s Repo 105 accounting fallout, the agency may catch a little break since Lehman surreptitiously neglected to disclose any of this controversial accounting trickery.The SEC and multiple state Attorney Generals may investigate Valukas’ findings further to see if civil or criminal charges against Fuld and other Lehman executives are appropriate.

The Ignorance Defense

Will ignorance be an adequate defense for Lehman executives? So far, this tactic appears to be the leading approach of 40-year Lehman Brothers veteran, Dick Fuld. Fuld’s lawyer claims the CEO had no knowledge of Repo 105 “nor did Lehman’s senior finance officers, legal counsel or Ernst & Young raise any concerns about the use of Repo 105 with Mr. Fuld.” The Lehman chief’s supposed unawareness becomes less credible in the midst of smoking emails such as the following one from a senior trader:

“We have a desperate situation and I need another $2 bn [balance sheet reduction] from you either through Repo 105 or outright sales.”

 

Other executives referred to Repo 105 as a “drug” that they needed to “wean themselves off.” When Bart McDade, a senior Lehman Brothers exec was asked about Fuld’s knowledge regarding the accounting gimmick, McDade had no qualms in explaining Fuld “knew about the accounting of Repo 105.”

The sheer size of these multi-billion dollar off-balance sheet transactions won’t make Fuld’s innocence campaign any easier. I  believe when courts discuss values exceeding $50 billion in size, ignorance will not qualify as an excuse you can hide under – even in the context of a company holding net assets of $328 billion in June 2008.

Valukas doesn’t mince any of his words in the report when the conversation moves to Lehman’s objectives:

“The examiner has investigated Lehman’s use of the Repo 105 transactions and has concluded that the balance sheet manipulation was intentional, for deceptive purposes.”

 

Time will tell how the ultimate judgment will fall upon Dick Fuld and his partnering Lehman Brothers executives, but one need not be a bloodhound to smell the stale fishy odor of Repo 105. Fuld better find some potent breath mints, to quickly fight off the horrible seafood scent, or he might end up as fish bait himself.

Read Financial Times Article on Fuld & Lehman

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct position in TYC on any security referenced. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 14, 2010 at 11:45 pm 1 comment

Decade in Review

We laughed, we cried, we kissed another ten years goodbye. It is virtually impossible to cram ten years into one article, nonetheless I will attempt to chronicle some of the central and silly events that bubble up in my memory bank.

2000

Capture of Elian Gonzalez

  • Technology-heavy NASDAQ index peaks at 5,132 before completing its -78% decline by late 2002.
  • Y2K (Year 2000) fears do not materialize and technology orders begin downward slide.
  • AOL buys Time Warner for $164 Billion in hopes of converging media and internet worlds.
  • Al Gore Democratic nominee for the Presidency wins popular vote but loses election to George Bush after effort for Florida recount fails.
  • Elian Gonzalez, six-year old boy returned to Cuba.
  • Reality TV show Survivor finishes first season with Richard Hatch winning prize.

2001

Enron Logo at Headquarters

  • Apple introduces iPod digital music player.
  • Enron files Chapter 11 bankruptcy.
  • Wikipedia online community encyclopedia launches.
  • 9/11 attacks occur pushing economy further down.
  • Alan Greenspan starts 1st of 11 rate cuts  in 2001.
  • China joins WTO (World Trade Organization).

2002

 

  • Severe Acute Respiratory Syndrome (SARS), an atypical form of pneumonia, rears its ugly head in the Guangdong Province of China. 
  • SEC files charges against WorldCom and Tyco international in connection with accounting irregularities
  • United Airlines files for bankruptcy.
  • American Idol television singing contest begins first season.
  • Guantanomo Bay detention camp is opened.

2003

  • Federal Funds rate reaches a 45 year low at 1.00% – fuel for future credit bubble.
  • $350 billion in tax cuts approved, spanning a ten year period.
  • Iraqi Gulf War II commences with “shock and awe” military campaign.
  • Space Shuttle Columbia disintegrates upon attempted reentry into the Earth’s atmosphere.
  • Broad stock market recovery (>90% of stocks in S&P500 climb), including a +50% rise in the NASDAQ index.
  • Martha Stewart indicted for using privileged investment information and then obstructing a federal investigation.
  • Arnold Schwarzenegger, movie star, becomes governor of California.

2004

  • Google (GOOG) goes public with IPO at $85 per share.
  • Mark Zuckerberg unveils Facebook and people begin “friending” each other.
  • Comcast makes failing unsolicited bid for Disney. K-Mart buys Sears with aid of Eddie Lampert
  • Ronald Reagan, 40th President, dies at 93.
  • Janet Jackson and Justin Timberlake experience “wardrobe malfunction” on Super Bowl halftime show.
  • Boston Red Sox win their first World series since 1918.

