Lehman exploited Linklaters opinion to tidy up balance sheet
A report into the collapse of Lehman Brothers has found that the failed investment bank exploited its relationship with Linklaters to green light an accounting practice that kept billions of dollars off its balance sheet.
Although there is no suggestion that Linklaters acted either illegally or unethically, the report by Jenner & Block chairman Anton Valukas claims that Lehman turned to the magic circle firm after it was unable to get sign off from US lawyers on the transactions, known as Repo 105.
The Repo 105 mechanism used a loophole in US accountancy regulations to make repurchasing agreements appear as permanent sales rather than temporary transactions. This in turn enabled Lehman to lower its balance sheet leverage.
The deals needed to be ratified by an opinion letter before they could be classed as true sales, but Lehman’s US legal adviser, understood to be Weil Gotshal & Manges partner Harvey Miller, could not sign off the letter.
Instead, the bank turned to its European adviser in the form of Linklaters to get sign off on the Repo 105 transactions originating from its EU entity Lehman Brothers International Europe (LBIE).
Valukas asserts that the Linklaters letter was addressed solely to LBIE and related only to transactions taking place under English law.
The letter reads: “This opinion is limited to English law as applied by the English courts and is given on the basis that it will be governed by and construed in accordance with English law.”
It continues: “For the purpose of this opinion we have assumed that… there are no provisions of foreign law which would affect this opinion.”
Although the opinion letter was used to approve Repo 105 transactions undertaken by the UK-based LBIE, the report claims that some of these transactions used securities owned by and originating from US-based Lehman entities.
David Barwise, a City based structured finance partner at White & Case, said that he believed Linklaters “acted as any UK firm would have”.
He added: “Repos work like secured loans. Firms are asked to opine on whether they are actually secured loans or a sales transaction. But the requirements for a true sale are not the same in the US as they are in the UK.”
A spokesperson at Linklaters said: “The US examiner’s report into the failure of Lehman Brothers includes references to English Law opinions which Linklaters gave in relation to a number of Lehman transactions.
“The examiner - who did not contact the firm during his investigations - does not criticise those opinions or say or suggest that they were wrong or improper. We’ve reviewed the opinions and are not aware of any facts or circumstances which would justify any criticism.”
Readers' comments (5)
A W | 14-Mar-2010 1:27 am
Why is a repo transaction that classifies a borrowing as a sale legal under UK law?
Why was an opinion letter that related solely to English law used to disguise transactions involving US securities?
Who should have questioned these practices?
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Anonymous | 18-Mar-2010 6:08 am
This is ample proof that we need an International body to regulate international transactions, or indeed any transaction with the potentional for cross-border consequences.
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Anonymous | 19-Mar-2010 5:38 pm
The law is the law. You cannot reasonably expect to do business across international borders and then cry like an infant when a perfectly legal interpretation of the law goes against you.
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B Hansen | 23-Mar-2010 10:43 am
It seems clear that the common law defines a 'true sale' as one where the asset is put beyond the reach of the Seller. The position is set out in the Widows and Orphans Case in Ontario Canada, in reliance upon, inter alia, Welsh Development Agency v. Export Finance Co.
There can be no doubt that the 2 part recharacterization test set down by the court could not yield a 'true sale' opinion where the Seller has a contractual obligation, as opposed to an option, to buy back the assets. In this case the common law informs us that the Lehman transaction was in fact a short-term loan with a 5% coupon, which if payable in the time frames set out in Mr. Valukas' report to the South New York Bankruptcy Court, would be a criminal rate of interest.
It seems clear that Linklaters failed in discharging its duties as an expert when they gave an opinion that could not reasonably be argued to be a 'true sale' by singular reference to FASB 140. The accounting position is not a statement of the law. It's an accounting circular for use by Audit firms in the United States.
It would be constructive to post a copy of Linklaters Opinion Letter so that further comment can be garnered. I note that it should not be subject to privilege because it was not, I assume, issued for the dominant purpose of litigation. At least, let's hope not.
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Anonymous | 23-Mar-2010 12:07 pm
The Linklaters opinion is available on-line as it forms part of the bankruptcy report. It would have been privileged because it would have been covered by legal advice privilege had it not been used. However it was intended to be publicly disclosed-that was its whole point. I am no expert but it is clear that Linklaters have interpreted the law correctly. They are not criticised in the report. I do not know enough about this to assess whether they have interpreted it correctly but aggressivley ie whether this was only technically legal.
As for the law is the law poster at 5.58-are you a lawyer?? The law is whatever a "good" lawyer can argue it is with any credibility, regardless of whether the lawyer and the client know that the law was in fact meant to prohibit the conduct they are engaging in. Engaging in technically legal behaviour may be clever but it isn't something to be proud of. Law firms who lose sight of that- and most do-suffer damage to their reputations when it comes to light.
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