[Congressional Record Volume 156, Number 38 (Tuesday, March 16, 2010)]
[Senate]
[Pages S1609-S1611]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
COOKING THE BOOKS
Mr. KAUFMAN. Mr. President, last Thursday, the bankruptcy examiner
for Lehman Brothers Holding Company released a 2,200-page report about
the demise of the firm, which included riveting detail on the firm's
accounting practices. That report has put into sharp relief what many
of us have expected all along: that fraud and potential criminal
conduct were at the heart of the financial crisis.
Now that we are beginning to learn many of the facts, at least with
respect to the activities at Lehman Brothers, the country has every
right to be outraged. Lehman was cooking its books, hiding $50 billion
in toxic assets by temporarily shifting them off its balance sheet in
time to produce rosier quarter-end reports. According to the bankruptcy
examiner's report, Lehman Brothers's financial statements were
``materially misleading'' and said its executives engaged in
``actionable balance sheet manipulation.'' Only further investigation
will determine whether the individuals involved can be indicted or
convicted of criminal wrongdoing.
According to the examiner's report, Lehman used accounting tricks to
hide billions in debt from its investors and the public. Starting in
2001, that firm began abusing financial transactions called repurchase
agreements or repos. Repos are basically short-term loans that exchange
collateral for cash in trades that may be unwound as soon as the next
day. While investment banks have come to overrely on repos to finance
their operations, they are neither illegal nor questionable, assuming,
of course, they are clearly accounted for.
Lehman structured some of its repo agreements so the collateral was
worth 105 percent of the cash it received--hence, the name ``Repo
105.'' As explained by the New York Times' DealBook:
That meant that for a few days--and by the fourth quarter
of 2007 that meant end-of-quarter--Lehman could shuffle off
tens of billions of dollars in assets to appear more
financially healthy than it really was.
Even worse, Lehman's management trumpeted how the firm was decreasing
its leverage so investors would not flee from the firm. But inside
Lehman, according to the report, someone described the Repo 105
transactions as ``window dressing,'' a nice way of saying they were
designed to mislead the public.
Ernst & Young, Lehman's outside auditor, apparently became
comfortable with and never objected to the Repo 105 transactions. While
Lehman could never find a U.S. law firm to provide an opinion that
treating the Repo 105 transactions as a sale for accounting purposes
was legal, the British law firm Linklaters provided an opinion letter
under British law that they were sales and not merely financing
agreements. Lehman ran the transaction through its London subsidiary
and used several different foreign bank counterparties.
The SEC and Justice Department should pursue a thorough
investigation, both civil and criminal, to identify every last person
who had knowledge Lehman was misleading the public about its troubled
balance sheet--and that means everyone from the Lehman executives, to
its board of directors, to its accounting firm, Ernst & Young.
Moreover, if the foreign bank counterparties who purchased the now
infamous ``Repo 105s'' were complicit in the scheme, they should be
held accountable as well.
It is high time that we return the rule of law to Wall Street, which
has been seriously eroded by the deregulatory mindset that captured our
regulatory agencies over the past 30 years, a process I described at
length in my speech on the floor last Thursday. We became enamored of
the view that self-regulation was adequate, that ``rational'' self-
interest would motivate counterparties to undertake stronger and better
forms of due diligence than any regulator could perform, and that
market fundamentalism would lead to the best outcomes for the most
people. Transparency and vigorous oversight by outside accountants were
supposed to keep our financial system credible and sound.
The allure of deregulation, instead, led to the biggest financial
crisis since 1929. And now we are learning, not surprisingly, that
fraud and lawlessness were key ingredients in the collapse as well.
Since the fall of 2008, Congress, the Federal Reserve and the American
taxpayer have had to step into the breach--at a direct cost of more
than $2.5 trillion--because, as so many experts have said: ``We had to
save the system.''
But what exactly did we save?
First, a system of overwhelming and concentrated financial power that
has become dangerous. It caused the crisis of 2008-2009 and threatens
to cause another major crisis if we do not enact fundamental reforms.
Only six U.S. banks control assets equal to 63 percent of the nation's
gross domestic
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product, while oversight is splintered among various regulators who are
often overmatched in assessing weaknesses at these firms.
Second, a system in which the rule of law has broken yet again. Big
banks can get away with extraordinarily bad behavior--conduct that
would not be tolerated in the rest of society, such as the blatant
gimmicks used by Lehman, despite the massive cost to the rest of us.
