Ian Fraser: Something Sinister About the Lack of Prosecutions at Lehman Brothers

By Ian Fraser, a financial journalist who blogs at his web site and at qfinance. His Twitter is @ian_fraser.

This is the first interview that Chicago lawyer Anton Valukas has given since the publication of his 2,292 page report into the bankrutpcy of Lehman Brothers on March 11th, 2010. At that time, Valukas found strong evidence of financial and accounting fraud designed to deceive investors at the defunct New York-based investment bank. Valukas is surprised, especially given Lehman Brothers’ rampant abuse of Repo 105 to disguise its precarious financial position in the quarters ahead of its September 2008 collapse, that neither the former Lehman Brothers’ chief executive Dick Fuld nor any other Lehman Brothers’ director has been charged with fraud or related offences.

Matthew Lee, a Lehman Brothers’ whistleblower who raised grave concerns about the bank’s deceptive approach to accounting to his bosses — controller Martin Kelly, head of capital markets product control Gerard Reilly, chief financial officer Erin Callan, and chief risk officer Christopher O’Meara — is also interviewed in the CBS programme above. The Englishman, senior vice president in charge of the investment bank’s consolidated and unconsolidated balance sheet, was stonewalled on repeated occasions by Kelly,Reilly, Callan, and O’Meara. He eventually became so frustrated by their failure to even discuss the issues he sent what he calls “a grenade” in the shape of this powerful May 16th 2008 letter. But yet again Lehman Brothers most senior financial and risk officers closed their ears. They continued to ignore his warnings and fired him within a week.

And surprise, surprise, that incredibly honest and upstanding international firm of accountants, Ernst & Young, the failed bank’s auditors, failed to carry out their legal duties (they should have alerted their client’s audit committee or the board of directors to Lee’s concerns after their meeting with whistleblower — at which he warned them of among other things, the bank’s persistent abuse of accounting trick Repo 105 to park toxic assets offshore and manipulate its balance sheet).

Andrew Cuomo, former attorney general of New York State, initiated a process of pursuing Ernst & Young for aiding and abetting a fraud using the Martin Act, one of the most powerful prosecutorial tools in the United States, just before stepping down from that role in December 2010. The case bounced from the New York State to the Supreme court and is now back in the State court. A trial is expected soon [thanks, Cate Long, for the update here].

The whole thing is sinister and astonishing in equal measure. The reason that no director of Lehman Brothers has been brought to book would appear to be that US financial regulator the Securities & Exchange Commission, which had a dedicated team inside Lehmans’ headquarters at 745 Seventh Avenue prior to the uber-leveraged bank’s collapse, knew all this chicanery was going on, and must therefore have given it the nod at the time. The SEC may therefore be complicit in the alleged crime and no less guilty than Lehman. Shades of the FSA’s hopelessly compromised position where failed UK banks like Royal Bank of Scotland and HBOS are concerned?

H/T Cate Long

Cross-posted from ianfraser.org

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  1. Glen

    I’m not shocked.

    Are they just trying to run out the clock on all the possible criminal cases? Because the civil penalties are just a joke – just the cost of doing business.

    I sure wish I could write a bad check for a million bucks, get caugth and pay a thousnad buck fine. But alas, two tiered justice…

    1. Lambert Strether

      I asked Gladys about this and she responded:

      That’s why you’re in the 99%.

      Peter Pinguid wishes he could write a bad check for a million bucks and not get caught. Again.

      That is why Peter Pinguid is in the 1%.

    2. Optimader

      Agreed on the S of L comment Why else would Holder persist other than to be on station for his shadow employer to make sure the clock runs down. He’s like the co-conspirator that is smothering the legal process with a pillow

      1. zygmuntFRAUDbernier

        Sarbanes-Oxley or Sox was enacted after Enron and all that. I think the CFO and/or CEO certify that somesuch thing is somesuch-compliant. Anyway, I seem to recall thay SOX says something about sox-compliance and reports by corporations to the SEC. But I forgot the Chapter and Verse.

  2. Titus Pullo

    I’m not a Repo person, so I maybe off base. However, it seems to me:

    Lehman used a small company, Hudson Castle (one quarter owned by Lehman), to move a number of transactions and assets off Lehman’s books through Special-Purpose Investment Vehicles. Hudson Castle created at least four separate legal entities (which included ‘Fenway’) to borrow money in the markets by issuing short-term IOU’s to investors, which then sold them as investment-grade rated short-term debt to institutional investors in the capital markets. It then used that money to make loans to Lehman and other financial companies, via repurchase agreements, or repos.

