Repo 105
Encyclopedia
Repo 105 is a repurchase agreement
which results in an accounting maneuver where a short-term loan
is classified as a sale
. The cash obtained through this "sale" is then used to pay down debt
, allowing the company to appear to reduce its leverage
by temporarily paying down liabilities
—just long enough to reflect on the company's published balance sheet
. After the company's financial reports are published, the company borrows cash and repurchases its original asset
s.
three times according to a March 2010 report
by the bankruptcy court examiner. The report stated that Lehman's auditors, Ernst & Young
, were aware of this questionable classification. Law firm Linklaters
has received unfavorable press treatment in relation to their issuance of an English law opinion which characterised the arrangements as a true sale as opposed to a transfer by Lehman with a charge back in favour of the transferor.
, Chairman of Jenner & Block
. The report details the use of both "repo 105" and "repo 108" which are basically identical procedures, the first costing 5% and the second 8% of the assets exchanged. In other words, assets valued at 100 will produce 95 in cash, assets valued at 100 will produce 92 in cash respectively.
After the Examiner’s report was published, the Securities and Exchange Commission (SEC) sent letters to chief financial officer
s of nearly two dozen large financial and insurance companies asking about their firms' use of repurchase agreement
s, including the number and amount of such agreements that qualify for sales accounting, and detailed analysis of why such transactions can be treated as sales. SEC chairman, Mary Schapiro
, indicated that the agency was trying to determine whether other companies used similar techniques as the "repo 105" used by Lehman Brothers.
filed charges against Ernst & Young in December 2010, alleging that the firm "substantially assisted... a massive accounting fraud" by approving the accounting treatment. The Wall Street Journal drew attention to the increasing levels of fees that Ernst & Young had been paid by Lehmans from 2001 to 2008.
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
which results in an accounting maneuver where a short-term loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
is classified as a sale
Sales
A sale is the act of selling a product or service in return for money or other compensation. It is an act of completion of a commercial activity....
. The cash obtained through this "sale" is then used to pay down debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
, allowing the company to appear to reduce its leverage
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
by temporarily paying down liabilities
Liability
A liability can mean something that is a hindrance or puts an individual or group at a disadvantage, or something that someone is responsible for, or something that increases the chance of something occurring ....
—just long enough to reflect on the company's published balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
. After the company's financial reports are published, the company borrows cash and repurchases its original asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s.
Use by Lehman Brothers
Repo 105 was used by investment bank Lehman BrothersLehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
three times according to a March 2010 report
Report of Anton R. Valukas
The Report of Anton R. Valukas is an examination into the demise of Lehman Brothers, a formerly dominant global financial institution, that collapsed into bankruptcy during the Financial crisis of 2007-2010. Anton Valukas, chairman of the Chicago law firm Jenner & Block, was appointed by a ...
by the bankruptcy court examiner. The report stated that Lehman's auditors, Ernst & Young
Ernst & Young
Ernst & Young is one of the largest professional services networks in the world and one of the "Big Four" accountancy firms, along with Deloitte, KPMG and PricewaterhouseCoopers ....
, were aware of this questionable classification. Law firm Linklaters
Linklaters
Linklaters LLP is a global law firm headquartered in London, United Kingdom and a member of the 'Magic Circle' of leading UK law firms. Linklaters is the world's fourth largest global law firm by revenue. In 2009/10 it received total revenues of £1.18 billion and profits per equity partner of £1.2...
has received unfavorable press treatment in relation to their issuance of an English law opinion which characterised the arrangements as a true sale as opposed to a transfer by Lehman with a charge back in favour of the transferor.
Examiner’s Report
The report published on March 11, 2010, was titled "Lehman Brothers Holdings Inc. Chapter 11 Proceedings". The Examiner in this matter was Anton R. ValukasAnton R. Valukas
Anton R. Valukas was the United States Attorney for the Northern District of Illinois from 1985 to 1989. In 2007, he became the chairman of Chicago law firm Jenner & Block, in which capacity he gained notoriety in 2009, when he was appointed bankruptcy examiner in the bankruptcy of Lehman...
, Chairman of Jenner & Block
Jenner & Block
Jenner & Block is a U.S. law firm with offices in Chicago, New York, Los Angeles, and Washington, DC. Approximately 450 attorneys serve a wide range of clients in corporate litigation, business transactions, and in the public sector. Jerold S. Solovy was the longtime Chair of the firm, but on Sept...
. The report details the use of both "repo 105" and "repo 108" which are basically identical procedures, the first costing 5% and the second 8% of the assets exchanged. In other words, assets valued at 100 will produce 95 in cash, assets valued at 100 will produce 92 in cash respectively.
After the Examiner’s report was published, the Securities and Exchange Commission (SEC) sent letters to chief financial officer
Chief financial officer
The chief financial officer or Chief financial and operating officer is a corporate officer primarily responsible for managing the financial risks of the corporation. This officer is also responsible for financial planning and record-keeping, as well as financial reporting to higher management...
s of nearly two dozen large financial and insurance companies asking about their firms' use of repurchase agreement
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
s, including the number and amount of such agreements that qualify for sales accounting, and detailed analysis of why such transactions can be treated as sales. SEC chairman, Mary Schapiro
Mary Schapiro
Mary L. Schapiro is the 29th chairperson of the U.S. Securities and Exchange Commission .She is the immediate past chairperson and CEO of the Financial Industry Regulatory Authority , the securities industry self-regulatory organization for broker-dealers and exchanges in the United States, and...
, indicated that the agency was trying to determine whether other companies used similar techniques as the "repo 105" used by Lehman Brothers.
Fraud charges
In response to the report, the auditors said that the transactions were accounted for in line with Generally Accepted Accounting Principles. However, New York attorney general Andrew CuomoAndrew Cuomo
Andrew Mark Cuomo is the 56th and current Governor of New York, having assumed office on January 1, 2011. A member of the Democratic Party, he was the 64th New York State Attorney General, and was the 11th United States Secretary of Housing and Urban Development...
filed charges against Ernst & Young in December 2010, alleging that the firm "substantially assisted... a massive accounting fraud" by approving the accounting treatment. The Wall Street Journal drew attention to the increasing levels of fees that Ernst & Young had been paid by Lehmans from 2001 to 2008.