SEC Staff Ends Probe of Lehman Without Finding Fraud

U.S. Securities and Exchange Commission investigators have concluded their probe of possible financial fraud at Lehman Brothers Holdings Inc. without recommending enforcement action against the firm or its former executives, according to an excerpt of an internal agency memo.

Lawmakers and investors have pressed the agency for more than three years to determine whether Lehman misrepresented its financial health before filing the biggest bankruptcy in U.S. history in September 2008.

Under a heading reading “Activity in Last Four Weeks,” the undated document reads, “The staff has concluded its investigation and determined that charges will likely not be recommended.”

SEC officials didn’t dispute the authenticity of the memo or its contents.

Pressure on the agency to punish any wrongdoing related to Lehman’s collapse escalated after Anton Valukas, the court- appointed bankruptcy examiner, found the firm misled investors with “accounting gimmicks” that disguised its leverage.

Senior SEC officials have been reluctant to formally close the matter even though investigators found a lack of evidence of wrongdoing, according to people with direct knowledge of the matter. The officials have weighed issuing a public report on their findings that would stop short of an enforcement action while highlighting the firm’s questionable conduct.

Under Analysis

SEC Chairman Mary Schapiro said the case was still “under investigation and analysis” when she testified at a congressional hearing last month.

“Our staff has conducted an independent and extremely extensive investigation of all these issues,” Schapiro said in the April 25 hearing before the House Financial Services Committee. “They have searched through millions of pages of documents. We have taken testimony of all the key people including members of Lehman senior management, outside accountants.”

John Nester, an SEC spokesman, said the case remains under review.

“As the chairman said, it’s still under review and no final decision has been made,” Nester said in an e-mail.

Repos Questioned

In a 2010 report, Valukas said Lehman used transactions known as Repo 105s to hide billions of dollars in assets and artificially reduce the firm’s leverage. In a typical repo agreement, one party temporarily transfers a security to another as collateral for short-term cash. A Repo 105 transaction requires extra collateral, making it a more costly form of borrowing. Those deals were accounted for by Lehman as “sales,” as opposed to financing transactions, Valukas said.

After Valukas released his findings, the SEC sent letters to financial firms asking for information on their use of repos. While investigators found that Lehman’s accounting of the transactions was in accordance with generally accepted accounting principles, or GAAP, the people said, regulators have since changed the rules to keep other firms from doing the same.

“The SEC would have to prove that the accounting wasn’t correct under GAAP, and sometimes that’s subjective,” said Joseph Dever, a former SEC attorney who is now at law firm Cozen O’Connor in New York. “When you have a subjective analysis like that, it’s hard to prove to a judge or jury that they intentionally got the numbers wrong.”

‘Grossly Negligent’

According to Valukas, Lehman’s former Chief Executive Officer Richard Fuld was “at least grossly negligent” for letting Lehman file financial reports that distorted the firm’s risks.

Fuld didn’t structure or negotiate the Repo 105s, nor was he aware of the accounting treatment, his lawyer, Patricia Hynes of Allen & Overy LP, said in a statement after Valukas’s report was released. Hynes didn’t immediately respond to an e-mail seeking comment.

According to the internal memo, SEC staff investigated whether Lehman and its officers misrepresented the firm’s financial health, capital situation, liquidity and its commercial real estate portfolio.

In its final year, Lehman overvalued real-estate holdings, including a stake in U.S. apartment developer Archstone-Smith Trust, Valukas said. Lehman and Tishman Speyer Properties LP completed a joint acquisition of Archstone for $22 billion, including debt, in October 2007.

Lehman presented “unreasonable” valuations of its Archstone stake in the first three quarters of 2008, overvaluing the holding by as much as $450 million in the second quarter, Valukas said.

Lehman agreed to buy the rest of Archstone for almost $1.6 billion from Bank of America Corp. and Barclays Plc, ending a dispute with the banks over the price, a person familiar with the deal said. Lehman had been trying to stop the lenders from concluding an option to sell to Sam Zell’s Equity Residential.

The defunct investment bank has said it plans later to sell Archstone, its biggest real estate asset, to help pay creditors.

To contact the reporter on this story: Joshua Gallu in Washington at jgallu@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net

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