[Congressional Record (Bound Edition), Volume 156 (2010), Part 3]
[Senate]
[Pages 3488-3490]
[From the U.S. 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 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

[[Page 3489]]

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.
  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

[[Page 3490]]

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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