What lessons should we take from the bankruptcy examiner's report on
Lehman, and from other recent examples of misleading conduct on Wall
Street? I see three.
First, we must undo the damage done by decades of deregulation. That
damage includes--financial institutions that are ``too big to manage
and too big to regulate''--as former FDIC Chairman Bill Isaac has
called them--a ``wild west'' attitude on Wall Street, and colossal
failures by accountants and lawyers who misunderstand or disregard
their role as gatekeepers. The rule of law depends in part on
manageably-sized institutions, participants interested in following the
law, and gatekeepers motivated by more than a paycheck from their
clients.
Second, we must concentrate law enforcement and regulatory resources
on restoring the rule of law to Wall Street. We must treat financial
crimes with the same gravity as other crimes, because the price of
inaction and a failure to deter future misconduct is enormous.
Third, we must help regulators and other gatekeepers not only by
demanding transparency but also by providing clear, enforceable ``rules
of the road'' wherever possible. That includes studying conduct that
may not be illegal now, but that we should nonetheless consider banning
or curtailing because it provides too ready a cover for financial
wrongdoing.
The bottom line is that we need financial regulatory reform that is
tough, far-reaching, and untainted by discredited claims about the
efficacy of self-regulation.
When Senators Leahy, Grassley and I introduced the Fraud Enforcement
and Recovery Act--FERA--last year, our central objective was restoring
the rule of law to Wall Street. We wanted to make certain that the
Department of Justice and other law enforcement authorities had the
resources necessary to investigate and prosecute precisely the sort of
fraudulent behavior allegedly engaged in by Lehman Brothers that we
learned about recently.
We all understood that to restore the public's faith in our financial
markets and the rule of law, we must identify, prosecute, and send to
prison the participants in those markets who broke the law. Their
fraudulent conduct has severely damaged our economy, caused devastating
and sustained harm to countless hard-working Americans, and contributed
to the widespread view that Wall Street does not play by the same rules
as Main Street.
FERA, signed into law in May, ensures that additional tools and
resources will be provided to those charged with enforcement of our
Nation's laws against financial fraud. Since its passage, progress has
been made, including the President's creation of an interagency
Financial Fraud Enforcement Task Force, but much more needs to be done.
Many have said we should of seek to punish anyone, as all of Wall
Street was in a delirium of profitmaking and almost no one foresaw the
sub-prime crisis caused by the dramatic decline in housing values. But
this is not about retribution. This is about addressing the continuum
of behavior that took place--some of it fraudulent and illegal--and in
the process addressing what Wall Street and the legal and regulatory
system underlying its behavior have become.
As part of that effort, we must ensure that the legal system tackles
financial crimes with the same gravity as other crimes. When crimes
happened in the past--as in the case of Enron, when aided and abetted
by, among others, Merrill Lynch, and not prevented by the supposed
gatekeepers at Arthur Andersen--there were criminal convictions. If
individuals and entities broke the law in the lead up to the 2008
financial crisis--such as at Lehman Brothers, which allegedly deceived
everyone, including the New York Fed and the SEC--there should be civil
and criminal cases that hold them accountable.
If we uncover bad behavior that was nonetheless lawful, or that we
cannot prove to be unlawful, as may be exemplified by the recent
reports of actions by Goldman Sachs with respect to the debt of Greece,
then we should review our legal rules in the United States and perhaps
change them so that certain misleading behavior cannot go unpunished
again. This will not be easy. As the Wall Street Journal's ``Heard on
the Street'' noted last week, ``Give Wall Street a rule and it will
find a loophole.''
This confirms what I heard on December 9 of last year when I convened
an oversight hearing on FERA. As that hearing made clear, unraveling
sophisticated financial fraud is an enormously complicated and
resource-intensive undertaking, because of the nature of both the
conduct and the perpetrators.
Rob Khuzami, head of the SEC's enforcement division, put it this way
during the hearing:
White-collar area cases, I think, are distinguishable from
terrorism or drug crimes, for the primary reason that, often,
people are plotting their defense at the same time they're
committing their crime. They are smart people who understand
that they are crossing the line, and so they are papering the
record or having veiled or coded conversations that make it
difficult to establish a wrongdoing.
In other words, Wall Street criminals not only possess enormous
resources but also are sophisticated enough to cover their tracks as
they go along, often with the help, perhaps unwitting, of their lawyers
and accountants.
