Monthly Archives: March 2010

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

The Week in Ethics


The Week in Ethics: Toyota and the Ethics of Greed

U.S. Sen. Jay Rockefeller, D-WV, said this week that he had once worked hard to have Toyota locate an engine plant in his state because he knew it was a company built on the philosophy of quality first. “If they designed and built the safest and most reliable cars possible, then sales and profits would follow,” the senator said. “Now it is clear that somewhere along the way public safety took a back seat and corporate profits drove the company’s decisions.” Rockefeller made this comment in opening remarks as chairman of the Commerce, Science and Transportation Committee, which marked the third separate congressional hearing Toyota has faced to date.

In previous columns, I’ve talked about ways Toyota could begin rebuilding trust, dealing with challenges in reputation and image, and restoring what was lost in a process-only focus. Sen. Rockefeller’s comments, and Toyota’s own admission of losing sight of its mission, propel the Japanese auto giant into a growing category of corporate losers – those who shift focus to go after more growth and more profits, at the cost of what gave them a great reputation in the first place. Toyota, once the world’s most profitable automaker, suffered its first losses in its past two fiscal years; the turning away from a quality to a profit focus only created far more problems.

The idea that “Greed isn’t as good as we thought” is one of 10 ideas that will reshape the business world in the next decade, according to a recent Financial Times article. The author points to Bill Allen, legendary leader at Boeing, who inspired the organization to eat, breathe and sleep aeronautics and led them to market dominance and profits. Successor Phil Conduit’s focus on using measurements like unit cost, return on investment and shareholder return didn’t pay off: Boeing had scandals and lost its market leadership. Other companies mentioned — Citigroup, ICI, Enron and Lehman Bros – offer additional examples to future leaders of the quicksand of a profit-at-any-cost approach.

Toyota had a failure of ethical leadership. Delivering to the values of high quality standards and safety is ethics in action.

Ethics is at the heart of creating customer loyalty, creating an engaged workforce, and providing the reality behind the differentiating qualities that marketers use to describe a brand. Failing to build the highest quality product is, in fact, unethical. For Toyota and every other company, ethics and success in business are inextricably entwined. This lesson is proving very painful and costly to have to re-learn.

Gael O’Brien, March 4, 2010

The Week in Ethics