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Repo Men - How Lehman Used "Repo 105" to Manipulate Its Balance Sheet

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

March 21, 2010

In “The Origins of Lehman’s ‘Repo 105’”, a recent post from the New York Times DealBook Blog, authors Michael J. de la Merced and Julia Werdigier discuss the so-called Repo 105 technique. Repo 105 came to light in the 2,200-page report of the court-appointed examiner in the bankruptcy case. Using this technique, Lehman was able to move $50 billion in debt off its balance sheets just before the end of each of the last several quarters leading up to the company’s collapse. The techniques used by Lehman are reminiscent of the types of misleading accounting practices I thought had ended after the Enron and WorldCom scandals:

"Like all repos, short for 'repurchase agreements,' it involved what amounts to a short-term loan, exchanging collateral for cash up front, and then unwinding the trade as soon as overnight. . . . Unlike other repos, the value of the securities Lehman pledged in Repo 105 transactions were worth 105 percent of the cash it received. . . . Yet the beauty of Repo 105 was that, . . . . the firm could book the transactions as a 'sale' rather than a 'financing,' as most repos are regarded. That meant that for a few days — and by the fourth quarter of 2007 that meant end-of-quarter — Lehman could shuffle off tens of billions of dollars in assets to appear more financially healthy than it really was."

The DealBook post goes on to describe that Lehman could not get any U.S. law firms to give a legal opinion that the transaction was a “true sale” rather than a loan. So Lehman went opinion-shopping and got the U.K.-based law firm Linklaters to give the “sale” opinion under English law. To accomplish this, Lehman moved the transactions offshore, to its European subsidiary (even though it still used a large amount of U.S.-originated securities). Even though Martin Kelly, a former financial officer, had questioned whether there was any purpose for the transactions other than to manipulate the balance sheet, Lehman’s top officers and advisors seemingly did not ask the hard questions. As described in this additional DealBook post on the topic, the examiner’s report leaves the door open for lawsuits and enforcement proceedings against all of these parties. We will be hearing about “Repo 105” for a long time to come.

A word for Repo 105 comes to mind that I always thought originated, like Lehman’s legal opinion, in the U.K.: “Shenanigans”. It turns out that its origin is uncertain, but it sounds Irish, so I guess that’s close enough.


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