    Interestingly, Hudson Castle’s-sponsored special-purpose finance companies combined were the 4th largest borrower under the Fed’s program, receiving $53.3 billion, of taxpayer’s money all of which was repaid.

    In short:
    1.) Hudson Castle created a special purpose vehicle called Fenway.
    2.) Lehman lent $3 billion to Fenway, in exchange for IOUs.
    3.) Fenway lent the money to a Lehman subsidiary (secured elsewhere).
    4.) Lehman later used the IOUs from Fenway as collateral to borrow more money from JPMorgan.

    JP Morgan that was the ultimate cash lender, and Lehman the ultimate borrower; which suggests that:

    5.) Lehman had an immediate need for cash (obviously),
    6.) They could not raise it by selling commercial paper directly,
    7.) Nobody was willing do repo with them on their assets, and
    8.) nobody would buy “Fenway‘s” paper either. But apparently, they would accept Fenway paper for repo.

    So, Fenway would repo whatever Lehman wanted – it was a captive entity. In which case, Fenway was a collateral-laundering (money-laundering) service that allowed Lehman to issue paper indirectly (the negative carry on repo vs. CP being immaterial because it’s just an internal transfer).

    In this context, Hudson Castle “appeared” to be a standard asset backed commercial paper or ABCP conduit – where Lehman (and other banks) would buy the commercial paper of conduits that were backed by their own guarantees to avoid (in 2007/08), suddenly, being forced to take tens if not hundreds of billions of dollars of assets onto the balance sheet.

    1. JP Morgan, as ultimate cash lender, had to have been at severe risk in 2007/08 (vis-à-vis Lehman)
    2. Given the number and frequency of repos, it’s a fair hypothesis that Hudson Castle made billions on this type of transaction.
    3. The makeup of Hudson’s management team is, publicly, not known.
    4. Find the management team and you find the reason why no prosecutions or indictments have resulted from Lehman’s collapse.

      1. Titus Pullo

        It certainly raises the question as to why all three agencies (Federal Reserve Bank of New York, the SEC and the Securities Investors Protection Corporation) were on deck at the same time…. But it should be noted that all three would primarily look at ‘executive’ power point summaries of the quarterly Tier 1 capital ratios (the ratio of a bank’s core equity capital to its total risk-weighted assets (RWA)) as a measure of a banks health and well-being – I doubt they would have had he resources (or the resources any inclination) for much else. As such, I doubt they were explicitly engaged in Lehman’s own deceit and deception – beyond the usual agency/regulatory mendacity.

        Given that Lehman’s repos-for-cash (assets like cash usually have zero risk weight, while certain loans have a risk weight at 100% of their face value) were brisk and frequent, I doubt they would looked into the nitty-gritty of financial transaction mechanism and off-balance sheet accounting – especially if Lehman’s went out of their way to not doing so.

        Now, Ernst & Young is a different proposition – they certainly should have been auditing anything that cost more than a cup of corporate coffee. I suspect that the Fed might have questioned E&Y as to any “irregularities”. What happened?… Your guess is as good as mine.

        1. fresno dan

          very interesting insights.
          So, what is your learned opinion on the lack of prosecution – corruption in the sense of venal bribery, or corruption in the sense that the regulatory agencies don’t want their sheer incompetance (hidden under the guise of it would be bad for the “markets” and the the economy to reveal that they have no clue) made public?
          Or maybe something more subtile – a stubborn ideaology that America has the best banks, and the best economist/bank regulators/FED in the world, and nothing was done wrong. Just an earthquake or sumthin’…

  3. Barry Popik

    In February/March of 2008, my wife was pregnant with our first child. I was blogging (and not “working”). I told my very experienced financial adviser that we needed to invest for safety. We were told to buy Lehman Brothers’ preferred stock offering. We were informed that this was a solid company that had the highest credit rating.

    Within about six months, we lost all our money.

    The credit rating agency (Fitch) that gave Lehman its highest rating has not been prosecuted. The accounting firm (Ernest & Young) that hid accounting irregularities has not been prosecuted. The NY Fed chairman who helped Lehman to lie to investors was promoted to Treasury secretary. Lehman Brothers’ CEO Dick Fuld walked away with $550 million in salary, but he hasn’t gone to jail and he hasn’t had to pay back anything at all.

    My family was knowingly defrauded by all of these people. We lost everything.

    There is no justice in America and no one even cares.

