BECG ASSINGMENT ON LEHMAN BANKRUPTCY

By:
A.Sachin-09
Ankita Jindal-14
Apoorv Gupta-17


Lehman Brothers

I ntroduction:
Lehman Brothers Holdings Inc. was a global financial services firm. Before
declaring bankruptcy in 2008, Lehman was the fourth-largest investment bank in the US
(behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), doing business in investment
banking, equity and fixed-income sales and trading (especially U.S. Treasury securities),
research, investment management, private equity, and private banking.
The Collapse of Lehman Brothers
On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in
assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its
assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman
was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees
worldwide. Lehman's demise also made it the largest victim, of the U.S. subprime mortgage-
induced financial crisis that swept through global financial markets in 2008. Lehman's collapse
was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of
close to $10 trillion in market capitalization from global equity markets in October 2008, the
biggest monthly decline.
The History of Lehman Brothers

Lehman Brothers had humble origins, tracing its roots back to a small general store
that was founded by German immigrant Henry Lehman in Montgomery, Alabama, in 1844. In
1850, Henry Lehman and his brothers, Emanuel and Mayer, founded LehmanBrothers. While
the firm prospered over the following decades as the U.S. economy grew into an international
powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived
them all the railroad bankruptcies of the 1800s, the Great Depression of the 1930s, two world
wars, a capital shortage when it was spun off by American Express in 1994, and the Long Term
Capital Management collapse and Russian debt default of 1998. However, despite its ability to
survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman
Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a
disastrous step.
The Sub Prime Culprit
In 2003 and 2004, with the U.S. housing boom (read, bubble) well under way, Lehman
acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan
Services, which specialized in Alt-A loans (made to borrowers without full documentation).
Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate
businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a
faster rate of growth than other businesses in investment banking or asset management. The
firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported
record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record
$4.2 billion of revenue $19.3 billion.
Lehman's Colossal Miscalculation
In February 2007, the stock reached a record $86.18, giving Lehman a market
capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S.
housing market were already becoming apparent as defaults on subprime mortgages rose to a
seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five
years on concerns that rising defaults would affect Lehman's profitability; the firm reported
record revenues and profit for its fiscal first quarter. In the post-earnings conference call,
Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies
were well contained and would have little impact on the firm's earnings. He also said that he did
not foresee problems in the subprime market spreading to the rest of the housing market
The Beginning of the End

As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge
funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-
related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender
Aurora in three states. Even as the correction in the U.S. housing market gained momentum,
Lehman continued to be a major player in the mortgage market. In 2007, Lehman underwrote
more mortgage-backed securities than any other firm, accumulating an $85-billion portfolio, or
four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as
global equity markets reached new highs and prices for fixed-income assets staged a temporary
rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio,
which in retrospect, would turn out to be its last chance.
Hurtling Toward Failure

Lehman's high degree of leverage - the ratio of total assets to shareholders equity -
was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to
deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear
Stearns - the second-largest underwriter of mortgage-backed securities - Lehman shares fell as
much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the
company returned to some extent in April, after it raised $4 billion through an issue of preferred
stock that was convertible into Lehman shares at a 32% premium to its price at the time.
However, the stock resumed its decline as hedge fund managers began questioning the
valuation of Lehman's mortgage portfolio.

On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since
being spun off by American Express, and reported that it had raised another $6 billion from
investors. The firm also said that it had boosted its liquidity pool to an estimated $45 billion,
decreased gross assets by $147 billion, reduced its exposure to residential and commercial
mortgages by 20%, and cut down leverage from a factor of 32 to about 25.

Too Little, Too Late

However, these measures were perceived as being too little, too late. Over the
summer, Lehman's management made unsuccessful overtures to a number of potential partners.
The stock plunged 77% in the first week of September 2008, amid plummeting equity markets
worldwide, as investors questioned CEO Richard Fuld's plan to keep the firm independent by
selling part of its asset management unit and spinning off commercial real estate assets. Hopes
that the Korea Development Bank would take a stake in Lehman were dashed on September 9,
as the state-owned South Korean bank put talks on hold.

The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike in
credit-default swaps on the company's debt. The company's hedge fund clients began pulling
out, while its short-term creditors cut credit lines. On September 10, Lehman pre-announced
dismal fiscal third-quarter results that underscored the fragility of its financial position. The
firm reported a loss of $3.9 billion, including a write-down of $5.6 billion, and also announced
a sweeping strategic restructuring of its businesses. The same day, Moody's Investor Service
announced that it was reviewing Lehman's credit ratings, and also said that Lehman would have
to sell a majority stake to a strategic partner in order to avoid a rating downgrade. These
developments led to stock a 42% plunge in the on September 11.


With only $1 billion left in cash by the end of that week, Lehman was quickly running out of
time. Last-ditch efforts over the weekend of September 13 between Lehman, Barclays PLC and
Bank of America, aimed at facilitating a takeover of Lehman, were unsuccessful. On Monday
September 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its
previous close on September 12.


Summary:

Lehman brothers (global financial services firm)

What happened: hid over $50 billion in loans disguised as sales

Getting caught: Went bankrupt.

