Lehman Brothers’ Perfect Storm: Where Ethical Lapses Met Bad Judgment

Update: September 9, 2013: Five years ago this month Lehman Brothers collapsed. The New York Times reports today about the SEC’s several- year investigation, internal disputes over whether evidence against Lehman was strong enough to bring charges, and why they haven’t.

Update August 26, 2011: Former CEO Richard Fuld and 12 other Lehman executives and directors, accused in investor lawsuits of lying about Lehman’s financial condition leading up to the bankruptcy, filed in Federal Bankruptcy Court yesterday requesting a judge release insurance proceeds to pay for settlements. The former executives have agreed to pay $90 million to settle a shareholder suit and $8.25 million in another suit. They are neither admitting or denying wrongdoing.  

Update: April  20, 2010: Today former Lehman CEO Richard Fuld testified before the U.S. House Financial Services Committee insisting he had no recollection whatsoever of hearing about Repo 105 transactions while at Lehman. Fuld testified Bankruptcy Court Examiner Anton Valukas distorted relevant facts about Repo 105, and that he signed off on SEC filings because his chief legal officer and others raised no issues. Rep. Jackie Speier (D- CA)  disagreed that the Examiner’s report vindicated Fuld saying that billions of Lehman shares had traded on misrepresentation.

Did Wall Street’s financial meltdown really have nothing to do with ethics or governance? Was it instead about bad business decisions and poor government oversight? That is what some business leaders, in a series of 30 interviews I recently conducted, have suggested.

I disagree. And I think the Bankruptcy Court Examiner’s report on the collapse of Lehman Brothers, released last week, backs me up.

It offers a prime example of how ethics and governance are part of the lens that should be focused on in what went wrong in the meltdown; indeed, ethics and governance are what we need to have more, not less, of as we re-establish the soundness of our economy.

The report by Examiner Anton R. Valukas identifies what he says are Lehman Brothers’ non-culpable errors of bad judgment and areas where there is “sufficient credible evidence to support a finding by a trier of fact” (for example, a judge or jury). Not exactly a ringing endorsement of the transparency of Lehman’s business practices, eh?

The report finds that Lehman painted a misleading picture of its financial condition using a Repo 105 accounting strategy that auditors Ernst & Young knew about but didn’t question.

What’s in a name?

The report also indicates that Lehman did “actionable” balance sheet manipulation to keep Rating Agency approval. Lehman and Ernst & Young may yet face criminal charges as a result of these and other findings.

The report offers rich material for crucial conversations including:

  • Governance – Beyond findings of law, what should directors be counted on to ask and pursue?
  • Corporate culture – What prevented employees and “whistle blowers” who called out problems and concerns from being heard and heeded?
  • Managing risk – What are implications for culture and business practice when risk management framework is superseded by executives’ “practical experience” – and how are errors in judgment corrected or concealed?
  • Transparency – What are, or should be, the consequences of manufacturing confidence at any cost?
  • Ethical leadership – What kind of example do you set as the “Gorilla of Wall Street”?
  • Accountability – To whom and for what?

Questions also remain about the ethics and legality of JP Morgan Chase’s and Citigroup’s actions as unsecured creditors, as well as Ernst & Young’s behavior. How are accounting tricks – that may be technically legal but create false information about financial health – aligned with maintaining the highest professional standards? A standard well below that, it seems, was accepted business practice here.

Through the floor

Now that the business model of rewarding excessive risk and leveraging that brought Lehman and others down has been eviscerated, what is the next evolution for capitalism and free markets. And what will the role of ethics be, in helping companies be profitable and successful? Will the term “business ethics” seem less an oxymoron?

Lehman lost 95 percent of its stock price in less than eight months which Richard Fuld, former CEO,

blamed on external factors (credit agencies, short sellers, rumor mongers among others) when he testifiedbefore Congress.