    1. diptherio

      “There is no justice in America and no one even cares.”~BP

      TPTB may not care, but plenty of us do. And our numbers are growing all the time, with every new revelation. Whether that turns out to make any difference or not, only time will tell. But some of do care…don’t let the bastards get you down.

    2. Anna Van Z

      I’m so sorry that happened to you and your family! The fact that none of these folks have been prosecuted and jailed, while the DOJ spends it time and energy harassing medical marijuana patients/dispensaries, is an obscenity!

      1. Glenn Condell

        ‘There seems to be no current way for us to express our views together. No doubt that will come.’

        But how?

        I like your optimism Lambert but can’t share it.

        There is only one way we can ‘express our views together’ – in real time, locally and globally, in a way that can be tabulated and recorded as ‘the will of the people’ – by utilising technology to bring democracy into the here and now, freeing it from the rigged two-horse race only run once every four years by making it literally ‘quotidian’.

        And what are the chances of that?

        1. different clue

          There is “express our views together”. There is also “apply our understanding together.” How many people could understand what is being worked out by hundreds of economic rebellionaries such as Catherine Austin Fitts, Woody Tasch, and hundreds of others . . . and apply such methods of “leading the money around by the nose” within their communities? This won’t help the defrauded people get un-defrauded, but it may help not-yet-defrauded people and community-loads of people to develop and protect some of their own self-and-co-created wealth from predation by the OverClass.

    3. tar, etc.

      It seems to me that, as public agencies have driven the getaway car, the crime is ongoing. Therefore, the statute of limitations’ clock isn’t ticking. I’d also like to know why RICO isn’t being used in these cases. Some regulator eventually gets around to some slap on the wrist and the destruction done to people like you is never recompensed. I was the victim of insurance company price collusion and got a check for $8. It’s a joke. And they wonder where confidence has gone.

  4. allcoppedout

    I’be been pondering an odd point of law in relation to these financial swindles. In the Jimmy Saville scandal in the UK (sexual abuse)it seems our Crown Prosecution Service now believes good evidence against Saville lies in the multiple complaints (on reviewing about 4 or 5 – there have been 400 plus). The CPS reasoning is that the likelihood of conviction is increased because of multiple accounts of his behaviour.

    In my simplistic ex-cop mode the law is the law. The anthropologist in me can imagine a society in which sticking one’s tongue down another’s throat is merely a greeting – but this hardy let’s a squit like Saville off the hook of our law. How are the financial squits evading prosecution on the basis of ‘multiple incident corroboration’?

    My sense of a solution is public trials inviting the real spectrum of victims to come forward. The financiers’ defence appears to be character – as no doubt Saville got away with for years. Incidentally, he is on record in CPS files threatening detectives with his LL.D (actually honourary) and top lawyers. C’est la meme chose?

    1. Ray Phenicie

      “My sense of a solution is public trials inviting the real spectrum of victims to come forward.” That’s exactly what Yves has been saying lo these many,many months. Use the Google search box on this page to look up Sarbanes Oxley and start reading.

      The US. Justice, headed by the chief attorney general who in turn reports to the Oval Office, has sat on its hands-deliberately I would say. No doubt on orders from those in the corner offices at Golman Sachs, Citibank and their ilk. The Giant Squid vampire banks are in control and will remain there until the life blood is totally drained off the country.

  5. JDM

    Isn’t there supposed to be a “neither” in the sentence “Valukas is surprised, especially given Lehman Brothers’ rampant abuse of Repo 105 to disguise its precarious financial position in the quarters ahead of its September 2008 collapse, that the former Lehman Brothers’ chief executive Dick Fuld or any other Lehman Brothers’ director has been charged with fraud or related offences.”

    1. Ian Fraser

      You’re right. I’ve asked Yves to correct this. Thanks for pointing it out.
      BTW are you the same JDM who commented on one of my HuffPo pieces via the FT?? If so, I think you’re labouring under some misapprehensions about RBS GRG abuses. For example, you totally ignore important matters such as the City of London and Tayside Police inquiries into GRG’s activities, both of which I believe are still active

      Also in Q3 2012 circa 25-30 RBS business and corporate customers of RBS were contacting me every week to alert me to alleged wrongdoing by GRG. It’s impossible to say how many of these were genuine frauds or illegal misappropriations of assets. However, I can assure you that these people were not getting in touch to talk about the weather!