How did they do it: Allegedly sold toxic assets to Cayman island banks with the understanding
that they would be bought back eventually. Created the impression Lehman had $50 billion
more cash and $50 billion less in toxic assets than it really did.
Penalties: Forced into largest bankruptcy in U.S history. SEC didnt prosecute due to lack of
evidence.
Main culprits: lehman executives, company auditors Ernst & Young

After bankrupt:

1) Barclays announced its agreement to purchase, subject to regulatory approval, Lehman's
North American investment-banking and trading divisions along with its New York
headquarters building.
[3][4]
On September 20, 2008, a revised version of that agreement
was approved by US Bankruptcy Court Judge James M. Peck.
[5]
The next week, Nomura
Holdings announced that it would acquire Lehman Brothers' franchise in the Asia-Pacific
region, including Japan, Hong Kong and Australia,
[6]
as well as Lehman Brothers'
investment banking and equities businesses in Europe and the Middle East. The deal
became effective on October 13, 2008.


2) Lehman's collapse roiled global financial markets for weeks, given the size of the
company and its status as a major player in the U.S. and internationally. Many questioned
the U.S. government's decision to let Lehman fail, as compared to its tacit support for
Bear Stearns (which was acquired by JPMorgan Chase) in March 2008. Lehman's
bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse
also served as the catalyst for the purchase of Merrill Lynch by Bank of America

Analysis (Ethical)
Ethical Issues Examined
So what went wrong? The collapse of Lehman Brothers was not the result of a single
lapse in ethical judgment committed by one misguided employee. It would have been nearly
impossible for an isolated incident to bring the Wall Street giant to its knees, especially after it
successfully withstood so many historical trials.
Instead its demise was the cumulative effect of a number of missteps perpetrated by several
individuals and parties. These offenses can be categorized into three acts: Lies told by Chief
Executive Officer Richard Fuld; concealment endorsed by Chief Financial Officer Erin Callan;
and negligence on behalf of Ernst & Young.
Main Three Wrong Doings:
1. When the housing marketing began faltering in 2007, Fuld was entrenched in a highly
aggressive and leveraged business model, not unlike many other Wall Street players at the time.
Unlike the competitors, a few of whom had the foresight to identify the pending collapse and
evaluate possible consequences of mortgage defaults, Fuld did not rethink his strategy. Instead
he proceeded into mortgage-backed security investments, continuously increasing Lehman
Brothers asset portfolio to one of unreasonably high risk given market conditions. In short, he
was obstinate, but when the time came to recognize his error, he did not assume responsibility
or admit wrongdoing. Fuld had an opportunity in 2007 to voice concerns about his banks short-
term financial health and its heavy involvement in risky loans, and he squandered it in favor of
communicating to investors and Wall Street that no foreseeable concerns existed. Had he been
truthful, more competitive solutions along with the benefit of time would have been
available, likely helping prevent or minimize the financial hemorrhage that loomed on the
horizon. For example, commercial banks, such as Barclays and Bank of America, which were
approached for a snap acquisition decision, would have had more time to evaluate whether the
move would complement their long-term strategies. They also would have had more time and
opportunity to resuscitate Lehman Brothers than they did a few quarters down the road.
Additionally, while the immediate effects of admitting a shaky outlook would have been
negative, two repercussions must be considered. First, large capital investors would have been
appreciative of the transparency, and after getting past the initial shock, they would have taken
action to get the bank back on track. Second, had the general public including the federal
government been aware of the situation and the actionable measures being taken to rectify it,
more intellectual and financial aid would have been available to minimize losses and potentially
avoid total collapse. This was not the case, however, and by choosing to paint an unrealistically
optimistic picture of Lehman Brothers financial situation, Fuld forfeited the opportunity to take
advantage of various solutions that would have cut the companys losses. Had he acted more
prudently, Lehman Brothers story may have ended differently.
2. The second ethical lapse, which was perhaps the most premeditated and fundamentally
wrong, was Callans approval of siphoning assets away from Lehman Brothers accounts and
into Hudson Castle, the phantom subsidiary created for the benefit of its parent companys
balance sheet. This blatant misrepresentation of financial health, perpetrated through the
employment of Repo 105, was an attempt to grossly manipulate the banks many stakeholders
and also clearly indicative of a much bigger problem. Even more telling is the fact that this
technique was used in two consecutive quarters.
Various documents examining the collapse of Lehman Brothers, including congressional
testimonies and investigative reports, confirm that the purpose of Repo 105 was not to diminish
earnings for tax benefits or similar effects. Instead, moving assets away from the balance sheet
was intended to create the illusion of a company that was stable and secure. Had Lehman
Brothers executive team been capable of managing the issue, this tactic would have been a
temporary stay until reorganizational measures were taken and accurate statement releases
could be resumed. Instead, for six consecutive months, the banks leverage was so dangerously
high that it had no choice but to intentionally mislead its shareholders if it hoped to maintain
any semblance of confidence in its operation. As with Fulds decision to lie about the
companys state of affairs, Lehman Brothers would have been better served by fully and
accurately disclosing the details of its finances. With the benefit of credibility and time to
strategize, the likelihood of receiving much-needed aid would have been far greater.
3. Finally, Ernst & Young, the only third party privy to the happenings at Lehman
Brothers, failed to reveal the extensive steps taken by executive leadership to conceal financial
problems. As a firm of certified public accountants expected to honor and uphold an industry-
wide code of ethics, Ernst & Young may be accused of being responsible for gross negligence
and lack of corporate responsibility. Why would such a highly respected organization risk its
own reputation and turn a blind eye on behavior that is clearly unethical? Obviously Lehman
Brothers was a sizeable (and presumably lucrative) client of the firm. But past scandals
involving questionable accounting observances, such as Enron, have demonstrated firsthand
that inaction is as equally reprehensible as direct involvement in the scheme itself. More than
just a paycheck was at risk, and failure to act successfully discredited Ernst & Young on the
basis of ethical and industry standards.
As an accounting firm, Ernst & Young is charged with certifying that companies deliver
accurate and reliable information to shareholders. In this regard, Ernst & Young failed
completely, as executives were aware of behind-the-scenes bookkeeping and the extent to
which it was occurring. In this situation, concern for ethical behavior was of minimal or
nonexistent concern. Therefore, the companys shareholders were deliberately deceived for the
purpose of preserving a paycheck, and in that regard, the team of accountants who chose not to
act disappointed more than just their company; they let down the entire industry and each of the
right-minded professionals within it.

