Ernst & Young’s (E&Y) failure
to challenge the use of Repo 105 accounting techniques by failed
bank Lehman Brothers is being examined by both a US government
panel and the UK Financial Reporting Council.
The most controversial aspect of the bank’s
financial reporting, the Repo 105 transactions, has an interesting
trans-Atlantic aspect. Repo 105 is allowed under US GAAP, but would
have been questionable under international standards.
Yet Lehman Brothers was unable to find a US law
firm that would provide it with an opinion letter permitting it to
use the accounting method under United States law, so US Lehman
entities wishing to use Repo 105 transaction transferred their
securities to the bank’s Europe arm to conduct the transaction.
Leading UK law firm Linklaters provided the necessary opinion
Institute of Chartered Accountants in England
and Wales executive director Robert Hodgkinson said that although
it has not been officially confirmed how the repo transactions were
treated in UK financial reports, there is a general consensus that
the accounting practice would be problematic under international
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“It is important to get across the idea that in
the UK with principles-based standards, whether it is UK GAAP or
IFRS, looking at the substance of the transaction you would have
said that these were not sales,” Hodgkinson said.
“The clue is in the title – repo is repurchase
and if you have got a commitment to repurchase, the presumption
under most substance over form accounting is you have not really
Most repo transactions are accounted for as
financings; but some – the Repo 105 transactions – are accounted
for as sales if they meet the requirements of the US GAAP standard
FAS 140 Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities.
Lehman’s use of the practice, and the fact
Ernst & Young did not question it in its audit of the bank’s
financial statements, came under fire this month in a 2,200 page
report from US court-appointed investigator Anton Valukas.
Valukas alleged that Lehman Brothers used the
technique to allow the bank to temporarily move $50bn off its
balance sheets in late 2007 and early 2008. This made Lehman’s
statements and related disclosures materially misleading, Valukas
Critics of Valukas’ allegations have pointed
out the Repo 105 complies with US GAAP and is commonly used by
E&Y has said Lehman’s bankruptcy, which
occurred in September 2008, was the result of a series of
unprecedented adverse events in the financial markets.
The Big Four firm added that it will
co-operate fully with all relevant parties on the matter.