Opportunity

Although the company was using accounting scheme to raise its balance sheet, it was
doing everything according to accounting standards put forth by the Financial
Accounting Standards Board (FASB). For a REPO 105 transaction, however, Lehman
believed that they would not be able to easily replace an asset valued as 5% more than
what they got for it. Thus, this interpretation results in a relinquishment of control, which
is then classified as a “true asset sale”, which was also agreed by SFAS 140.

With SFAS 140 on their side, Lehman Brothers was allowed to account for their assets
as sales and lower their debt. To finalize a repo transaction as a sale under SFAS 140,
FASB requires that the transferor (Lehman Brother) obtain an opinion letter from a law
firm confirming the true sale and relinquishment of control of asset.

Lehman couldn’t find a law firm in United States that would draft an opinion letter for
their REPO 105 transactions, however, a London based law firm agreed to draft the
letter under UK Law. To facilitate the process, Lehman created a Lehman Brothers
International Europe (LBIE) to execute the Repo transaction in UK. LBIE would either
use assets owned by LBIE or assets originated from US-based Lehman entity for the
REPO 105 transactions.

With the opinion letter from a UK law firm, Lehman now had the opportunity to freely
book their relinquished asstes as sales and hide their debts.

Rationalization

Lehman Brothers made $50 billion in debt disappear from their balance sheet. Their
leverage ratio, as a result, was lowered by an average factor of 1.8 percent per quarter
in 2007 and 2008.

Lehman could justify their actions by claiming they had received a stamp for approval
from their auditors and government regulators. Regardless of the fact that Lehman new
they were materially misstating their balance sheet, the law was on their side.

The Ernst and Young also stated that they did nothing wrong because REPO 105 is
within the GAAP, and that Lehman's bankruptcy was not caused by any accounting
issues.