    2. diptherio

      Yeah, I puzzled over that for a second too. It should read like this:

      “Valukas is surprised that [neither] the former Lehman Brothers’ chief executive Dick Fuld [n]or any other Lehman Brothers’ director has been charged with fraud or related offences, especially given Lehman Brothers’ rampant abuse of Repo 105 to disguise its precarious financial position in the quarters ahead of its September 2008 collapse.”

      BTW, I’m available for copy-editing work if anyone’s looking…

  6. London Banker

    As Valukas’ report makes very clear, the Federal Reserve Bank of New York, the SEC and the Securities Investors Protection Corporation all had staff co-located in Lehmans from March 2008. They collaborated in the looting of all Lehman affiliates globally of all assets that could be lent or repo’d to the US parent, liquidated, and proceeds streamed to US creditors of the failing bank. This action minimised losses for US counterparties and investors, and maximised losses for global creditors and investors.

    As this model proved hugely profitable, it has beent the template for all future failures. See MF Global for the same pattern.

    The US authorities were complicit in global looting of customer assets and defrauding globals creditors, all the while deceiving their peers in central banks and financial supervisors around the world. That is the story revealed in the Valukas report. That is the reason there will not be any prosecutions.

    1. AbyNormal

      “The very same corporate psychopaths, who probably caused the crisis by their self-seeking greed and avarice, are now advising governments on how to get out of the crisis. Further, if the corporate psychopaths theory of the global financial crisis is correct, then we are now far from the end of the crisis. Indeed, it is only the end of the beginning.”

      1. McMike

        No one is advising anyone on how to “get out of the crisis.”

        They are advising on how to “get the MOST out of the crisis.”

    2. Generalfeldmarschall Von Hindenburg

      The reason there have been no prosecutions is that Obama was installed to protect these people, who bought the presidency for him. The political elite is dysfunctional, but they are not completely stupid.

  7. Goin' South

    Oceania’s Ministry of Truth has been exceeded by ‘Murca’s Department of Justice in Orwellian absurdity.

    Can we just start to call it the Department of Injustice?

  8. McMike

    I believe we are moving into the Pravda era of finance and government regulation.

    Everyone who matters knows it’s full of lies, that’s an open secret, but we still need something to wrap the fish. It is running on momentum and being vigorously proppoed up by desperate people.

    We are in the pretense stage. The fourth order of simulacra.

    The Wall Street system will end. Must end. It is a law of nature. How and when and what replaces it is another qestion.

  9. Brian B

    I feel sorry for Mary Jo White. She’s going to get into the SEC looking to do something and Holder and the rest of the corrupt do-nothing clowns in that Administration are going to pull the rug out from under her every chance that they get ala Elizabeth Warren. The systemic fraud at these institutions is obvious and yet unprosecuted while they go after all these insider trading slam dunks to get headlines and keep the TBTF Golden Goose Banks pumping out their campaign contributions.

    1. Oliver Budde

      Your overall sentiments are correct, but you may have a misplaced understanding of White.

      There is an August 2007 report entitled The Firing of an SEC Attorney and the Investigation of Pequot Capital Management, prepared by the Minority Staff of the
      Senate Committee on Finance and the Senate Committee on the Judiciary, available here: http://aguirrelawapc.com/global_pictures/Attachment_9.pdf. The report discusses how former SEC attorney Gary Aguirre had strong evidence of wrongdoing by soon-to-be Morgan Stanley head John Mack, how Mary Jo White intervened on behalf of Mack, how the Mack investigation was closed shortly after White’s intervention, how Aguirre was fired and how Aguirre’s boss then went to work for White at Debevoise(!). (Later, Aguirre won $755k in a wrongful termination suit against the SEC.) The entire report is fascinating, but if you just search the term “White” and read those sections, you get a very unflattering picture of White. Zealous advocacy is one thing, but her actions in this case appear to have been something else. Read it and decide yourself; I think we can and should do better.

  10. Dr. Pitchfork

    “But yet again Lehman Brothers most senior financial and risk officers closed their ears. They continued to ignore his warnings and fired him within a week.”

    Classic! And not surprising. Still, we need more people risking their ass(ets) by doing the right thing and standing up to those in power. Unfortunately, our managerial class is made up primarily of bullies and pussies (pardon the French). Not only that, but young professionals (in all fields) are encouraged by their mentors and peers to avoid making waves. Maybe that’s a symptom, not a cause, but that part of our broader professional culture needs to change.

    1. ambrit

      Dear Dr.;
      The same applies to Retail as well. I suspect it is an aspect of any heirarchial system. Brave people are always in short supply, alas.

