Lehman update: SEC, FASB to review repo accounting rules

The Financial Accounting Standards Board (FASB) will evaluate the need for accounting rule changes relating to repurchase transactions following the Securities and Exchange Commission’s (SEC) review of how financial institutions other than Lehman Brothers use these transactions, according to a letter written to the U. S. House Financial Services Committee by Robert Herz, FASB chairman.

The SEC staff is in the process of obtaining information from a number of financial institutions relating to their practices.
 
The purpose of his letter, Herz said, is to discuss accounting guidance relevant to Lehman’s accounting for repurchase practices. The FASB has read the report of the Lehman bankruptcy examiner, press accounts, and other reports, he wrote, but “did not have sufficient information to assess whether Lehman had violated particular standards.”
 
SEC Chairwoman Mary Schapiro also told the Financial Services Committee that the commission needed more information before making changes to rules. She said the SEC could change disclosure rules connected to accounting for the Lehman repurchase agreements, called Repo 105s, but that the SEC is first trying to find out if Lehman’s accounting was in accordance with generally accepted accounting principles.
 
"If there is a loophole, we'll cut it off," Schapiro said.
 
Unlike normal repurchase transactions, which are classified as short-term borrowings and have no impact on the balance sheet, the Repo 105 transactions, which took place before quarterly filings, were classified as sales and helped Lehman to decrease its leverage ratio.
 
Herz explained how accounting standards prescribe “when a company can and cannot recognize a sale of a financial asset based on whether it has surrendered control over the asset.” In the Lehman case, “The assessment of legal isolation may have only considered whether the securities were isolated from a U.K. subsidiary, as opposed to the consolidated U.S. entity.”
 
According to Herz, attorneys have told the board that there is considerable difference between UK law and U.S. law on how repo transactions are viewed in the case of insolvency. “In the United States, case law related to repurchase transactions has been varied enough that most attorneys generally would not provide a true sale opinion,” he stated in the letter.
 
Existing accounting guidance for when a repurchase transaction may be accounted for as a sale has been unchanged since 1997, Herz wrote, and was never intended to be a “bright line.”
 
Schapiro said the SEC has received responses to the letters it sent to the financial institutions, MarketWatch reported. The responses will be posted no sooner than 45 days after the review of the documents has been completed.
 
The Wall Street Journal has reported that 18 large banks had consistently lowered one type of debt at the end of each of the past five quarters, reducing it on average by 42 percent from quarterly peaks.
 
Lehman’s former CEO, Richard Fuld, in testimony at the same House Financial Services Committee hearing, said that he had “absolutely no recollection whatsoever of hearing anything about Repo 105 transactions while I was CEO of Lehman. Nor do I have any recollection of seeing documents that related to Repo 105 transactions.”
 
Ernst & Young, Lehman’s auditor, which stands by its audit work for the bankrupt firm, continues to face scrutiny. Unsecured creditors of Lehman have asked the bankruptcy court to order that Ernst & Young produce certain documents, and its employees and partners submit to an oral examination.
 
"It is unlikely that Ernst & Young will voluntarily provide this information to the committee," the unsecured creditors said.
 
The Big Four firm has also been asked by the UK’s Financial Reporting Council, which oversees the UK’s financial reporting of public companies, to turn over all documents related to Lehman.
 
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