The case against Lehman Brothers

(CBS News) It's hard to overstate the enormity of the 2008 collapse of Lehman Brothers. It was the largest bankruptcy in history; 26,000 employees lost their jobs; millions of investors lost all or almost all of their money; and it triggered a chain reaction that produced the worst financial crisis and economic downturn in 70 years.

Yet four years later, no one at Lehman has been held responsible. Steve Kroft investigates the collapse of Lehman Brothers: what the SEC did and didn't know about the firm's finances, the role of a top accounting firm, and why no one at Lehman has been called to account.

The following script is from "The Case Against Lehman" which originally aired April 22, 2012, and was rebroadcast on August 19,2012. Steve Kroft is the correspondent. James Jacoby and Michael Karzis, producers.

On Sept. 15, 2008, Lehman Brothers, the fourth largest investment bank in the world, declared bankruptcy -- sparking chaos in the financial markets and nearly bringing down the global economy. It was the largest bankruptcy in history -- larger than General Motors, Washington Mutual, Enron, and Worldcom combined. The federal bankruptcy court appointed Anton Valukas, a prominent Chicago lawyer and former United States attorney to conduct an investigation to determine what happened.

Included in the nine-volume, 2,200-page report was the finding that there was enough evidence for a prosecutor to bring a case against top Lehman officials and one of the nation's top accounting firms for misleading government regulators and investors. That was two years ago and there have been no prosecutions. Anton Valukas had never given an interview about his report until we broadcast this story in April of this year.

Steve Kroft: This is the largest bankruptcy in the world. What were the effects?

Anton Valukas: The effects were the financial disaster that we are living our way through right now.

Steve Kroft: And who got hurt?

Anton Valukas: Everybody got hurt. The entire economy has suffered from the fall of Lehman Brothers.

Steve Kroft: So the whole world?

Anton Valukas: Yes, the whole world.

When Lehman Brothers collapsed, 26,000 employees lost their jobs and millions of investors lost all or almost all of their money, triggering a chain reaction that produced the worst financial crisis and economic downturn in 70 years. Anton Valukas' job was to provide the bankruptcy court with accurate, reliable information that the judges could use to resolve the claims of creditors picking over Lehman's corpse.

Steve Kroft: Had you ever done anything like this before?

Anton Valukas: I've never done anything like Lehman Brothers. I don't think anybody else has ever done anything like Lehman Brothers.

Steve Kroft: So your job, I mean, in some ways, your job was to assess blame?

Anton Valukas: Our job is to determine what actually happened, put the cards face up on the table, and let everybody see what the facts truly are.

Valukas' team spent a year and a half interviewing hundreds of former employees, and pouring over 34 million documents. They told of how Lehman bought up huge amounts of real estate that it couldn't unload when the market went south -- how it had borrowed $44 for every one it had in the bank to finance the deals -- and how Lehman executives manipulated balance sheets and financial reports when investors began losing confidence and competitors closed in.

Steve Kroft: Did these quarterly reports represent to investors a fair, accurate picture of the company's financial condition?

Anton Valukas: In our opinion, they did not.

Steve Kroft: And isn't that against the law?

UPDATE: A statement from Ernst and Young: Lehman's bankruptcy occurred in the midst of a global financial crisis triggered by dramatic increases in mortgage defaults, associated losses in mortgage and real estate portfolios, and a severe tightening of liquidity.

We firmly believe that our work met all applicable professional standards, applying the rules that existed at the time. Lehman's demise was caused by the global financial crisis that impacted the entire financial sector, not by accounting or financial reporting issues.

Anton Valukas: It certainly, in our opinion, was against civil law if you will. There were colorable claims that this was a fraud, yes.

By colorable claims Valukus means there is sufficient evidence for the Justice Department or the Securities and Exchange Commission to bring charges against top Lehman executives, including CEO Richard Fuld, for overseeing and certifying misleading financial statements, and against Lehman's accountant, Ernst and Young, for failing to challenge Lehman's numbers.

Anton Valukas: They'd fudged the numbers. They would move what turned out to be approximately $50 billion of assets from the United States to the United Kingdom just before they printed their financial statements. And a week or so after the financial statements had been distributed to the public, the $50 billion would reappear here in the United States, back on the books in the United States.

Steve Kroft: And then the next financial statement, they would move it overseas again, and file the report, and then move it back?

Anton Valukas: Right.

Steve Kroft: It sounds like a shell game.

Anton Valukas: It was a shell game. It was a gimmick.

