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MCR Case Study

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Mirza Zia

on 4 November 2012

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Transcript of MCR Case Study

Lessons from Lehman Brothers: Will We Ever Learn? Presented by Mirza Zia G1213229 Fourth largest investment bank before the crisis *first two minutes of BBC documentary The Love of Money - The Bank That Bust the World The Bank That Bust the World Largest bankruptcy in U.S. history - US$690 billion "If we don't do this, we may not have an economy on Monday." - Ben Bernanke, Chairman of the U.S. Federal Reserve "....repeatedly exceeded its own internal risk limits and controls, and a wide range of bad calls by its management led to the bank's failure" - Anton Valukas, bankruptcy examiner of Lehman Brothers Reward Structure Excessive risk taking was encouraged, and handsomely rewarded ....while whistle blowers were ignored or over-ruled ".....it was not right, and I told them" - Oliver Budde, Associate General Counsel at Lehman Brothers Had argued with bosses over questionable accounting treatment of medical pay and under-representation of top executive pay Leadership "....serious errors of business judgement to actionable balance sheet manipulation" - Anton Valukas "....former CEO Richard Fuld was at least grossly negligent in causing Lehman to file misleading periodic reports." - Anton Valukas The questionable accounting practice - Repo 105 Used by Lehman to offload assets worth US$50 billion, instead of selling it off at a loss. According to the examiner's report, internal e-mails confirm that the only reason for Repo 105 transactions were to make the accounts look good by "reducing the balance sheet", and that "there was no substance to the transaction." Lehman auditors, Ernst & Young, were aware of the use of Repo 105, but did not question it. In fact, they blamed the bankruptcy on "a series of unprecedented adverse events in the financial market. Significant evidence to suggest that Fuld knew about these transactions, a fact his attorney denies. Those making questionable deals were treated as "conquering heroes"..... INTRODUCTION QUESTION 1 QUESTION 2 QUESTION 3 QUESTION 4 QUESTION 5 Q & A Suggested Reading and Watching.... Reads... COCKSURE - Banks, battles, and the psychology of overconfidence, by Malcom Gladwell (July 27, 2009) Watch..... Repo 105 - An explanation by Paddy Hirsch, Senior Producer of Marketplace.org Describe the situation at Lehman Brothers from an ethics perspective. What's your opinion of what happened here? What was the culture at Lehman Brothers like? How did the culture contribute to the company's downfall? What role did the Lehman's executives play in the company's collapse? Were they being responsible and ethical? Discuss. Could anything have been done differently at Lehman Brothers to prevent what happened? Explain. After all the public uproar over Enron and the passage of Sarbanes-Oaxly act to protect shareholders, why do you think we still continue to see these types of situations? Is it unreasonable to expect the businesses can and should act ethically? Ethical Leadership Top management should have displayed ethical leadership and refrained from exploiting accounting loopholes, and thus set the tone across the organization. Ethics Based Employees Selection Lehman Brothers should have done a better job at hiring staff with the highest ethical standards. Stronger Audit Control ....the external auditors working with Lehman Brothers should have upheld high integrity in presenting their audit findings. The firms should have adopted a formal structure that would encourage whistle blowing For Lehman Brothers, lack of whistle blowers was not an issue. The atmosphere at Lehman Brothers was conducive to whistle blowing. In fact, apart from Oliver Budde, three other high ranking employees, Mike Gelband, Head of Fixed Income; Alex Kirk, Global Head of Trading Research and Sales; and Larry McCarthy, Head of Bond Trading, all had raised concerns about the company's exposure to the real estate market. The problem was that all of them were ignored. Thrice. A formal structure, such as a hotline or a department, in which whistle blowers identities are kept anonymous, and more importantly, the complaints are investigated free from any bias and pressure, could have averted such a crisis Instead, Richard Fuld and other top management heads turned a blind eye and often went along with questionable accounting practices and excessive risk taking behavior. Only a few employees raised concerns about the questionable accounting practice