WASHINGTON — Securities and Exchange Commission Chairman Mary Schapiro said her agency's oversight of Lehman Brothers Holdings was "terribly flawed," days after a bankruptcy examiner found the SEC didn't try to stop the firm's exaggeration of liquid assets.
"It was so terribly flawed in design and execution," Schapiro testified to a Congressional committee Wednesday, referring to SEC examinations aimed at monitoring the soundness of Wall Street's biggest investment banks. "We were ill-suited because of our enforcement and disclosure mentality."
Eighteen months after Lehman's collapse, the 2,200-page report by Anton Valukas has reignited the debate over what regulators should have known and done before Lehman's collapse triggered a global financial crisis. The House Financial Services Committee announced Wednesday that it will hold a hearing so that lawmakers can question U.S. watchdogs at the time.
"Either the SEC and the New York Federal Reserve failed to discover the ongoing accounting fraud at Lehman, or they turned a blind eye," said Rep. Spencer Bachus, R-Ala. "In either case, the actions of these two regulators represent a grave failure and should be explored at a public hearing."
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Bachus wants to summon former SEC Chairman Christopher Cox, then-Lehman CEO Richard Fuld and ex-New York Fed president Timothy Geithner, who is now Treasury Secretary. Schapiro, Cox's successor, took her post in January 2009.
Valukas' March 11 report describes a gap between how Lehman and the SEC viewed the firm's so-called liquidity pool, used to pay bills in a pinch, in the firm's final months. Behind the scenes, the SEC questioned how quickly some assets could really be tapped. Still, Lehman didn't tell investors that a growing share of the pool was being pledged as collateral to clearing firms, the report found.
The SEC deemed assets to be liquid only if they were convertible to cash within 24 hours. Lehman afforded itself five days. The SEC told Lehman it preferred the shorter limit and never enforced it, according to the report.
In another instance, the SEC didn't take action after determining in June 2008 that Lehman had counted a $2 billion deposit at Citigroup among cash-like assets available in an emergency, according to the report. SEC analysts deemed the deposit's designation as problematic, because withdrawing the money could have impaired Lehman's trading.
In prior years, the SEC's periodic objections to some assets prompted the firm to remove them. In 2008, though, the agency didn't challenge the Citigroup deposit.
The silence of examiners, who focused more on stability than honesty with investors, was invoked as a defense as Valukas quizzed more than 100 executives and other witnesses about the financial health and reporting at Lehman, based in New York.
"A recurrent theme in their responses was that Lehman gave full and complete financial information to government agencies," Valukas wrote. They told him that "the government never raised significant objections or directed that Lehman take any corrective action."
Valukas also found that Lehman kept regulators and credit rating firms in the dark when it "reverse-engineered" a key measure of stability through transactions known as Repo 105s. Lehman temporarily moved as much as $50 billion in assets off its balance sheet before reporting quarterly results.
The SEC's examiners at Lehman didn't belong to the agency's ranks of investigators and disclosure specialists. Instead, they were part of the Consolidated Supervised Entities program, set up in 2004 to guard against the collapse of systemically important investment banks.
A week after Lehman's collapse, Cox told Congress that no law authorized the voluntary program to prescribe a companywide liquidity level or enforce SEC leverage requirements. The SEC announced Sept. 26, 2008, that the program was ending.
Valukas didn't draw conclusions in the report about whether the SEC's interactions with Lehman were appropriate. The SEC allows firms to determine how they disclose liquid assets, so long as they don't deceive investors. Schapiro has replaced most of the agency's top officials.
"We are looking closely at the examiner's findings as part of our ongoing review of the accounting and disclosures of major financial institutions and their role in the financial crisis," SEC spokesman John Nester said.