INTRODUCTION OF LEHMAN BROTHERS

In the year 1844, a 23-year-old Henry Lehman come to Birmingham, Alabama from Bavaria and opened a dry-

goods store, named as “H. Lehman”. In 1847, Emanuel Lehman arrived and the company is further named as “H.

Lehman and Bro” The Company was basically founded in the year 1850 when Mayer Lehman arrived to

Montgomery, Alabama, USA and it is renamed as Lehman Brothers. Accepting cotton as payment and reselling

them was the most important part of their business. In 1969 Robert Lehman died, and the company had been led by

non-Lehman’s ever since. In 2008, The Company was headquartered at New York, USA under the Chairman and

CEO, Richard S. Fuld Jr when it became bankrupt.

The core business of Lehman Brother was buying and selling of shares, fixed income assets, trading, research,

investment banking, investment management and private equity. Lehman Brothers bank was a major player in the

U.S. Treasury Security Market, acting as a primary dealer. The firm was dealing with governments, companies and

other financial institutions and operating at wholesale level. It was the fourth largest bank in USA in terms of

investment.

The firm had worldwide presence employing more than 25,000 people worldwide, including 5,000 in the UK till

2008. There were some subsidiaries of the bank from time to time and they are as follows:

Lehman Brothers Inc., Eagle Energy Partners, Aurora Loan Services, Inc., Neuberger Berman Inc.,   Crossroads

Group, FSB and Lehman Brothers Bank.

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 INTRODUCTION OF ACCOUNTING SCANDAL OF LEHMAN BROTHERS

Corporate malfeasance has earned a place among the definition themes of the last decade and a half,

helping give birth to the present global recession and the occupy Wall Street movement. Here’s a look back

at the who, what, when and how Lehman Brother’s accounting scandal. With over $639 billion in assets

and $613 billion in liabilities and 25000 employees worldwide the Lehman Brothers’ bankruptcy was the

largest in United States history.

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 DETAILS OF LEHAN BROTHERS’ SCANDAL AND ITS DISCOVERY
 Leverage

The best way to improve one’s returns during the good times is to gear the returns up by borrowing money and

investing in the assets that are rising in value. This helps individual to ‘leverage’ (magnify) one’s returns. This is

useful when interest rates are low. Leverage also magnifies losses and gets magnified when asset prices fall.

This is what happened exactly in case of Lehman Brother when in 2004 it was leveraging at the running of 20 to

reach to an incredible 44 in the year 2007. Thus the investment giant was leveraged 44 to 1 at a time when asset

prices began heading south. This situation was something bit like someone on a wage of $100,000 buying a house

using a £4,400,000 mortgage. Lehman was facing a similar situation.

 Liquidity

Most of the businesses in the world collapse not only because of the lack in profits but also because of the

problems in cash-flow. Lehman was an upturned pyramid balanced on small cash didn’t have enough liquidity in

its way. In one hand other others were easily selling assets while on the other hand the bank was lacking in ready

cash. Thus Lehman started losing liquidity at fast pace.

 Losses

After the terrorist attacks of 9/11, the interest rates in US started dropping. This caused a five-year boom in

domestic and commercial property prices in US. This boom ended in 2006 and after that U.S. housing prices

started fallen for three years.

Lehman Brother was heavily open to the U.S. real-estate market. Lehman Brother had over $60 billion invested in

commercial real estate market and was very big in subprime mortgages which were the loans to the risky

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homebuyers. As property prices crashed Lehman Brother was caught in a perfect storm. In 2008, the loose of

Lehman came to about $6.5 billion.

 Subprime Mortgage crisis.

 Boom and then burst in the housing market.

 Policies of the Central Bank.

 Indulgent in high risk mortgage loans, lending and borrowing.

 Boom and then fall of shadow banking system.

 Inaccurate credit ratings and securitizing practices.

 Credit default swaps.

 Lehman Brothers commonly used repurchase agreements as a source of financing.

 Repurchase agreements are considered a liability and increase an institution’s leverage ratios.

 Loopholes in financial accounting standards allowed for repurchase agreements to be moved off-balance

sheet in the event that certain requirements are met.

 Lehman Brothers would (legally) move repurchase agreement debts off of their balance sheet during

reporting periods in order to mislead investors by decreasing leverage.

 Investors were unaware of Lehman Brothers’ repurchase agreement shell games.  Had they known, it may

have negatively impacted Lehman Brothers’ stock price. No other financial institutions were employing

this deceptive practice.

 In March 2010, the report of Anton R. Valukas, the Bankruptcy Examiner, drew attention to the use

of Repo 105 transactions to boost the bank's apparent financial position around the date of the year-

end balance sheet. The New York attorney general Andrew Cuomo later filed charges against the bank's

auditors Ernst & Young in December 2010, alleging that the firm "substantially assisted... a massive

accounting fraud" by approving the accounting treatment.

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 On April 12, 2010, a New York Times story revealed that Lehman had used a small company, Hudson

Castle, to move a number of transactions and assets off Lehman's books as a means of manipulating

accounting numbers of Lehman's finances and risks. One Lehman executive described Hudson Castle as an

"alter ego" of Lehman. According to the story, Lehman owned one quarter of Hudson; Hudson's board was

controlled by Lehman, most Hudson staff members were former Lehman employees.

IMPACT OF LEHMAN BROTHERS’ SCANDAL ON STAKEHOLDERS

 26.3 Billion the total shareholders' equity that Lehman reported prior to its bankruptcy filing.

 Creditors of the Lehman estate will receive roughly $0.18 on the dollar when all is said and done in

2016.

 Stocks fell across Europe & Asia.

 The US stock fluctuated with over $300 Billion in market value.

 The dollar lost the most against the yen in a decade & as a result treasuries surged.

