Corporate fraud is a serious offense that can have huge ramifications on society, clients and the business or organization itself. There have been famous cases of corporate scam that resulted in gigantic financial losses for firms, loss of their reputation and costly legal battles. Famous ethical scandals include: Enron, Arthur Andersen, Lehman Brothers, AIG, Barings Bank, etc. Lehman Brothers was involved in a scandalous ethical scheme and was bound to file Chapter 11 bankruptcy after its loan extension request was denied.
The bankruptcy of Lehman Brothers was a shock to the economy and financial markets in the US. It was the leading cause for the financial crisis that happened in the US in 2008 which impacted the rest of the world severely. In 2008, the US government refused to bail out the sinking investment bank which triggered a huge economic recession. The bankruptcy of Lehman Brothers was the most colossal one in the history of the US financial markets due to a debt amount that reached an alarming level o $619 billion versus $639 billion in assets. The fall of Lehman Brothers contributed to the subprime mortgage crisis that sank the US and the world financial markets in a huge crisis (Investopedia, 2009).
Lehman Brothers experienced various challenges through time and managed to survive the Great Depression and the world wars, but it failed following the decline of the housing market. In 2003 and 2004, Lehman Brothers purchased five mortgage lenders and invested heavily in subprime mortgages which were specialized in lending money without full documentation. The housing market experienced a considerable expansion from 2004 to 2006 which generated record revenues for Lehman Brothers with a record market capitalization of $60 billion. Starting the first quarter of 2007, the housing market started experiencing a decline due to the high number in defaults in subprime mortgages. After the slight market rebound in 2007, Lehman Brothers underwrote the highest amount in the mortgage-backed securities reaching a $85-billion portfolio. The amount of debt that Lehman Brothers engaged in 2007 was four times the amount of its assets which made it defenseless in the face of market conditions. Following the fall of one of the biggest mortgage securities underwriters, Bear Stearns, Lehman Brothers’ stock followed suit and its price fell considerably. Despite cutting its exposure to housing and commercial mortgages in 2008, Lehman Brothers had already lost more than 70% of its stock value by September 2008 and suffered from a 66% increase in credit default swap on its debt. The fragile financial situation of Lehman Brothers led to its demise and ultimately to its closure after its credit extension request was denied (Investopedia, 2009).
The fall of Lehman Brothers serves as a warning sign to the world markets about the dangers of excessive risk taking and started the subject about the moral and ethical practices being followed in financial markets. The excessive risk taking of Lehman Brothers put the whole world economy at risk. Besides leveraging its operations with excessive debt, the investigation that was run by a court-appointed examiner about Lehman Brothers’ accounting practices reflected unethical tricks that were followed to hide the truth about its accounts (The Wall Street Journal, 2010). Lehman Brothers tricked its investors, regulators and its own code of ethics by inflating the real value of its assets. The accounting technique that is normally used in repurchase agreements (Repos) involves exchanging assets for cash with the obligation of paying back the money. Lehman Brothers reported these amounts as sales in its balance sheet which made its financial statements look stronger than they were (Ethics Newsline, 2010).
Because of the fraudulent accounting practices, Lehman Brothers failed in implementing strong internal controls that could have prevented its demise. Its financial reporting methods lacked the robustness in disclosing an accurate snapshot of its financial accounts. The Federal Reserve and the Securities Exchange Commission could have foreseen these failures and imposed fines on Lehman Brothers due to excessive indebtedness and excessive risk taking before their situation collapsed. The poor ratings of Lehman Brothers were a great warning sign that should have been taken into consideration by the government to prevent bankruptcy. Moreover the government agreed to bail out Bears Stern which suffered from severe financial problems and refused to do the same thing for Lehman Brothers which sends the wrong signal for stakeholders (Apostolos, 2013).
Bailing out underperforming financial institutions is a dangerous move that should be studied and analyzed carefully. These kinds of bailouts are financed with taxpayers money and allow people who are behind irresponsible actions to get away with what they do. Better risk management and financial compliance systems need to be in place to avoid another disaster like Lehman Brothers. Risk assessment should include several kinds of risk evaluation including liquidity, credit, operational, counterpart risks and other types of risk. Clients and investors need to be provided with better assurance about the internal records of the prime brokerage firms that they are involved with. Moreover, a careful risk assessment needs to be established to evaluate the financial products that may have some hidden risks like the Repos. Finally, a separation shall be made between the entity that holds the assets and the one with whom the prime mortgage transaction was executed (Price Waterhouse Coopers, 2009).
Works Cited
Apostolos G. Christopoulos. “Could Lehman Brothers’ Collapse Be Anticipated? An Examination Using CAMELS Rating System”. 20 February, 2011. 4 Dec. 2013. <http://www.ccsenet.org/journal/index.php/ibr/article/viewFile/10009/7111>
“Case Study: The Collapse of Lehman Brothers”. 2 April, 2009. 4 Dec. 2013.
Investopedia. <http://www.investopedia.com/articles/economics/09/lehman-brothers-
collapse.asp>
“Lehman Insider's Letter Warned About Violating Code of Ethics”. The Wall Street
“Lehman Brothers’ Bankruptcy. Lessons learned for the survivors”. Price Waterhouse Coopers. August 2009. 5 Dec, 2013. <http://www.pwc.com/en_JG/jg/events/Lessons-learned-for-the-survivors.pdf>
“Scathing Report on Lehman Brothers Says Ethical Lapses Contributed to Collapse”.
Ethics Newsline. 15 March, 2010. 4 Dec. 2013.
<http://www.globalethics.org/newsline/2010/03/15/lehman-collapse/>