Assistant Attorney General Lanny Breuer and Khuzami, along with
Assistant FBI Director Kevin Perkins, all emphasized at the hearing the
difficulty of proving these cases from the historical record alone. The
strongest cases come with the help of insiders, those who have first-
hand knowledge of not only conduct but also motive and intent. That is
why I have applauded the efforts of the SEC and DOJ to use both carrots
and sticks to encourage those with knowledge to come forward.
At the conclusion of that hearing in December, I was confident that
our law enforcement agencies were intensely focused on bringing to
justice those wrongdoers who brought our economy to the brink of
collapse.
Going forward, we need to make sure that those agencies have the
resources and tools they need to complete the job. But we are fooling
ourselves if we believe that our law enforcement efforts, no matter how
vigorous or well funded, are enough by themselves to prevent the types
of destructive behavior perpetrated by today's too-big, too-powerful
financial institutions on Wall Street.
I am concerned that the revelations about Lehman Brothers are just
the tip of the iceberg. We have no reason to believe that the conduct
detailed last week is somehow isolated or unique. Indeed, this sort of
behavior is hardly novel. Enron engaged in similar deceit with some of
its assets. And while we don't have the benefit of an examiner's report
for other firms with a business model like Lehman's, law enforcement
authorities should be well on their way in conducting investigations of
whether others used similar ``accounting gimmicks'' to hide dangerous
risk from investors and the public.
At the same time, there are reports that raise questions about
whether Goldman Sachs and other firms may have failed to disclose
material information about swaps with Greece that allowed the country
to effectively mask the full extent of its debt just as it was joining
the European Monetary Union, EMU. We simply do not know whether fraud
was involved, but these actions have kicked off a continent-wide
controversy, with ramifications for U.S. investors as well.
In Greece, the main transactions in question were called cross-
currency swaps that exchange cash flows denominated in one currency for
cash flows denominated in another. In Greece's case, these swaps were
priced ``off-market,'' meaning that they didn't use prevailing market
exchange rates. Instead, these highly unorthodox transactions provided
Greece with a large upfront payment, and an apparent reduction in debt,
which they then paid off through periodic interest payments and finally
a large ``balloon'' payment at the contract's maturity. In other words,
Goldman Sachs allegedly provided Greece with a loan by another name.
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The story, however, does not end there. Following these transactions,
Goldman Sachs and other investment banks underwrote billions of Euros
in bonds for Greece. The questions being raised include whether some of
these bond offering documents disclosed the true nature of these swaps
to investors, and, if not, whether the failure to do so was material.
These bonds were issued under Greek law, and there is nothing
necessarily illegal about not disclosing this information to bond
investors in Europe. At least some of these bonds, however, were likely
sold to American investors, so they may therefore still be subject to
applicable U.S. securities law. While ``qualified institutional
buyers,'' QIBs, in the United States are able to purchase bonds, such
as the ones issued by Greece, and other securities not registered with
the SEC under Securities Act of 1933, the sale of these bonds would
still be governed by other requirements of U.S. law. Specifically, they
presumably would be subject to the prohibition against the sale of
securities to U.S. investors while deliberately withholding material
adverse information.
The point may be not so much what happened in Greece, but yet again
the broader point that financial transactions must be transparent to
the investing public and verified as such by outside auditors. AIG fell
in large part due to its credit default swap exposure, but no one knew
until it was too late how much risk AIG had taken upon itself. Why do
some on Wall Street resist transparency so? Lehman shows the answer:
everyone will flee a listing ship, so the less investors know, the
better off are the firms which find themselves in a downward spiral. At
least until the final reckoning.
Who is to blame for this state of affairs, where major Wall Street
firms conclude that hiding the truth is okay? Well, there is plenty of
blame to go around. As I said previously, both Congress and the
regulators came to believe that self-interest was regulation enough. In
the now-immortal words of Alan Greenspan, ``Those of us who have looked
to the self-interest of lending institutions to protect shareholder's
equity--myself especially--are in a state of shocked disbelief.'' The
time has come to get over the shock and get on with the work.
What about the professions? Accountants and lawyers are supposed to
help insure that their clients obey the law. Indeed they often claim
that simply by giving good advice to their clients, they are
responsible for far more compliance with the law than are government
investigators. That claim rings hollow, however, when these
professionals now seem too often focused on helping their clients get
around the law.