followed. A handful of employees are clearly not enough to instil principled ethical behavior in an organization, especially when majority of the workforce have a pre-conventional moral standard. Internal auditors, such as Oliver Budde, demonstrated a reasonably strong ethical compass by flagging questionable accounting practices to top management, however..... Among the reasons we continue to see these types of situations, Covering up failure; being afraid of admitting a mistake A major contributing factor for this is the pressure to meet shareholder expectations The feeling that they can get away with the crime Feeling of too big to fail?? Ethical and Social Awareness/Responsiveness was not part of corporate culture for most money-making companies. The problem starts slowly and increases gradually until it is impossible to cover it. Business as an entity – person committing crime is not charged. Punishment as example from previous cases not enough to serve as deterrent. Barings 1995, Enron 2001, Worldcom 2002 Due to its historical performance, external parties did not apply strict enforcement. This resulted in a loose organization structure and poor monitoring. The expectation that businesses can and should act ethically is …. ....somewhat difficult to a point that it may be seen as unreasonable. BUT..... ..businesses can be ethical if the people inside are ethical. Google for example - Don't Do Evil. Other leading examples of ethical companies, .....based on Ethisphere's World's Most Ethical Companies Ranking Isa Johari G1217531 Bujar Berisha G1217167 Subprime Loans Amount of Loans given increased enormously, from $30 Billion to $600 Billion per year. ....at the same time... ....annual bonuses spiked, traders and CEO’s became enormously wealthy during the bubble. $14 million ocean front home in Florida Summer vacation home in Sun Valley, Idaho He and his wife own an art collection filled with millions of dollars of paintings Private elevator Lehman Brothers Six private jets..... ....and a Sikorsky helicopter (Gulfstreams and Dassaults) Senior Management Bankers generated huge cash bonuses based on short-term profits. These incentives encouraged bankers to take risks that might eventually destroy their own firms or even the entire financial system. Were the Executives Being Unethical? Risk takers, impulsive Part of their behavior and personality Involvement of drugs and prostitution While using corporate money, justifying on computer service repair, trading researches, consulting for marketing, clients, or providing them with letter heads so they can make their own invoice. (Kristin Davis) Lies told by Chief Executive Officer Richard Fuld Fuld was entrenched in a highly aggressive and leveraged business model, not unlike many other Wall Street players at the time, He continuously increased Lehman Brothers’ asset portfolio to one of unreasonably high risk. When the time came to recognize his error, he did not assume responsibility or admit wrongdoing. Had he been truthful, more competitive solutions would have been available helping prevent or minimize the financial loss that emerged the horizon. Choosing to paint an unrealistically optimistic picture of Lehman Brothers’ financial situation, Fuld forfeited the opportunity to take advantage of various solutions that would have cut the company’s losses Blatant misrepresentation of financial health, perpetrated through the employment of Repo 105, was an attempt to grossly manipulate the bank’s many stakeholders and also clearly indicative of a much bigger problem. Blatant misuse of Repo 105 Moving assets away from the balance sheet was intended to create the illusion of a company that was stable and secure Lehman Brothers would have been better served by fully and accurately disclosing the details of its finances. With the benefit of credibility and time to strategize, the likelihood of receiving much-needed aid would have been far greater Nurul Hafizah G1125596 Irfanulloh G1122803 Zubli Quzairi G1213269 Cover-up endorsed by Chief Financial Officer Erin Callan By moving assets away from the balance sheet was intended to create the illusion of a company that was stable and secure Negligence on behalf of Ernst & Young Ernst & Young, the only third party aware of to the happenings at Lehman Brothers, failed to reveal the extensive steps taken by executive leadership to conceal financial problems. As a firm of certified public accountants expected to honor and uphold an industry-wide code of ethics. In this situation, concern for ethical behavior was of minimal or nonexistent concern
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