Archive for March, 2010

A 2,200-page report by Anton R. Valukas, the bankruptcy examiner for Lehman Brothers Holdings, sheds disturbing light on how an obscure accounting maneuver called Repo 105 enabled Lehman to hide $50 billion of troubled, toxic assets from investors and regulators alike.

Valukas’ report reveals that Lehman Brothers had actually reached the insolvency stage some time before it was forced to file for bankruptcy in September 2008. Investors never saw it coming, however, because of alleged accounting trickery and Lehman’s prolific use of Repo 105. Essentially, Repo 105 temporarily keeps certain assets off of a bank’s balance sheets for a short period of time, thereby giving a healthier financial appearance to investors.

Repo 105 is a common fixture in the investment banking world. The deals themselves are very short term, and occur when an investment bank exchanges securities or bonds for cash for a short period of time. The bank then agrees to repo, or repurchase, the bonds, less a small amount that the company gets to keep as interest.

As reported March 13 by the Wall Street Journal, if deemed as sales, the deals would shrink Lehman’s balance sheet, helping satisfy investors’ qualms about Lehman’s use of borrowed money, or leverage.

One of the most shocking revelations in the examiner’s report is Lehman’s growing dependence on Repo 105s. In the fourth quarter of 2007, Lehman’s turned to Repo 105 transactions to reduce its leverage by $38.6 billion, by $49 billion in the first quarter of 2008 and an astounding $50.4 billion in the second quarter of 2008.

Besides offering a slew of evidence on the factors leading up to Lehman’s downfall, the report squashes, once and for all, claims by ex-Lehman chairman Richard Fuld that Lehman met its demise because of rumors and loss of confidence on the part of clients and trading partners.

Among the tidbits of information Valukas raises in his report:

• A Lehman accounting executive, Matthew Lee, raised the alarm bells about Lehman’s questionable accounting methods and took his concerns to auditor Ernst & Young. One month later he was ousted from his job.
• Lehman failed to value its inventory of financial products in a “fully realistic or reasonable” manner, thereby once again giving a misleading and false picture of its true financial condition to investors.
• Oversight systems were ineffective and there were “tens of billions of dollars” of possibly toxic liabilities.

The bankruptcy of Lehman Brothers in September 2008 is the biggest bankruptcy in U.S. history involving $613 billion in debts.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Like many states, Hawaii has been hit hard from investments in auction-rate securities. Two years after the market for the instruments collapsed, Hawaii has lost about $250 million in market value on $1 billion in student-loan securities initially sold by a single Citigroup broker as a “cash substitute.” The story was first reported March 4 by Bloomberg.

Hawaii can’t find a buyer for the securities, half of which were purchased eight months before the ARS market crashed from Honolulu broker Pete Thompson.

According to the Bloomberg story, the deal transpired while Citigroup was increasing brokerage commissions and traders were being told to “make sure all hands are on deck” and to “do whatever is necessary” to dispose of auction-rate bonds as signs of the market’s demise began to appear.

Auction-rate securities have been the root of financial problems for hundreds of thousands of individual and institutional investors for more than two years. The nightmare began in February 2008 when the $330 billion ARS market came to a standstill after the Wall Street banks that underwrote the securities abruptly pulled back their support.

Meanwhile, purchasers like Hawaii - which were under the impression that auction-rate securities equaled a cash substitute - have been left with few options. They could sell the instruments but only at a considerable loss.

According to Bloomberg, an end-of-the year valuation from Citigroup showed that securities with a face value of $1 billion were worth about $752 million.

“It was represented to us that these were liquid investments that we could get out every seven to 10 days,” said Scott Kami, an administrator at Hawaii’s Finance Department, in the Bloomberg story.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Michael Lewis’ appearance on the March 14 episode of 60 Minutes offered a deconstruction of the nation’s mortgage crisis and brought to light how Wall Street, even today, continues to operate under a sense of entitlement. Lewis is the author of The Big Short: Inside the Doomsday Machine, a new book that attempts to explain how some of the brightest players in the investment world managed to destroy $1.75 trillion of wealth in the U.S. mortgage markets.

Lewis lays blames on a handful of Wall Street investment firms, including Goldman Sachs. In 2005, for instance, Goldman Sachs got American International Group (AIG) to insure $20 billion worth of mortgage securities that the ratings agencies had deemed AAA - the best of the best. In reality, the securities were toxic waste.

60 Minutes correspondent Steve Kroft asked Lewis point blank: “Do you think the big banks like Goldman Sachs played AIG for a patsy?”

“That’s exactly what they did,” Lewis replied.

Lewis also faults the credit rating agencies, which were responsible for rating the products that Wall Street created, for their role in the financial crisis of 2008.

The real insanity is that nothing has changed. Wall Street talks about reform but is slow to produce it. Transparency and oversight are bantered about in the media but that’s as far as it goes. The very financial instruments that brought down the world’s financial markets are still being sold to investors. As for the credit rating agencies, which are paid by the firms whose products they rate, little has been done to improve the transparency of their ratings.

The same thing goes for credit default swaps. “This market is the closet thing to ground zero, yet nothing has changed to make it more transparent,” said Lewis on 60 Minutes. “How can an investment firm advise clients on what to buy and sell while at the same time betting on those products to fail?,” Lewis asks.

Now that’s a question every investor out there wants an answer to.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

There’s a new twist in the legal debacle over six Morgan Keegan proprietary bond funds - i.e. the RMK Bond Funds - that suffered massive losses due to overexposure in risky mortgage-related securities. Last week, a Tennessee court vacated an arbitration award that had previously been decided by a Financial Industry Regulatory Authority (FINRA) panel in favor of an investor and his claims against the Memphis-based broker.

The reason for the Tennessee court’s decision reportedly had to do with bias on the part of two FINRA arbitrators who ruled against Morgan Keegan in a similar case involving the bond funds.

Ultimately, the court’s decision could spell big headaches for FINRA in the future. So far it’s been standard practice for arbitrators who are familiar with claims involving Morgan Keegan and the specific group of bond funds to reside on multiple FINRA arbitration panels. That could change in light of Tennessee’s recent decision to vacate a prior FINRA award, creating a flood of new motions filed to request that FINRA remove any arbitrator who has sat on previous panels involving similar claims.

The funds involved in investors’ claims against Morgan Keegan include the Select Intermediate Bond Fund; Select High Income Fund; RMK High Income Fund; RMK Strategic Income Fund; RMK Advantage Income Fund; and the RMK Multi-Sector High Income Fund. Among other things, investors allege that Morgan Keegan represented the funds as safe and secure, as well as an investment designed to provide opportunities for high income without high risks.

Contrary to those characterizations, the Morgan Keegan bonds were heavily invested in risky collateralized debt obligations and other mortgage-related securities.

As reported Feb. 23 by the Wall Street Journal, FINRA has received more than 400 arbitration claims against Morgan Keegan and the six bond funds. Earlier that same month, a FINRA arbitration panel awarded $2.5 million to an investor for his claim involving the Morgan Keegan funds. It is the largest amount awarded thus far in response to investors’ claims over losses in the RMK funds.

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