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March 12, 2010 11:27 AM

Unwanted Attention: Linklaters Nabs Starring Role in the Lehman Report

Posted by Zach Lowe

For our purposes, the highlight of the 2,200-page (with appendices) report released Thursday that examines the demise of Lehman Brothers starts at around page 700, when the examiner, Jenner & Block chair Anton Valukas, delves into the accounting tricks Lehman used to temporarily shift $50 billion in bad assets off of its balance sheet.

This detail jumps out at us because the report names Linklaters as the only firm Lehman could find to bless the transactions in the way Lehman wanted, according to our reading of the report. (The New York Times offers a similar analysis.)

The transactions, which one Lehman exec characterized as "window-dressing" in an interview with Valukas's team, involved a variation on standard repurchase agreements, or "repo" deals. In a normal repo deal, a bank such as Lehman exchanges collateral for cash and agrees to take back the collateral very soon after the initial deal. The arrangement essentially works like a short-term loan. The bank (Lehman in this instance) then uses the cash to fund ongoing operations before taking back the initial collateral and repaying the cash. (For a more thorough description, complete with graphics, see the NYT link above). Such deals are normally characterized as a form of financing, meaning that the collateral stays on the bank's books for the duration of the transaction. 

But Lehman wanted to get its collateral off the books for that brief period while the repo deal was still in play. Knowing the collateral might consist of bad securities, Lehman believed that by temporarily shifting it off its balance sheet could make its debt situation look better than it actually was, the report states.

To execute its desired maneuver, however, Lehman needed to alter the normal repo procedure so that it could be characterized as a sale instead of a financing. The idea: a so-called Repo 105 transaction (expect that to become a catchphrase in finance circles now that the Jenner report has memorialized it).

Under this Repo 105, Lehman lent out collateral worth 105 percent of the cash it took back, according to the report. In other words, the deal was a loser from the start. Not only that, but the report says Lehman paid interest when it eventually repaid the cash it received in the deal. All of this--plus the fact that Lehman could repurchase slightly different, but basically equivalent, securities than those it used as collateral--might make the transactions pass muster as sales rather than financings.

One problem: No U.S. law firm would bless such transactions as sales, since U.S. lawyers cannot provide a sale opinion under U.S. law, according to the report and the NYT. Enter Linklaters. The firm blessed the deals in the way Lehman wanted, but made it clear it did so only under English law, the report states.

In a statement, a Linklaters spokesman says Valukas never contacted the firm during his yearlong investigation, and that the report never says the firm's opinions blessing the deals were improper or illegal. 

Back to the report as a whole: One goal of the investigation that produced the report was to determine whether there might be actions creditors and Lehman's estate can take against parties who may have acted with negligence (or worse) in ways that caused Lehman's collapse. Federal prosecutors in Manhattan and Brooklyn are also investigating causes of action, The Wall Street Journal says. There are many potential targets identified in the report, though how much Jenner's effort will aid any potential cases brought against those targets remains unclear.

The report faults Lehman executives, including ex-CEO Richard Fuld, ex-CFO Erin Callan, and former managing director Christopher O'Meara, with certifying misleading public documents, committing "errors in business judgment," and engaging in "actionable balance sheet manipulation," according to the report and this nice summary in Bloomberg

Let's review some of the lawyers involved here: Patricia Hynes of Allen & Overy has been representing Fuld for years. Lewis Liman of Cleary Gottlieb Steen & Hamilton (fresh of his role as Bank of America's counsel in the Merrill Lynch litigation with the SEC) is representing former Lehman executive vice president Ian Lowitt. Hynes and Liman released statements saying their clients did nothing wrong, and Hynes has said Fuld was not aware of the Repo 105 deals, according to Bloomberg. 

Another possible target: the accounting firm Ernst & Young, Lehman's auditor in 2008. In mid-2008, a senior Lehman exec raised questions about the Repo 105 deals, but Ernst didn't bring up the issue at a meeting of the Lehman Board Audit Committee in June 2008, the report states. A lawyer for the accounting firm could not immediately be reached. 

There's also a 300-page section on Lehman's deal to sell its North American operations to Barclays, a deal that has resulted in litigation in which Lehman charges that Barclays got an unfair "windfall" in the deal by (among other things) acquiring assets it shouldn't have gotten under the transaction's terms. Barclays has countered that it hasn't received billions in securities that it's owed by Lehman, court records show. Jones Day is representing Lehman in that litigation; Boies, Schiller & Flexner is advising Barclays.

The report also says Barclays got "a limited amount of assets" it should not have received under the terms of the deal, including office furniture, some technology assets and (possibly) some securities. In places, the examiner seems to be throwing his hands up and saying the record is so complex that "there is no way to determine" whether some securities Barclays received should have stayed with the Lehman estate. In any case, Valukas concludes that though Lehman may have some "colorable actions" against Barclays (with "colorable action" defined as a case a party would likely win), the material value of any assets wrongly sent to Barclays is minimal--possibly around $10 million, and not the billions Lehman has alleged. 

That's our quick take. There will be much more fallout to come.

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