How Lehman Understated their Liabilities

How Lehman Understated their Liabilities
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How Lehman Understated their Liabilities
How did Lehman Brothers understate their liability?
Ernst & Young was responsible for handling Lehman's financial statements before the company sold investor's billions of monies in Lehman securities. In the audit, the firm failed to flag the "Repo 105" aspect of the financials. Repo 105 is a repurchase agreement that allowed Lehmann to temporarily lower its leverage and make it appear as though the firm was in a healthy state to reduce reliance on borrowed money. In essence, this accounting maneuver involves banks borrowing money from big companies by selling the company some assets. However, Lehman did this by taking less cash than the asset was worth (therefore, understating its liability) (Rapoport, 2013). In 2008, the company moved $50 billion off its balance sheet using this method. Expectations are that investors must be provided with all the necessary information before their monies are invested and that the use of Repo 105 should be disclosed both to investors and the government. In this case, therefore, Lehman misled investors about exposure to risky mortgage & real estate assets, risk management, financial health, and the bank's leverage. Thus, when the bank sold investor dollars in Lehman securities, the investors accumulated significant losses as Lehman went into bankruptcy in late 2008.
Why do you think EY was not held liable for the incident as much as investors wished?
Investors rely on the information before they can decide on making investments. With information, investors understand the extend of risk along with the potential gains before making a decision. In this case, however, investors expected EY to conduct due diligence, detect issues in Lehman's financials, and provide information that would have enhanced their investment decisions. They argue that EY gave Lehman's financials a clean bill of health despite that the firm had prior knowledge that Lehman was using the Repo 105 accounting...