Other Aspects:
4. Watch out for balance sheet tricks. Companies and governments often employ
balance-sheet trickery to avoid full disclosure of their financial problems. That was certainly the
case with Lehman, which temporarily shipped assets to London during a difficult stretch to
make loans appear like revenue, according to investigation.
"One of the key issues people need to think about is if conduct can be technically within the
rules and technically legal, does that still raise questions as to whether it's ethical conduct?" .
"That's a very subtle and nuanced question but it's a question the students should focus on."
5. Boom times can foster mischief. Conventional wisdom may be that mischief occurs when
the economy is in bad shape, but often times it's the opposite. To maintain an aggressive pace of
growth, executives are often tempted to hide troubles.
"After there's a financial disaster like a recession and companies start to fail, we start to see
misconduct that may have happened during the boom," .And also "During the boom times when
things are going well, there's a tendency not to question things."
"We should be asking those questions during the time of disparity instead of waiting until the
end."
6. Ethical problems should be exposed and rectified in the public square as they are
discovered, so that the market has a chance to digest the news.
one of the problems with Lehman's collapse was that it was so shocking and sudden, which led
to panic in the market. He said a better example of how to handle a financial crisis is the
European community's open, collaborative way of discussing how to address Greece's debt
crisis.
An open process like that can "moderate the consequences" of a financial disaster. "In Lehman,
there was no forewarning that it was going to happen. It just happened," .
7. When implementing ethical reforms, the actual process of implementation is just as
important as the wording of the original legislation. In other words, you can design reforms
well but if you don't implement them intelligently, they won't be effective and could be
detrimental.
As the "framework" of the Dodd-Frank legislation but is not sure whether regulatory officials
are appropriately implementing and enforcing it.
The ethical issue here was that Lehmans executives exploited loopholes in the
accounting standards to manipulate their balance sheet in order to mislead the
investing public. Using Repo 105, Lehman was able to clear huge amount
unprofitable assets off its balance sheet instead of selling at loss. Evidence
pointed out that the chief executive, Richard Ruld, knew about the use of it but
faked ignorance in defence. Even the auditors from Ernst and Young knew
about the use of the suspicious Repo 105 but chose to keep quiet.
Conclusion:
The story of Lehman Brothers demise is unfortunate, and not just because its collapse
meant the end of a Wall Street institution. The real tragedy lies in the lack of ethical behavior of
its executives and professional advisors. They made conscious decisions to deceive and
manipulate, and the consequences proved too dire to preserve the historic investment banks
existence. The perennial lesson of the Lehman Brothers case is that no matter how dire the
circumstances may appear, transparency and accountability are paramount. Right action up
front may sting initially, but as history has repeatedly shown, gross unethical business practices
rarely endure in the long term. A global financial crisis such as that of 2008 may not be
prevented from happening again. What can be improved, in large measure through ethics
education, is how corporations behave. Wall Street should take note of the case of Lehman
Brothers to ensure history does not find a way to repeat itself.
Over-zealous ambition and desperation create opportunities for financial malfeasance. If all
business leaders subscribed to being accountable and responsible for their actions we wouldn't
have a Lehman Brothers type of an event. And this is why some measure of regulation is
required. History has proven that even adult men cannot play nice
References:

http://www.annarbor.com/business-review/4-ethical-lessons-of-lehman-
brothers-collapse-from-bankruptcy-examiner/
http://www.accounting-degree.org/scandals/
http://sevenpillarsinstitute.org/case-studies/the-dearth-of-ethics-and-the-death-
of-lehman-brothers
http://www.na-businesspress.com/jlae/stevensb_web10_1_.pdf