2005

  • P&G announces $57 billion acquisition of Gillette. Conoco Philips buys Burlington Resources for over $30 billion. Bank of America buys credit card company MBNA.
  • Ben Bernanke is nominated as new Federal Reserve Chairman.
  • Hurricane Katrina overwhelms New Orleans as 80% of city becomes covered with water.
  • North Korea announces its nuclear weapons arsenal.
  • YouTube starts sharing online videos before Google Inc. eventually buys company.
  • Lance Armstrong wins 7th consecutive Tour de France.

2006

  • Inverted yield curve turns out to be an accurate leading indicator for 2008 recession despite markets advance.
  • Internet activity accelerates: Google buys YouTube after News Corp buys MySpace. Twitter is introduced.
  • Playstation 3 (PS3) and Nintendo Wii unveiled.
  • Merger & acquisition activity reaches $3.79 trillion worldwide, surpassing previous 2000 peak (Thomson).
  • Options backdating takes center stage. United Health and technology companies were among those dragged into controversy.
  • Housing market peaks.

2007

 

  • Markets continue multi-year rally with three major indexes holding single-digit gains. Emerging markets build on previous year gains – Shanghai composite +97%.
  • Monoline insurers MBIA and rival Ambac become early canaries in the coal mine given the greater than $1 trillion in exposure on insuring securities.
  • Apple presents the iPhone – part phone, part music, part computer.
  • KKR (Kohlberg Kravis Roberts & Co.) and TPG complete $44.4 billion buyout of Texas power company TXU Corp.
  • Microsoft Vista operating system introduced after five years of development.
  • Housing decline accelerates as Countrywide Financial announces 12,000 job cuts (20% of its workforce), New Century Financial (#2 subprime lender at one point) files Chapter 11 bankruptcy, and two Bear Stearns mortgage based hedge funds go under.
  • Chuck Prince, Citigroup CEO, steps down.

2008

 

  • Bank of America agrees to buy Countrywide mortgage company for about $4 billion.
  • JPMorgan Chase agrees to buy Bear Stearns for $2 per share in a sale brokered by the Fed and the U.S. Treasury – eventually bid revised upwards to $10 per share (~$1.1 billion) to appease angry shareholders.
  • Lehman Brothers goes bankrupt.
  • Bank of America agrees to acquire Merrill Lynch for about $50 billion.
  • Government takes over AIG after providing insurance company $85 billion loan.
  • Goldman Sachs and Morgan Stanley become bank holding companies to improve access to capital.
  • Washington Mutual Inc. is seized by FDIC and sold to JPMorgan Chase in the biggest U.S. bank failure in history.
  • Wells Fargo & Co., agrees to purchase Wachovia for about $15.1 billion, trumping Citigroup’s bid.
  • $700 billion TARP (Troubled Asset Relief Program) eventually approved by Congress to stabilize financial system.
  • Eliot Spitzer resigns after prostitution scandal.
  • Michael Phelps wins eight gold medals at the 2008 Beijing Summer Olympics.

2009

 

  • Barack Obama inaugurated in as 44th President of the United States. Healthcare reform bills pass in both the House and Senate.
  • GM and Chrysler declare bankruptcy.
  • Recession ends as stimulus kicks in and inventories rebuild. Government announces new PPIP and TALF programs.
  • Warren Buffett pays $26 billion to buy Burlington Northern Santa Fe. Other announcements include: Oracle /Sun Microsystems; Pfizer/Wyeth; Merck/Schering Plough; and Pulte Homes/Centex.
  • Commodities and emerging markets rebound. Gold tops $1,000 per ounce.
  • Signs of housing bottoming as low mortgage rates, tax credits, and declining inventories create a more constructive environment.
  • Madoff goes to prison after he was convicted for a $65 billion Ponzi Scheme.
  • Chesley B. “Sully” Sullenberger successfully carries out the treacherous crash-landing of US Airways Flight 1549 into the Hudson River.
  • Dubai debt debacle forces Abu Dhabi to lend support to calm global markets.
  • Tiger Woods admits transgressions after car crash pushes him into spotlight.

2010 ???

Time will tell what the new year will bring. Stay tuned for some iron clad 2010 predictions coming to an Investing Caffeine blog near you in the not too distant future!

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and BAC, AAPL, and GOOG, but did not have any direct positions in the following stocks mentioned in this article at time of publication (including AOL/TWX, VIA/CBS, NWS, TYC, UAUA, MSO, CMCSA, DIS, SHLD, PG, COP, Nintendo, MBI, ABK, MSFT, C, JPM, AIG, MS, WFC, GM, Chrysler, BRKA, ORCL, JAVA, PFE, MRK, PHM, BNI, LCC, GLD, and NKE). No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 29, 2009 at 1:00 am 1 comment


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