Lehman misused an accounting trick called Repo 105 to temporarily remove the $50 billion from its ledgers to make it look as though it was reducing its dependency on borrowed money and was drawing down its debt. Lehman never told investors or regulators about it.

Steve Kroft: This is really deception to make the company look healthier than it was?

Anton Valukas: Yes.

Steve Kroft: Deliberate?

Anton Valukas: Yes.

Steve Kroft: How are you so sure of that?

Anton Valukas: Because we read the emails in which we observed the people saying that they were doing it. We interviewed the witnesses who wrote those emails, or some of those emails, and asked them why they were doing it, and they told us they were doing it for purposes of affecting the numbers.

Steve Kroft: Do you think that Lehman executives knew that this was wrong?

Anton Valukas: For some of 'em, certainly. There was concerns being expressed by-- at high levels about whether this is appropriate, what happens if the street found out about it. So, you know, there was a concern that there's a real question about whether we can do this, whether this was right or not.

One of those people was Matthew Lee who had been a senior executive at Lehman and the accountant responsible for its global balance sheet. Lee was one of the first to raise objections inside Lehman about the accounting trick known as Repo 105.

Matthew Lee: It sounded like a rat poison, Repo 105, when I first heard it. So I investigated what it was, and I didn't like what I saw.

Steve Kroft: Was there a point in which you saw the accounting principles employed by Lehman Brothers change?

Matthew Lee: November 30th, 2007 was the end of our fiscal year. And I fully expected us, you know, to make a loss that year like everyone else. And when I saw we made money -- it was a record year, in fact -- I thought, "That doesn't sound right." You knew the markets were doing badly, so why wasn't Lehman doing badly? And every time I found something and I went to my boss or whoever, no response.

That was 10 months before Lehman Brothers went bankrupt. Lee's position required him to sign off on the accuracy of the firm's accounting practices every quarter. But in November of 2007 he declined to do it.

Steve Kroft: By refusing to sign it, you were saying that you didn't believe the numbers.

Matthew Lee: Correct.

Steve Kroft: That this wasn't a fair and accurate representation of the financial condition of Lehman Brothers.

Matthew Lee: Right. 'Something's up here. Why can't people answer my questions?' You know, 'Why has Repo 105 doubled? Give me an answer.' You know, nothing was said.

Lee continued to press people for more information, but nothing changed. And four months before Lehman collapsed, he sent this letter to Lehman's top executives.

Matthew Lee: 'I've been telling you all year. I've been banging my head against the wall. I'm now putting it in writing.'

Steve Kroft: Says, "it requires me to bring to the attention of management conduct and actions on the part of the firm that I consider to be possibly unethical and unlawful."

Matthew Lee: Yeah.

Steve Kroft: What were you talking about specifically?

Matthew Lee: Well, in that particular letter, I was general. There were so many specifics. I could have written laundry lists.

Steve Kroft: What kind of a response did you get from this letter?

Matthew Lee: It's like throwing a grenade. I wanted to wake somebody up, at least to address the topics.

It worked. Six days after he sent that letter, Matthew Lee was downsized, let go after 14 years. But Lehman executives couldn't ignore the letter and asked their accountants from Ernst and Young to interview Matthew Lee.

Anton Valukas: And in those interviews, we have the notes -- which are part of the report -- he says very specifically $50 billion, Repo transactions, moving money off the balance sheet at quarter end. So our conclusion was Ernst and Young certainly knew it as of that time, and did nothing with it.

Valukas says Ernst and Young was legally bound to make sure that Lehman's audit committee and its board of directors knew about Lee's allegations of unethical and unlawful accounting practices. But they never did.

Steve Kroft: Did the audit committee know?

Anton Valukas: No.

Steve Kroft: Did the board of directors know?

Anton Valukas: No.

Steve Kroft: Did Dick Fuld know?

Anton Valukas: Did Dick Fuld know? Well, he says no.

The only place Lehman's CEO, Richard Fuld, has publicly answered any questions about his firm's bankruptcy has been in front of Congress.

[Richard Fuld: I have absolutely no recollection whatsoever of hearing anything about or seeing documents related to Repo 105 transactions while I was the CEO of Lehman.]

Anton Valukas: He said the same thing to me face-to-face.

Steve Kroft: Do you believe him?

Anton Valukas: There was evidence which would show that that's not accurate. The president of Lehman Brothers told us that in fact he had conversations with Dick Fuld about this and documents were shared with him which would reflect the Repo 105 transactions and how they were being used. Richard Fuld's view on that was that he has no knowledge of it. You have other evidence that he did. A jury would have to decide who's telling the truth.

