On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy. By then, most of its clients were abandoning the debt-laden, sinking ship. Th­ere were huge losses in its stock and devaluation of its assets by credit rating agencies. It drew the curtains on a 158-year-old proud institution established by two immigrant brothers who came to the US from Bavaria, Germany — Hen­ry and Mayer Lehman. It was also the largest Chapter 11 filing in the history of the United States. The fall of Lehman Brothers triggered the black swan events that plunged the economies of the world into the worst financial crisis since the Great Depression —a state from which they have not fully recovered yet.

The US bankruptcy court appointed an examiner (read investigator) Anton Valukas, the chairman of the law firm Jennifer & Block. He collected facts and analysed the root causes of the collapse of Leh­man Brothers Holdings. It took the team led by him more than a year and it cost over $30 million to produce a report, which runs into 2,200 pages. The report concludes that Lehman executives manipulated its balance sheet, withheld information from the board and inflated the value of toxic real estate assets. The Valukas report has devoted more than 300 pages alone to balance-sheet manipulations, accusing Lehman of using questionable accounting methods to move assets off its books.

In the report, Valukas detailed a "materially misleading" approach that Lehman took to representing its financial condition. The examiner said that Lehman—anxious to maintain favourable credit ratings—engaged in an accounting device known within the firm as Repo 105 to essentially park about $50 billion of assets away from Lehman's balance sheet. The move helped Leh­man look like it had less debt on the balance sheet.

In order to understand the nature of the fraud one must understand what was Repo 105. Repo 105 was the name used at Lehman for what its own staff called an "accounting gimmick" taking advantage of an accounting rule called SFAS 140. Each quarter, Lehman sold some of its loans and investments temporarily to other financial institutions for cash using short-term repurchase (or repo) agreements. They bo­ught the­m back a few days later. Normally, the assets wo­uld be reflected on the bank's balance sheet. But he­re is the trick. Since they were valued at 105 per cent or more of the cash received, the transactions we­re treated as a "sale" under accounting rule SFAS 140 and Lehman was able to materially under report the extent of its debt and leverage.

Lehman used this ploy, according to the report, up to a limit of $25 billion of Repo 105 until early 2007. But to borrow Ramalinga Raju’s col­ourful expression, the Leh­man CEO, like Raju, was also “riding a tiger”. It began increasing the use of the Repo 105 magic in the first and second quarters of 2008 until the mass hypnotic accounting was “vanishing” quietly $50 billion of assets from investors, the government, rating agencies and regulators and reducing the amount of debt it showed to investors.

"In this way, unbeknownst to the investing public, rating agencies, government regulators and Lehman's board of directors, Lehman reverse-engineered the firm's net lev­erage ratio for public consumption," says the report. Lehman's own global financial controller, Martin Kelly, told Valukas that "the only purpose or motive for the tra­nsactions was reduction in balance sheet" and "there was no substance to the transactions." Kelly said he warned former Lehman finance chefs Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed "reputational risk" to Lehman if their use became publicly known. But Kelly did not blow the whistle, he simply confessed in the course of cross-examination.

If there is one courageous executive who pursued the “True North” according to the Lehman examiner’s report, it was Matthew Lee. He was the Lehman senior vice-president who warned the Lehman senior management as well as its auditors about Repo 105! Out of curiosity, I searched Linked-In and tracked him. He is still listed as a senior VP of Leh­man. He has studied at the University of Edinburgh. No other details are available.The Valukas Report suggests that Lee became a “whistleblower”. In May 16, 2008, exactly four months before Lehman filed for Chapter 11, he wrote a letter alleging a number of possible accounting irregularities, including balance sheet substantiation discrepancies, valuation issues, and the lack of competence and independence of Lehman's internal au­dit department. He met wi­th senior management and sp­ecifically raised the issue of Repo 105. Yet nothing was done to investigate and possibly avoid the grief and losses to millions of people. Ironically, Lehman finally became a victim of its own black magic. In the process of fooling everybody, it ended up fooling itself. One is reminded of what the French Nobel Laureate André Gide famously said: "The true hypocrite is the one who ceases to perceive his deception and, therefore, the one who li­es with sincerity."

The writer is the managing director, Deloitte Consulting.