Running Head: LEHMAN BROTHERS 1

MANAGERIAL
COMMUNICATION

LEHMAN BROTHERS
(International Management Institute, New Delhi)

Submitted to: Submitted by:

Prof. V. Chandra Group 4

Abhishek Jindal 16PGDM004

Asfar 16PGDM014

Khushboo Pahwa 16PGDM024

Naman Sethia 16PGDM034

Rachita 16PGDM044

Sumanth 16PGDM054

Date of Submission 4/9//2016

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ACKNOWLEDGEMENT

Foremost, we wish to express our heartfelt thanks to Prof. V. Chandra, a distinguished

professor for the continuous patronage through her lectures and interactive sessions that have

been really helpful in the entire process. We are thankful to her for giving us this opportunity

to further learn the various concepts taught in the class with the help of this project.

This project is the outcome of the untiring and determined efforts of all those who guided and

directed us during the making of this project, and made it a worthwhile experience.
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ABSTRACT

The purpose of this report is to understand how lack of proper communication, both internal

communication and external communication can bring about a downfall of an organization.

This report tries to explain it by giving an example of the fall of Lehman Brothers which used

to be one the most prominent firms. We have shown the various reasons leading to its demise

and the scenario prevailing after its downfall. We have concluded showing how lack of

proper communication was one of the main reasons for this and how the collapse could have

been prevented with proper communication and transparency.

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Contents

INTRODUCTION ..................................................................................................................... 5

BEFORE RECESSION (2005-2007) ........................................................................................ 7

DURING RECESSION (2007-2008) ........................................................................................ 9

CONTROVERSIES ................................................................................................................. 11

CONCLUSION ........................................................................................................................ 13

REFERENCES ........................................................................................................................ 15
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INTRODUCTION

Growing economies are often challenged by declination in the number of safe choices. One

such company, which is still considered the biggest downfall in the history is Lehman

Brothers, an investment banking firm founded in 1850. The firm’s operations included

investment banking and management, fixed income, sales, equity, research & trading, private

banking and private equity. Lehman Brothers was the fourth largest investment bank in US

after Goldman Sachs, Morgan Stanley and Merrill Lynch with 25,000 employees worldwide

before its collapse in 2008.

Lehman Brothers survived everything, the long term capital management collapse, The Great

Depression in the 1930s, two world wars and the Russian debt default of 1998 but the 158-

year-old firm could not recover from a $619 billion debt and filed for bankruptcy on 15th

September 2008. The collapse of Lehman Brothers was not the result of a single lapse in

ethical judgment committed by one misguided employee. It would have been nearly

impossible for an isolated incident to bring the Wall Street giant to its knees, especially after

it successfully withstood so many historical trials.

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The impact on the financial sector was so huge that the financial calendar got divided into pre

Lehman and post Lehman: Pre Lehman, being the period with a sense of impending doom.

Before Lehman’s collapse this doom seemed like a distant reality. Post Lehman period saw

panic all across the globe. The stock market crumbled alongside Lehman’s bankruptcy. The

financial system was completely disrupted and the magnitude of the impact was not only

because of the size of Lehman, but also because of the fact that Lehman being the leading

Investment bank, with vastly spread contacts and contracts around the world, was embedded

in the global financial system.

The impact of the downfall was so huge that George Bush (The President at that time)

decided to intervene and proposed a $700 billion bailout. Soon after this announcement,

another $500 billion lawsuit followed. The company crumpled to nothing and that marked as

the beginning of global economic recession.

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BEFORE RECESSION (2005-2007)

In 2003 and 04, during housing boom in US, Lehman acquired five mortgage lenders and

came under supervision from Consolidated Supervised Entity Programme by Securities and

Exchange Commission as it had started to follow Bear Stearns’s strategy and had too much

exposure to derivatives.

The downfall of Lehman Brothers all began when the firm headed by Richard Fuld adopted

an aggressive growth strategy in 2005. Because Lehman Brothers was heavily dependent on

fixed income securitization revenues, it invested its capital in assets like sub-prime and Alt-A

residential mortgages and mortgage-backed securities, commercial real estate and leveraged

its lending commitment.

After acquisition of five mortgage lenders, Lehman Brother’s real estate business experienced

56% surge from 2004 to 2006. Due to this the firm recorded a speedier rate of growth than

other businesses in the same line. In 2007, the firm reported net income of $4.2 billion on

revenues of $19.3 billion. During the same year, the stock of Lehman Brothers reached an all-

time high of $86.18 per share.

When the housing market began stumbling in 2007, a high number of mortgages based

defaults led to stock market experiencing the biggest single-day plunge in five years.

