Jennifer S. Taub is a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst. She is a member of the Economists’ Committee for Stable, Accountable, Fair and Efficient Financial Reform (SAFER). Taub formerly worked as an associate general counsel at Fidelity and as assistant vice president for the Fidelity Fixed Income Funds. Since reading portions of the report issued by Anton Valukas, the examiner in the Lehman bankruptcy and writing about the firm’s accounting tricks in “A Whiff of Repo 105,” I’ve been thinking about footnote 69. Perhaps ‘obsessing’ is a better description of my state of mind. Consider that I possess a printed copy of the nine-volume, 2,200 page report. However, that obsession seemed justified when the Wall Street Journal broke the story, “Big Banks Mask Risk Levels,” revealing the early results of the SEC’s probe of repurchase agreement accounting practices at major firms. According to the WSJ, based on data from the Federal Reserve Bank of New York, eighteen banks “understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods.” These banks include Goldman Sachs, Morgan Stanley, JP Morgan Chase, Bank of America and Citigroup. According to the story, these practices are perfectly legal. However, the full investigation is not yet complete. There remains still the possibility that this may be the “Watergate” of the financial crisis. If manipulation of balance sheets rises to the level of fraud, there may be convictions to follow. Thus far, levering up, binging on toxic assets and threatening the global economy have been protected within the bounds of simply bad business judgment. However, as we learned from Nixon, the cover up is a whole different narrative. Upon spotting the WSJ story this morning, I remembered that fascinating footnote from the examiner’s report. It appears on page 19 and reads as follows: “69 Examiner’s Interview of Martin Kelly, Oct. 1, 2009, at p. 8 (Kelly told the Examiner that Lehman was the last of the CSE firms to continue using Repo 105‐type transactions to manage its balance sheet by late 2007); Examiner’s Interview of Marie Stewart, Sept. 2, 2009, at p. 4 (Stewart believed that Lehman was the last of its peer group using Repo 105 transactions by December 2007).” (Emphasis added) These revelations by Martin Kelly, Lehman’s controller, and Marie Stewart, the global head of accounting policy, invited many questions. First, how reliable are they? Recall that Kelly is the first addressee listed on the May 2008 letter from Lehman whistleblower, Matthew Lee. Second, how could they know what the practices were at the competitor CSEs (CSE was the regulatory designation from 2004 – 2008 of the five large independent investment banks – Bear, Lehman, Merrill, Morgan Stanley and Goldman)? Third, if there was no legal change at that time, what was the magic of 2007? In other words, if the examiner, Anton Valukas, is correct in suggesting the “repo 105″ practice was actionable, are these other investment banks vulnerable to litigation for pre-2007 practices? Fourth, was it possible that the other investment banks had been hiding billions of dollars of debt off balance sheet? Fifth, what was the connection between these practices and the financial crisis? Sixth, was this still going on at the firms? Prior to finding the answers to these questions, I noticed that the SEC had posted a sample letter that it sent to “certain public companies requesting information about repurchase agreements, securities lending transactions, or other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets.” The illustrative letter was signed by the Senior Assistant Chief Accountant. Pleased that the SEC was on the job, I turned my attention to other matters, until this morning. It is hard to predict what will happen next. However, it is quite possible, that the Valukas Report will be the global financial crisis analog to the Pecora Hearings, helping to energize robust regulatory reform. At the very least, this reinforces the need that all debt and all transactions that have the economic effect of debt or leverage must be on balance sheet. Only time will tell. More on Financial Crisis

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SAFER: The Repo 18: It’s Not the Collateral, It’s the Cover-Up