Nearly 18 months after the collapse of Lehman Brothers, it looks like we might finally get some answers.

The long-awaited bankruptcy examiner's report came out Friday — and it's a whopper — clocking in at 2200 pages. The examiner looked at 10 million e-mails and 20 million documents in the case.

The financial world is still digesting the report, but the first scandal is already emerging. The biggest revelation so far is that Lehman was cooking their books since at least 2007. In the final quarter before filing bankruptcy, accounting tricks boosted their balance sheet by $50 billion.

Let's Get Some Lipstick on This Pig

Insiders called the scheme a "Repo 105." And let me tell ya, Lehman took a page straight out of Enron's playbook with this one.

Here's how it worked: Lehman entered into repurchase agreements with banks in the Cayman Islands. Under the deal, Lehman would "sell" toxic assets to the other bank — with the understanding that they would buy them back in a short time.

The trick made Lehman Brothers look much healthier — on paper, at least. These guys were desperate to fool investors and credit rating agencies. They had screwed up on a truly collosal scale, and lined their pockets all the while.

If (or when) the truth got out, executives knew their careers and reputations would be at stake. But by engaging in this kind of book-cooking to cover it up, they could end up behind bars.

Banks use similar repo agreements all the time. But they mark them on the books as loans, because that's what they are. Lehman marked them as sales. That might not sound like a huge deal, but the effect was that Lehman had $50b more in cash on its books, and $50b less in toxic mortgage assets.

This is complicated stuff, and that's not a mistake. Scams like this are complex by design. The goal is to confuse the mark. In this case, we were all the mark.

If you want a more in-depth explanation of how the scheme worked, here's Dylan Rattigan of MSNBC:

Accounting "Gimmicks," or Just Plain Fraud?

The examiner's report tip-toes around the f-word (fraud) using very careful language. Not one mention of fraud in sight. They refer to "gross negligence," but that's not necessarily a crime. And media outlets are reporting on Lehman's accounting "gimmicks," "tricks," or — my favorite — "shenanigans."

Let me get this straight: Lehman intentionally manipulated their accounting with the goal of deceiving investors, rating agencies, and possibly their regulators, leading to the largest corporate bankruptcy in U.S. history... And that's only considered "negligence"?

Being negligent means you lack concern or aren't paying attention when you should be. It doesn't mean willfully lying on your financial statements. What Lehman did sounds a whole lot more fraudulent than negligent. And this type of blatant manipulation is being referred to as a gimmick? Ridiculous.

The Repo 105 scandal is just getting started, but already the accusations are flying. Dick Fuld, former CEO, is denying knowledge of the Repo 105 transactions. Not true, according to COO Bart Mcdade. When interviewed by the bankruptcy examiner, Mcdade said, "Fuld knew about the accounting of Repo 105."

I'll be surprised if anyone actually goes to jail, but we should get much more information in the coming months. Expect a whole lot of "I do not recall having that conversations" when these guys are hauled up on Capitol Hill this time.

One of the biggest questions is this: Were any other banks using similar tricks? And are they still cooking the books today?

We don't know yet, but it wouldn't surprise me one bit. These investment banks were notorious for stealing each other's ideas. And the fact that it all took place under Tim Geithner's nose — when he was president of the NY Fed — is also something that needs to be explored.

A Great Call

Our own Ian Cooper alerted Wealth Daily readers about a possible Lehman bankruptcy back in June 2008, when the stock was still trading around $30. He warned, "It's only a matter of time before Lehman (LEH) joins the latest list of casualties." He recommended buying October $25 puts. It proved to be quite a profitable call, banking profits of 180% gains in just over a month. Readers who held onto the puts made significantly more.

Just recently Ian uncovered another opportunity, and this time it's in the foreclosure market. You can read all about it and his service, Options Trading Pit, here.

Stay nimble out there,

Adam Sharp

Analyst, Wealth Daily

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