The Examiner’s report didn’t find that the standard of negligence was met in senior management’s disregarding risk appetite limits, balance sheet limits, stress testing, quantitative risk limits and other metrics, as well as the advice of its risk managers. The report also said that Lehman’s senior management didn’t breach their fiduciary duty by not telling the board of directors the level of risk they’d assumed and the board didn’t breach its fiduciary duty by failing to monitor the risk Lehman was taking.

Okay, it seems that the standards for negligence and fiduciary duty take a lot to meet. This reminds me of what an NBA announcer said recently, observing a play that dangerously catapulted an L.A. Lakers’ player to the floor; he observed when the referees ignored it, “No ambulance, no foul.”

Much will be written about the culture at Lehman. Some insights are evident in a Vanity Fair article this month. Former CEO Fuld spent 42 years at Lehman but praise is scant. Dubbed the Gorilla of Wall Street, he earned Time Magazine’s designation as one of the 25 people to blame for the financial crisis.

In response to the Examiner’s findings about balance sheet manipulation and failure to disclose $50 billion of off-balance sheet assets by the Repo 105 trick, Fuld said through his lawyer, that he didn’t know about them, didn’t know what the transactions were, hadn’t structured or negotiated them, and none of the senior officers, lawyers or outside auditors had raised it with him. A tough sell under Sarbanes Oxley because by signing Lehman’s certified financial statements, he accepted responsible for their accuracy.

In response to criticism of professional negligence, Ernst & Young says their last Lehman audit was for the FY ending November 30, 2007; and it was conducted in accordance with GAAP (generally accepted accounting principles). Lehman filed bankruptcy September 15, 2008. This week, United Kingdom regulators demanded the accounting firm hand over documents related to their role in Lehman’s collapse.

So, a dead body. Ongoing investigations. Where is an ambulance when you need one?

Gael O’Brien, March 18, 2010

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11 Comments on “Lehman Brothers’ Perfect Storm: Where Ethical Lapses Met Bad Judgment”


  1. Hi Gael: -)
    I love your humor ! You’ve made a difficult subject accessible and sharable.
    Rita

    • amanda Says:

      Hi like your article.

      Did you hear about Mr. Lee who was a supposed whistle blower but then got shut up? Can you do an ethical analyses for firing Mr. Lee?

      I think it’s funny how Mr. Lee originally used his morals and tried to be a whistle blower but when it comes to money everyone goes quiet. I guess they tried to fire him and he got mad so they paid him off.

      • Gael O'Brien Says:

        Thanks for your comment, Amanda

        Then CFO Erin Callan and then Chief Risk Officer Chris O’Meara passed Matthew Lee’s letter off to Ernst & Young, who found it without merit, and yet, Lee WAS RIGHT. The timing of his firing right after that, although packaged by the company as cost cutting layoffs that affected lots of people, raises big suspicion about retaliation. Ignoring Lee was a risk; firing him was a risk but one that had with it a severance agreement that if Lee signed was confidential and precluded his filing a lawsuit. He signed the agreement. Nonetheless, Lee’s letter puts Callan, O’Meara and Ernst & Young very much on the proverbial hot seat. We haven’t heard the last of this.

    • David Schneider Says:

      You are very perceptive.


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  5. [...] make moral compromises.  You think this could never happen to you, but likely Mark McGwire and Lehman Brothers never set out to be corrupt either.  There’s a reason Macbeth is a classic (other than the [...]

  6. thedrunkmind Says:

    Our professor made us read and summarize this. OH GOD WHY? WHY GERALD WHY? WHY OZU WHY?

    • Gael O'Brien Says:

      One day when you are running a company or a department, you can think about all the mistakes leaders you’ve read about have made — and you can make different and better choices. When Paul O’Neill (former U.S. Treasury Secretary and former chairman of Alcoa) became the CEO of Alcoa he said he knew the kind of leader he wanted to be based on not wanting to repeat the mistakes of bosses he’d had or leaders he’d observed. Thank you for writing, even if you did read the column under duress.


  7. [...] highlight an almost sociopathic disregard for customers that seem a hallmark of the meltdown. From Lehman to Goldman Sachs customers were objectified, not real flesh and blood, the way a hit and run driver [...]


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