The art of illusion

Look for what's not on the page

By ACFE Regent Bruce G. Dubinsky, CFE, CPA, CVA; and Tiffany Gdowik, CFE

s2w-lehman-case.jpg“The essence of lying is in deception, not in words.”
— John Ruskin

Extrapolating the words of John Ruskin, a 19th-century British social thinker, I often say, “It’s not what’s on the page that matters; it’s what’s not on the page that matters.” As fraud examiners, we have been taught to gather documents, review information, interview subjects and then draw our conclusions. While that approach will detect the simplest of frauds, it won’t detect the type of complex financial frauds that are increasingly making headline news.

I’ve worked on some of the world’s largest frauds — including the Bernie Madoff Ponzi scheme, Parmalat, Lehman Brothers and International Brotherhood of Teamsters. In the Lehman Brothers case, the company used “accounting gymnastics” to manipulate the company’s financial statements during the 2005-2008 financial meltdown — the most devastating since the Great Depression. 


In 2008, Lehman Brothers’ shaky balance sheet and falling profits left the firm in dire financial peril. It desperately needed to create the illusion that it was healthier than it actually was. Lehman used what appeared to be a normal financial instrument in the banking world — a repurchase agreement (a repo) — to book billions of dollars of transactions. A repurchase agreement is a form of short-term borrowing for banks and other dealers typically using government securities. The bank sells the government securities to an investor (many times another bank), usually on an overnight basis, and buys them back the following day. In Lehman’s case, the company did it to exploit an accounting rule that was meant to give principled guidance to determine when a repo was a true short-term financing method versus a sale of a financial instrument. The latter desired treatment as a “sale” allowed Lehman to slyly portray its financial condition as rosy when it wasn’t.

Interestingly, investigators didn’t discover the illusion created by Lehman by looking at what was on the page (i.e. the entries in the accounting system). The accounting entries, which seemed straightforward, generated little to no alarm. The debits and credits were to the proper accounts. The explanation accompanying the entries also seemed normal. In fact, a review by even the most skilled auditor or fraud examiner would, in and of itself, have revealed nothing. Rather, investigators exposed the company’s deceptive behavior by looking at what was literally not on the page. The key to uncovering the ploy was to first obtain an understanding of what Lehman’s financial perils were at that time.

Lehman had unusually high amounts of leverage (debt to finance its assets) on its balance sheet, and the public markets were responding negatively. The company spent a considerable amount of time and effort trying to calm the markets during its investor calls. So, the first “red flag” came in the form of a question: Why was Lehman spending so much time focused on de-levering its balance sheets? Its access to public capital was critical to its continued survival. With investor panic running rampant, it had to create the illusion that it wasn't a house of cards but rather a solid financial institution with a sound balance sheet.

So how did Lehman create the delusion? It simply used the chameleon approach: make something that’s really one thing look like something else. Lehman took repos that were really short-term loan transactions and made them look like they were sales of financial product inventory (e.g. U.S. treasuries and certain equities). By knowingly exploiting that U.S. accounting rule and specifically structuring the repos to fail the requisite treatment as a repo financing, Lehman was able to disguise itself as a financially healthier institution.

Once it was determined that Lehman had a strong motive to reduce its leverage, the hunt was on. A New York bankruptcy court in 2009 appointed Anton R. Valukas, a prominent attorney and former U.S. federal prosecutor, to be the investigating examiner. He had many questions. How could the company do it? What mechanism could it use? Who would be able to make it happen? Only old-fashioned detective work could answer them.

Going back to Dr. Donald Cresseys’s fraud triangle (pressure, opportunity and rationalization) is always a helpful exercise when investigating frauds. 

The pressure was clearly evident; Lehman had to reduce its leverage or face certain demise. The opportunity presented itself because Lehman was a huge market participant in the repo market. The rationalization was simple; Lehman needed to do it to keep the business alive and “protect” the stakeholders.


Valukas, in his careful and thorough investigation, raised the cloaking curtain and revealed Lehman’s accounting gymnastics

His investigation focused on finding traditional pieces of evidence (emails, documents, accounting entries, etc.) that told the story and revealed accounting manipulations. However, he also focused on looking for what wasn’t on the page — the business reason for executing transactions under off-market terms. In other words, the repo transactions weren’t hidden on the underlying books of Lehman; they were simply devoid of any rational business reason other than the desired accounting trick Lehman needed to create its magic.

Valukas and his investigators were able to focus on those transactions that would have legitimately accomplished Lehman’s goal by first identifying and understanding the critical need for the company to de-lever its balance sheet.

The investigators couldn’t simply look at the accounting entries, the International Swaps & Derivatives Association (ISDA) master agreements and supporting documentation to reveal the illusion that Lehman was orchestrating. [The ISDA master agreement is the most commonly used master service agreement for Over the Counter (OTC) derivative transactions internationally. The ISDA master agreement is typically accompanied by a schedule, confirmations, definition booklets and a credit support annex.]

The fact that Lehman executed the repo transactions in question with counterparties at significantly off-market terms was the key piece of game-changing information (not on the page). Combined with the other traditional pieces of information, this ultimately exposed Lehman’s illusion.

Today’s fraud examinations are more challenging than ever. The volume of transactional accounting data in a typical examination is staggering. The amount of hard documents, emails, voice mails and text messages is growing exponentially. It's so easy to get lost in the weeds and focus only on the information that’s on the page. However, with the increasing complexity of today’s global business world, the need to perceive what’s not on the page is especially critical when trying to investigate and uncover the fraud.

Bruce G. Dubinsky, CFE, CPA, CVA, is managing director of commercial disputes for Duff and Phelps, LLC, and an ACFE Regent. 

Tiffany Gdowik, CFE, is a senior associate in the dispute practice of Duff and Phelps, LLC. 

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