  11. David

    The whistleblower wasn’t just blowing the whistle on Lehman. He was blowing the whistle on Ernst & Young too! That’s why E&Y wasn’t in a good position to investigate his warnings.

  12. ambrit

    Given the ‘compromised’ nature of Ernst & Young, why aren’t any competing accounting companies popping up? If this was a ‘real’ free range capitalist system, they should already be nipping at E&Ys’ heels. The whole thing is beginning to remind me of one of those ancient diagrams of the Cosmos. Rings of Planes of Existance all nestled within each other, graduated from Divine on down to Earthly. We need a Bruno, or a Kepler, really a Galileo. They paid the price. Who remembers the name of the Inquisitor that bullied Galileo or burned Bruno? Sad to say, we will have to let History make the final call.

    1. KnotRP

      Good luck finding a bank or corporation that wants
      a non-corrupt accounting firm.

      The elite are currently guided by the idea that
      “economics is not a morality play”, so “we” are not
      going to do something as counter productive as
      putting our financial experts in jail, because
      that would be letting our silly morals run roughshod
      over our fragile economic “health” at the worst possible
      time. Instead, as Rubin has said, it’s cheaper and easier
      to pump everything back up using the people’s own
      purchasing power. There’s an offer surely nobody can
      refuse. You can’t win, you can’t get even, and you can’t
      quit the game…and you can’t even put us in jail, losers.

      When the bad drives out the good, it always ends the same.

  13. econ

    While the American people are in great fear of terrorism and external enemies, all along the last 25 years of financial Wall St greed activities have done much greater damage.

  14. robert

    uh, maybe no prosecution because the former head of the Fed,outgoing Trys Sctry Geithner, would be implicated. He was respnsible for all banking in NY. The illegal repo (libor fixing, mortgages, Fx scams, munis, etc,)funds flowed thru his banks = massive money laundering. Gross, gross negligence at a minimum on his part. SO let the crooks go, blame it on the “challenges of risk,” and let the crooks lever up the market again….capitalism is reward crooks? really?

  15. Ashley

    No surprises here then! Even a successful prosecution or two isn’t going to fix what has become institutionalised corruption. The bankers, accountants and lawyer have been doing this for so long they no longer recognise that what they are doing is corrupt. When the effective tax rate of EY partners is around 17% why should the rest of us expect any better. The BIG 4 accountants need to be closed down together with 10-20 of the top law firms. Throw in a few banks – starting with HSBC and it just might get some traction on a long journey to cleaning up the professional services industries.

  16. OMF

    The SEC may therefore be complicit in the alleged crime and no less guilty than Lehman.

    So? Indict them as well. The Federal government is in court every day of the week in some jurisdiction. It would be perfectly possible for NY state to indict the SEC/Federal government for being complicit in a fraud.

      1. Chauncey Gardiner

        Interesting question regarding sovereign immunity, Lambert.

        As a privately owned entity, does the FRBNY and its employees enjoy sovereign immunity?

        Do SEC employees also have sovereign immunity as agents of the U.S. government?

        Just asking anyone here who is familiar with related law. Thank you.

  17. Justicia

    Could it be that more of the MSM is catching on? There seem to be quite a few articles of late on the stench from our rotten financial sector. From the current issue of The Atlantic:

    What’s Inside America’s Banks?

    Some four years after the 2008 financial crisis, public trust in banks is as low as ever. Sophisticated investors describe big banks as “black boxes” that may still be concealing enormous risks—the sort that could again take down the economy. A close investigation of a supposedly conservative bank’s financial records uncovers the reason for these fears—and points the way toward urgent reforms.


  18. ChrisPacific

    There are some good features of this article – the attempt to parse the financial statements of “America’s safest bank” is illuminating, and the comments about properly designed financial regulation on page 3 are good and mirror some points that have been made on NC.

    However the article misses the elephant in the room. Opacity did not come about by accident: as Yves has said, it’s a feature, not a bug. Opacity means greater profit for banks, and the fact that regulation hasn’t kept up is no accident. This is never discussed in the article. Even worse, it’s implicitly accepted as a constraint on possible solutions without ever discussing the reason why:

    Is this just a fantasy? The changes we’ve outlined would certainly be difficult politically. (What isn’t, today?) But in the face of sufficient pressure, bankers might willingly agree to a grand bargain: simpler rules and streamlined regulation if they subject themselves to real enforcement.

    If these are your terms of reference (that banks must agree to any regulations limiting their profits or freedoms) then you have lost the battle before you even begin.

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