Experts such as Professor Peter Henning of Wayne State University Law
School, looking at the Lehman examiner's report on the Repo 105
transactions, are stunned that the accountant Ernst & Young never
seemed to be troubled in the least about it. Of course, the fact that a
Lehman executive was blowing a whistle on the practice in May 2008 did
not change anything, other than to cause some discomfort in the ranks.
While saying he was confident he could clear up the whistleblower's
concerns, the lead partner for Lehman at Ernst & Young wrote that the
letter and off-balance sheet accounting issues were ``adding stress to
everyone.''
As Professor Henning notes, one of the supposed major effects of the
Sarbanes-Oxley Act was to empower the accountants to challenge
management and ensure that transactions were accounted for properly.
Indeed, it was my predecessor, then-Senator Biden, who was the lead
author of the provision requiring the CEO and CFO to attest to the
accuracy of financial statements, under penalty of criminal sanction if
they knowingly or willfully certified materially false statements. I
don't believe this is a failure of Sarbanes-Oxley. A law is not a
failure simply because some people subsequently violate it.
I am deeply disturbed at the apparent failure of some in the
accounting profession to change their ways and truly undertake the
profession's role as the first line of defense--the gatekeeper--against
accounting fraud. In just a few years time since the Enron-related
death of the accounting firm Arthur Andersen, one might have hoped that
``technically correct'' was no longer a defensible standard if the
cumulative impression left by the action is grossly misleading. But
apparently that standard as a singular defense is creeping back into
the profession.
The accountants and lawyers weren't the only gatekeepers. If Lehman
was hiding balance sheet risks from investors, it was also hiding them
from rating agencies and regulators, thereby allowing it to delay
possible ratings downgrades that would increase its capital
requirements. The Repo 105 transactions allowed Lehman to lower its
reported net leverage ratio from 17.3 to 15.4 for the first quarter of
2008, according to the examiner's report. It was bad enough that the
SEC focused on a misguided metric like net leverage when Lehman's gross
leverage ratio was much higher and more indicative of its risks. The
SEC's failure to uncover such aggressive and possibly fraudulent
accounting, as was employed on the Repo 105 transactions, provides a
clear indication of the lack of rigor of its supervision of Lehman and
other investment banks.
The SEC in years past allowed the investment banks to increase their
leverage ratios by permitting them to determine their own risk level.
When that approach was taken, it should have been coupled with absolute
transparency on the level of risk. What the Lehman example shows is
that increased leverage without the accountants and regulators and
credit rating agencies insisting on transparency is yet another recipe
for disaster.
Mr. President, last week's revelations about Lehman Brothers
reinforce what I have been saying for some time. The folly of radical
deregulation has given us financial institutions that are too big to
fail, too big to manage, and too big to regulate. If we have any hope
of returning the rule of law to Wall Street, we need regulatory reform
that addresses this central reality.
As I said more than a year ago:
At the end of the day, this is a test of whether we have
one justice system in this country or two. If we don't treat
a Wall Street firm that defrauded investors of millions of
dollars the same way we treat someone who stole $500 from a
cash register, then how can we expect our citizens to have
faith in the rule of law? For our economy to work for all
Americans, investors must have confidence in the honest and
open functioning of our financial markets. Our markets can
only flourish when Americans again trust that they are fair,
transparent, and accountable to the laws.
The American people deserve no less.
I yield the floor, and I suggest the absence of a quorum.
The PRESIDING OFFICER. The clerk will call the roll.
The legislative clerk proceeded to call the roll.
Mr. UDALL of Colorado. Mr. President, I ask unanimous consent that
the order for the quorum call be rescinded.
The PRESIDING OFFICER (Mr. Kaufman). Without objection, it is so
ordered.
Mr. UDALL of Colorado. Mr. President, before I speak to the topic
that brought me to the floor tonight, I want to acknowledge the
Presiding Officer's remarks on the situation with Lehman Brothers and
others on Wall Street. I know that the Senator is on a mission, and
nothing would make him happier, nor me happier, if the story of Lehman
Brothers is a story that is told for the last time, much less written
for the last time.
I listened with great interest to the narrative that is now
unfolding, and with that interest also the sense of horror and outrage
and anger that the Presiding Officer clearly carries. A crime is a
crime, as it was pointed out, whether it is $500 from a cash register
or literally billions, in fact trillions of dollars of net worth that
we have seen taken from Americans and American families.
I commend the Presiding Officer for his leadership, and I think he
put it well when he pointed out if you are too big to fail, you are too
big to exist, and too bad. Never again should that happen. So I wanted
to acknowledge the Presiding Officer.
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