Corporate Governance: Repo accounting and the pressure to massage figures

There are two things that need to be learned from the most recent, and voluminous, report on the collapse of Lehman Brothers. (Whether they will nor not is another matter.) The first is that the report underlines once more, with terrible gravity, that the role of the finance director is not to pull the wool over people’s eyes, though they sometimes do in the line of duty. The second is that US business culture almost insists that good businesses should mislead people.

Back when I wrote a weekly column in The Times, I used to take a shortcut to the newspaper’s central London office through the yacht marina at St Katharine’s Dock, just east of Tower Bridge.

Often, as I walked past one gin palace docked there, I would smile to myself: the boat had the name Fourth Quarter. The name transported me from London to New York – and summed up the cultural background to US financial reporting.

The fourth quarter is when you pile everything you can into the figures and boost the results, the share price and your remuneration. True, it goes on in any economy. But in the US it is a pivotal part of the cultural swagger of big companies. And this report had it writ large.

Sure enough, that was what was going on at Lehman. We learn this, as if we hadn’t known it in our hearts all along, from the report compiled by Anton Valukas, the lawyer and bankruptcy court-appointed examiner whose job it was to identify anyone involved in the bank’s collapse who can be sued blind for any cash that is going.

It captures just how demanding the needs of quarterly reporting are: it is an endless task to come up with new ways of ensuring that, come the final day of each quarter, the balance sheet looks as wondrous as it can.

Take this quote from the report, from an email which bounced into inboxes around Lehman on 27 March 2008.

“We are very much in need of balance sheet. We must move things off by the end of the quarter. I need you all to go back to clients and offer them discounts to move things off. We have a lot of wood to chop in a short period of time but we can’t afford to fail. If this means leaving profit and loss on the table, so be it. If you have questions get back to me but we HAVE TO DO THIS!!”

The technicalities around how Lehman did it are almost incidental to the lessons to be learned from the affair. And let’s not forget that Repo 105 can hardly be seen as a rare occurrence: it is the kind of financial engineering that we know is commonplace and not always looked down on.

Even so, there will be much arguing in courts to come: the likelihood is that, under US accounting rules, Repo 105 was OK, while, though the ruse was conducted under the auspices of UK regulation and international financial reporting rules, it may still not have actually been lawful in the UK. Judging by the 2,000-page report, we could be looking at cases that roll through the courts for years – or that take years just to get to court.

The emphasis within the report is more about who can be sued than the specifics of financial reporting rules. It is just as much of a smokescreen to argue that this is about accounting rules as it is to suggest that it is an auditing issue.

The essential point is that businesses are run by directors, not by the setters of accounting standards or by auditors. None of this great scandal would have come about if directors, in particular the three CFOs named and shamed in the report, who often claim that they are the conscience of the board, had done so. Their essential task should have been telling it like it is. They did not.

Robert Bruce is a leading commentator on accountancy issues

Repo accounting is to be reviewed – read more here