The Case for the Corporate Death Penalty by Mary Kreiner Ramirez & Steven A. Ramirez

Author:Mary Kreiner Ramirez & Steven A. Ramirez
Language: eng
Format: epub
Tags: LAW000000 Law / General
Publisher: NYU Press

The Government’s Response

The failure of Lehman bears a strong resemblance to that of Enron. Like Enron, Lehman attracted more capital for a longer time than would have been the case had the firm truthfully disclosed all material facts. Yet, the government’s response to the failure of Lehman could not stand in greater contrast to the response to Enron. Put simply, grounds for a criminal investigation were handed to the government on a silver platter, and yet the government refused to charge even a single person with fraud from the failure of Lehman.

The SEC, in an apparently internally divisive decision, declined to proceed with even civil charges. The SEC needs to show the elements of securities fraud only by a preponderance of evidence. Nevertheless, the SEC enforcement attorneys feared they could not demonstrate materiality by Lehman’s actions of routinely moving billions of debt per quarter off the Lehman balance sheet immediately before submitting quarterly reports to the agency during the days following the failure of Bear Stearns. The New York Times reported that the enforcement team may have allowed the great wealth of the senior Lehman managers to intimidate them from bringing charges. Given the role of Lehman in triggering the 2008 financial crisis, this outcome is difficult to fathom. SEC Chair Mary Schapiro reportedly was incredulous that her staff recommended no enforcement action (Protess & Craig 2013).

Her reaction is understandable. Sham transactions totaling $50 billion would strike any reasonable investor as material. Lehman engaged in such transactions quarter after quarter for years. If the leadership of Lehman had thought the impact of these massive sham transactions was immaterial, they would not have so persistently engaged in these transactions and monitored them so closely. Lehman engaged in these transactions specifically to alter perceptions of the degree of leverage. Senior officers knew the Repo 105 transactions operated like a “drug” and sounded like “rat poison.” They undertook them out of desperation to influence the price of Lehman shares by deterring investors from flight—the very definition of materiality, as discussed previously. Lehman’s senior managers emphasized the strong liquidity and net leverages deliberately in quarter conference calls precisely because of the important role the transactions played in misleading the public with regard to its leverage. In short, it stretches credibility to accept that the SEC shut down its case based upon materiality.

In fact, when hedge fund manager David Einhorn raised mere suspicions of accounting machinations in the spring of 2008, the stock price reacted dramatically. Einhorn argued that Lehman concealed its leverage and overstated its asset values in its financial statements. At a meeting of hedge fund managers, Einhorn reportedly practically accused Lehman of engaging in accounting fraud. These allegations drove Lehman’s stock price down, and as Einhorn stepped up his attacks the price fell even lower. Ultimately, Einhorn’s attacks led to the dismissal of Erin Callan, the firm’s chief financial officer, and Joe Gregory, the firm’s chief operating officer (Gasparino 2009). Einhorn’s attacks offer further proof that accounting issues involving leverage for investment banks heavily invested in real estate meet the definition of materiality.

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