 Depreciation in the price of commercial real estate was to be noticed.

 Liquidity prospect of Lehman’s $4.3 Billion in mortgage securities started a selloff process in the

commercial mortgaged-backed securities market.

 An atmosphere of fear started to sell securities in commercial real estate.

 The pension funds of the employees which holds bond in the firm, had lost most of their values

causing a risk of losing their pensions.

 On External financial entities

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There exist a principal agent relationship between managers and the owners, where the owners are the

principals and mangers are the agents to act on behalf of owners in relation to conduct their business in an

effective manner. Manager’s effort is usually unobservable to the firm’s owner as the owners are not

involved in day to day business activities and they have given authority to management to look after the

code of business. As they are far away from the business place they can’t keep eye on the efforts and work

done by management.

When some parties to the business transaction may have information advantage over others or may take

actions which are unobservable to other party is known as Information Asymmetry. The problems resulting

from information asymmetry are:-

 Adverse Selection: It occurs when firm managers and other insiders have better information about

the current condition and future prospects of the firm than the outside investors and the managers

take advantage of such information at cost of outside investors.

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  Moral Hazard: It arises when one party to a contractual relationship takes actions that are

unobservable to the other contracting parties. As the manager’s efforts are unobservable by owners,

managers may be tempted to shirk on effort, blaming any deterioration of firm performance on

factors beyond his/her control.

CURRENT STATUS OF LEHMAN BROTHERS AFTER SCANDAL

After the company had filed for bankruptcy under chapter-11, Lehman brothers had been acquired by:-

1. BARCLAYS CAPITAL (17th September 2008):Barclays acquired North American investment banking,

capital markets businesses and three real estate properties including LBHI’s Manhattan headquarters. The

consideration paid by Barclays Capital to Lehman Brothers is the amount of assured liabilities, $250

million in cash, certain contingent considerations and real estate properties of $1.45 billion. Barclays also

agreed to provide Debtor-in-Possession(DIP) financing to Lehman Brothers Holdings Inc of $500 million

and a substantial interim credit facility to Lehman Brothers.

2. NOMURA HOLDINGS INC. OF JAPAN (22 nd September 2008): It acquired equities and investment-

banking operations in Asia, Europe and Middle East. The cost of acquisition for Nomura was approx. $

2billion. After acquisition the workforce of Nomura increased from 1700 to 4700. And the pre tax income

was $5billion (net of one time losses such as subprime losses).

Business Synergies for Nomura Holdings Inc.

NOMURA LEHMAN

Global Equity Traditional Hedge funds

Domestic Fixed income Japanese Overseas

Others Retail Wholesale

3. PRIVATE EQUITY FIRMS: They acquired the principal investment management unit i.e. Neuberger

Berman and the fixed income and certain alternative asset management.
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 WHY SCANDALS OCCUR?

Sometimes there is a lack of interpretation of the accounting standard and the managers unintentionally mislead

financial statements as per his/her own understanding of the standard. But sometimes manager deliberately mislead

the financial statements even if they know that it is unethical and illegal; as we know that everyone wants to

maximise their wealth, so they manipulate the accounts for their own benefits. The managers think of short term

benefits but ignored the long run effect of the manipulation which they are doing and it leads to a big scandal in the

economy which brings the organisation into a big trouble and various fees and penalties are also be imposed on

organisation and the managerial persons involved in it.

ETHICAL DILEMMA IN LEHMAN BROTHERS

Ethical standards are the part and parcel of every business. Through the standards, organizations are able to

develop structures that will provide clear effective guidance in the day to day operation, safeguard the interests of

stakeholders and customers, while supporting a positive work culture.

The collapse of Lehman Brothers was not the result of a single lapse in ethical judgment committed by one

misguided employee. However it is due to the cumulative effect of a number of missteps perpetrated by several

individuals and parties. These missteps are lies told by Chief Executive Officer Richard Fuld; concealment

endorsed by Chief Financial Officer Erin Callan; and negligence on behalf of Ernst & Young.

1. When the housing market is started losing confidence in 2007, Fuld entrenched in highly aggressive and

leveraged business model. Some of the competitors had the foresight to evaluate the possible consequences of

mortgage defaults but 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. But when the time came to recognize his error, he did not assume responsibility or admit

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wrongdoing. Fuld forfeited the opportunity to take advantage of various solutions that would have cut the

company’s 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 Callan’s

approval of siphoning assets away from Lehman Brothers accounts and into Hudson Castle, the phantom

subsidiary created for the benefit of its parent company’s balance sheet. This misrepresentation of financial health,

perpetrated through the employment of Repo 105, was an attempt to grossly manipulate the bank’s stakeholders

and also clearly indicative of a much bigger problem.

3. Finally, Ernst & Young (auditor of Lehman Brothers), failed to reveal the extensive steps taken by executive

leadership to conceal financial problems. As a firm of auditors, they were expected to honour an industry-wide

code of ethics; Ernst & Young may be accused of being responsible for gross negligence and lack of corporate

responsibility.

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 CONCLUSION

The existence of multinational companies had a great impact on the socio-economic life in the world. The impact

on the economy due to failure of such companies can be well seen from the case of Lehman Brothers, Worldcom,

Enron etc.  It is through careful analysis of each failure by governing bodies that lessons are learned, policies are

developed, and legislation passed in an effort to prevent similar events from occurring in future: the Sarbanes-

Oxley Act is such an example. These failures help government bodies to see what are the loopholes in the laws and

regulations and to amend them to avoid such scandals in future.

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 REFERENCES

1. Investopedia.com

2. Sevenpillarsinstitute.org

3. academia.edu

4. Reports of New York Times

5. Financial Accounting Theory 7e by William R. Scott

6. wikipedia.org

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