But so far there has been no jury to hear the evidence. Despite Valukas' findings -- and the supporting documents and testimony to back them up -- the Securities and Exchange Commission has not brought any charges of any kind against former Lehman executives. For the past few months, we've made numerous requests to interview the SEC's head of enforcement. All of those requests have been declined.

Steve Kroft: The Securities and Exchange Commission has not brought a case.

Anton Valukas: No, they have not.

Steve Kroft: Does that bother you?

Anton Valukas: I'm not permitted to be bothered by that. You know, my job was to set out the facts, lay it out. They have to make their own prosecutive decisions.

There is one plausible explanation why SEC hasn't has not gone after top Lehman executives. As it turns out, some of Lehman's most egregious accounting shenanigans took place right under the noses of government regulators.

Steve Kroft: How closely was the SEC monitoring Lehman Brothers during this time?

Anton Valukas: They were on premises. They were talking to the Lehman people daily. They officed there.

It was not widely known at the time, but during the last six months of Lehman's existence, teams of officials from the SEC and the Federal Reserve took up residence inside the firm to monitor its precarious financial situation. They were inside the building when Matthew Lee wrote his letter to Lehman executives alleging unlawful accounting practices, and they were there when the practices took place. Valukas says the SEC also knew that Lehman was being less than truthful when it said it had enough assets to survive the crisis. But that and other damaging information was never disclosed to investors who continued to pump billions of dollars into the firm.

Steve Kroft: Should it have been disclosed?

Anton Valukas: Absolutely.

Steve Kroft: Isn't the government, the SEC in this case, the people who were supposed to protect the investors?

Anton Valukas: Yes.

Steve Kroft: Aren't they charged with informing investors?

Anton Valukas: Yes.

Steve Kroft: Why didn't they do it?

Anton Valukas: They may not have had the expertise necessary to understand the material they were receiving. They were getting the material. Whether they understood it is another question.

The very fact that government regulators were inside the company with access to its books and records would complicate any prosecution of Lehman officials.

Until seven months ago, David Kotz was the SEC's inspector general. Over the previous four years, he issued more than 100 reports about major deficiencies in the way the SEC does its job.

Steve Kroft: If the SEC knew about some of these problems at Lehman Brothers and they weren't disclosed, doesn't that make it difficult for the SEC enforcement division to come back and bring action against Lehman Brothers? They were there; they saw it.

David Kotz: Yeah. I think that that's definitely an impediment to a potential case. And, certainly, if you go before a jury, the defense lawyers can make a big point about the fact that, "You were there. You knew about it. Why didn't you do anything at the time? Now, you're coming after them."

In fact, former Lehman CEO Richard Fuld seemed too be trying out that defense when he testified before Congress in 2008.

[Richard Fuld: Throughout 2008, the SEC and Federal Reserve conducted regular and, at times, daily oversight of our business and our balance sheet. They saw what we saw in real time.]

Steve Kroft: Let's just assume for a moment that Anton Valukas' findings are true. I mean, isn't this just a free ticket for executives to say, "Well, look. You know, Lehman did so-and-so, and nothin' happened to them."

David Kotz: Right, no I think absolutely, that's a serious problem. I mean, obviously, there has been a tremendous financial crisis. The people who engaged in improper behavior need to be punished. I think it's critical for the SEC to go after not just companies, but also individuals, where they have the evidence to do so.

When Lehman's bankruptcy was finally settled, there were claims against it for $370 billion. The creditors settled for about 20 cents on the dollar. Former CEO Richard Fuld now runs a consulting business in Manhattan. He lost most of his fortune and is embroiled in a raft of litigation, but is still a wealthy man. Most of his senior colleagues at Lehman have landed on their feet.

Ernst and Young, Lehman's accounting firm is now being sued by New York State for aiding and abetting a fraud.

And Matthew Lee the senior account who blew the whistle at Lehman is still looking for work, unconvinced that much has changed in the world of finance over the last four years.

Matthew Lee: You know, the entrepreneurs of Wall Street are continually getting more and more sophisticated. And they don't necessarily want regulators or auditors to fully understand what they're doing.

Steve Kroft: Do you believe the balance sheets of big Wall Street firms if you read them now?

Matthew Lee: These numbers are so big and the financial instruments are so complex that, you know, nobody stands a chance, really, of understanding. I'd have more fun investing in crap tables in Las Vegas than Wall Street firms.