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New York Leads in Pursuit of Lehman
State Prosecutors, not U.S. Regulators, Are Set to Sue Over Accounting Overseen by Ernst & Young
By MICHAEL RAPOPORT

In 2001, the regulator of the nation's biggest banks told its examiners to be on the lookout for firms whose regulatory filings made them look healthier than they really were. That followed guidelines issued in 1990 that said banks could face disciplinary action if their filings "have significant inaccuracies or are 'window dressed.' "

But as early as this week, it is the New York attorney general—not the Office of the Comptroller of the Currency, the bank regulator—who is expected to file a lawsuit alleging accounting firm Ernst & Young LLP allowed Wall Street broker Lehman Brothers Holdings to fake its books so it could appear financially healthier.

But federal regulators, who were blamed for failing to stop financial abuses that led to the subprime mortgage crisis, haven't acted.

"They haven't taken any significant action in pretty much forever," said William K. Black, a bank regulator during the 1990s savings-and-loan crisis who now teaches economics and law at the University of Missouri-Kansas City.

"It's the usual problem of what you do with a ubiquitous practice," he said.

Bank regulators' apparent reluctance to crack down on window dressing comes as agencies assume even more authority for overseeing the banking system in the wake of the Dodd-Frank law's overhaul of financial regulation.

Bank regulators may have pressured some banks privately. But federal regulators have been criticized for their inaction and coziness with banks they police.

Though Lehman's transactions, designed to remove assets from the balance sheet, were of a different type than most others, many banks have engaged in window dressing on a broader scale—systematically reducing their debt before reporting financial results. The practice isn't illegal, though intentionally masking debt to deceive investors violates guidelines set by regulators.

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Bloomberg News

The New York attorney general is expected to file a lawsuit alleging accounting firm Ernst & Young allowed Lehman Brothers to fake its books so it could appear financially healthier. Here, Ernst & Young's headquarters in New York.
In a statement, the OCC said it would take appropriate action if necessary.

"Our procedures properly address this area and our procedures remain in effect," the statement said.

A Wall Street Journal analysis found that, since the beginning of 2009, the group of 18 large Federal Reserve primary-dealer banks has reduced a key form of short-term borrowing, known as repurchase agreements, or "repos."

The banks dropped their loans by an average of 42% at quarter's end from its peak level during the same quarter, only to raise it again after the start of the next quarter, according to the Journal analysis.

Window dressing came to the forefront as an issue in March, when a bankruptcy-court examiner's report said Lehman had used a window-dressing maneuver it called Repo 105—accounting for repo transactions as sales instead of borrowings—to take about $50 billion in assets off its balance sheet before its 2008 collapse.

Securities and Exchange Commission inquiries subsequently turned up billions of dollars in repo transactions that Bank of America Corp. and Citigroup Inc. acknowledged they had accounted for incorrectly—classifying them as sales when they should have been borrowings, akin to what Lehman did with its Repo 105s.

In Bank of America's and Citi's cases, the amounts were relatively small in the context of their giant balance sheets, however, and both banks said the inaccurate accounting was inadvertent.

The SEC proposed new disclosures about short-term borrowing to help investors spot when companies are window dressing. In a speech this month, SEC Chairman Mary Schapiro said "misleading 'window dressing' in quarterly reports" was one factor that has fostered investor skepticism.

But the SEC said it hasn't found any widespread inappropriate practices in companies' repo accounting. It hasn't taken any public action against any companies over the issue beyond requiring more disclosure.

The Federal Deposit Insurance Corp. said in a statement its examiners also look for window dressing and take appropriate action when improprieties are found. But it noted banks must report average balance-sheet figures that would make clear when they are reducing debt at the end of a period. It added that sometimes questionable practices arise from a bank's broker-dealer operations, which are outside the FDIC's purview.

FDIC regulations point to the Federal Reserve, which "will discourage temporary balance sheet adjustments or any other 'window dressing' practices." A Federal Reserve spokeswoman declined to comment.

Despite the inaccurate transactions found in the wake of the SEC inquiry, Citigroup "has followed appropriate accounting procedures on this issue," said spokesman Jon Diat.

Bank of America, which is among the companies being investigated by New York state prosecutors, has acknowledged it found six repo transactions that were wrongly classified. Those transactions are separate from what appears to be Bank of America's broader practice of reducing repo debt virtually every quarter in recent years before quarter's end.

The Journal analysis shows that, since late 2008, Bank of America's net repo borrowings have declined an average of 53% at quarter-ends compared with the average during the same periods.

The bank acknowledged it "manages" its balance sheets and requires its traders or divisions to meet certain balance-sheet limits. But the company says it isn't doing anything improper and provides significant disclosure that makes its practices clear. Jerry Dubrowski, a Bank of America spokesman, added that the bank's practice is to cooperate with any inquiry from regulators.


http://online.wsj.com/article/SB10001424052748704610904576032062171661374.html