Solved: 1 What was the most important reason for Lehman

Brothers

1. What was the most important reason for Lehman Brothers failure?
2. What is leverage and why is it so important?
3. Prepare the journal entries for a Repo 105 transaction sequence for $1 million in securities.
4. In your opinion, how large should a Repo 105 transaction be to be considered material, and
why?
5. Was LB’s interpretation of SFAS 140 – that Repo 105 transactions could be treated as sales
– correct? Provide your reasons.
6. If, as the Examiner’s Report states, LB continued to collect the revenue from the securities
involved in the Repo 105 transactions, how could LB say that they had given up ownership?
7. An emerging issues Interpretation Bulletin accompanying SFAS 140, gives examples
indicating Repo 102 transactions would not qualify as sales, but Repo 110 would. Why do you
think this Bulletin was issued?
8. Knowing that LB could not obtain a “true sale” opinion from a U.S. lawyer under U.S. law,
should LB have tried to obtain the opinion from a U.K. law firm? Why and why not?
9. Do the Repo 105 arrangements constitute fraud? Why and why not?
10. What is the auditor’s responsibility if a fraud is suspected or discovered? What professional
standards are most important in such cases, and why?
11. If you were the audit partner in charge in the U.S., what would you have required be done in
regard to the Linklater “true sale” letter?
12. Should consolidated financial statements of a U.S. parent company include (i.e. consolidate)
foreign subsidiary accounts prepared on a basis not considered appropriate U.S. GAAP?
13. Would the adoption of IFRS have prevented the Repo 105 misrepresentations?
14. What should the following have done upon learning of Matthew Lee’s whistleblower’s letter
– LB’s management, board of directors, and the external auditors, E & Y?
15. Arthur Andersen tried to keep its Enron audit problems quiet, whereas E & Y spoke out in its
own defense. Was it a good idea for E&Y to send a letter, such as the one reproduced above, to
their clients? Why and why not?
16. Based on the letter, should E&Y be in the clear of any wrongdoing related to the Repo 105
and 108 transactions and reporting? Provide your reasons for and against.
17. If an auditor explains a problem to the Chair of an Audit Committee, is there any further
obligation on the part of the auditor to ensure that the full board have been notified and why?
18. Organizations who use the Enterprise Risk Management (ERM) framework, should work
through the following stages: review on the internal environment, identification of the
organization’s risk appetite or objectives, risk identification and measurement, risk assessment,
risk response, providing risk information and communications, and risk monitoring. In which of
these did LB fail? Who was to blame for the failure?
19. How should the U.S. Bankruptcy Examiner’s Report be regarded – as a neutral set of
findings or as a signpost intended to point creditors in the direction of potential recoveries?
What are the implications of each?
20. After the Enron and WorldCom fiascos, regulators sought to avoid future misrepresentation
by enacting the Sarbanes-Oxley Act (SOX) in 2002. Why didn’t SOX prevent Lehman’s use of

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 Repo 105 and 108 misrepresentations? Does that mean that SOX is a failure?

On September 15, 2008, Lehman Brothers Holdings Inc., one of the world’s most respected
and profitable investment banks, filed for Chapter 11 bankruptcy protection in the United States
Bankruptcy Court in the Southern District of New York.1 Although Lehman Brothers (LB) had
reported record revenues of almost $60 billion and record earnings in excess of $4 billion for the
fiscal year ended November 30, 2007, only ten months later their bankruptcy proceeding
became the largest ever filed.

ANSWER
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