Lehman’s Chief financial officer (CFO) communicated to shareholders and media that risks

posed by rising home loan defaults were well contained and would have little impact on

firm’s balance sheet. He also said that he did not see any problems in subprime market.
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In few months, Bear Stearns, Lehman’s most comparable rival experienced total market

failure of two hedge funds. After Bear Stearns shut down, Lehman Brothers eliminated 2500

mortgage-related jobs and shut down its two of mortgage units. Regardless of deteriorating

market conditions, Lehman Brothers continued giving more mortgage-backed securities than

any other firm and endorsing its financial strengths while bad-mouthing that domestic and

global economies were in danger.

As it turned out, Lehman brothers missed the last chance of acknowledging and

communicating the misstep of continuing its massive risky mortgage portfolio. They could

have trimmed the portfolio and rethought the business strategy. They didn’t do it to show the

investors and Wall Street that no foreseeable concerns existed. Executives took internal action

to preserve the rosy façade and the employees who tried to right the wrongs of the poor

financial management were pushed out.

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DURING RECESSION (2007-2008)

Repo transaction is a transaction where one company transfers an asset to another company in

exchange for short term cash which in exchange comes with place when borrower will pay

back the cash and take back the asset at specified date usually within a week or so and in that

time the Wall Street will see the amount of assets. It helped Lehman hide off their debt by

showing off their money which allowed them to take more risk and in the process more

money by perpetuating the fraud. Richard Fuld CEO of Lehman paid himself with such

schemes 500million $ over 15 years. Instead of describing the repo transaction as loan they

described it as sale never disclosing they ever have to pay back the 50 billion $ they have

borrowed.

Lehman‘s failure to disclose the use of an accounting device to significantly and temporarily

lower leverage was significant. At the same time, it affirmatively represented those low

leverage numbers to investors as positive news, creating a misleading portrayal of Lehman’s

true financial health.

Lehman widely inflated the value of their company in the days before and after they issued

the quarterly reports: Q4 $39Billion (2007), Q1 $49Billion (2008), Q2 $50Billion (2008).

Richard Fuld and former Lehman’s CFO Christopher O’Meara, Erin M.Callan, IanT.Lowitt

were made aware that the fraud was happening and yet nothing was done by them.
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In May 2008, a Lehman Senior VP, Matthew Lee, wrote a letter to management alleging

accounting improprieties that Lehman used $50 Billion of Repo 105 transactions to

temporarily move assets of the Balance sheet at quarter end. In fact each of the CFOs and

CEOs are required by law to sign off the quarterly and annual reports showing the

transactions as sales and not as loan. Fuld, when interviewed for the report, denied it.

Ernst and Young knew about it and did nothing. Ernst &Young took no steps to question or

challenge the non-disclosure by Lehman of its use of temporary off balance sheet

transactions.

Lehman’s leverage ratio was of around 1:44 while that of Goldman Sachs and Bank of

America Was in 20s which led to higher risk for the company as compared to the competitors.

26000 employees lost their job and investors lost all their money post the collapse of Lehman

brothers. There was a scenario of asymmetric information and moral hazard wherein the

investors and stakeholders were not given the complete information of what was actually

happening within the company. Lehman never told about its use of Repo 105 to the regulators

or investors.

Teams from SEC and Federal Reserve took residence within the company to know what is

actually going on. Sec already knew that fraudulent activities were going on within the firm

also. Matthew Lee who was questioning the firm’s authenticity was side lined. But this

information was not shared with the investors and they continued to put billions of dollars

into the firm.

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CONTROVERSIES

There were many controversies surrounding the bankruptcy of Lehman Brothers. The major

talking point after the economy toppling bankruptcy of a major firm was the fact that the top

executives of the firm now staring at bankruptcy have started taking up huge bonus packages.

The documents from Lehman Brother’s showed that all the top 50 executives at Lehman

Brothers earned more than $8.1 million that year and the CEO Richard Fuld earned around

$40 million that year.

Following these reports, the U.S. House of Representatives’ Committee on Oversight and

Government Reform arranged for a questioning of the head of Lehman Brothers, Richard

Fuld. The Committee headed by Rep. Henry Waxman questioned on the fairness of Fuld

owning assets worth $480 million while his firm was facing bankruptcy and leading the

economy of the entire nation into turmoil. The other major controversy was that the executive

pay figures had increased just before the firm applied for bankruptcy. Waxman remarked that

internal documents showed that there was no accountability.

After the hearing was done, Waxman said "While Mr Fuld and other Lehman executives were

getting rich, they were steering Lehman Brothers and our economy toward a precipice" and

Waxman criticized Fuld’s approach of trying to socialise the losses incurred by his firm while

he made away with a huge chunk of profit.

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Later in December 2010, charges were filed against auditors of Lehman Brothers, Ernst &

Young accusing Ernst & Young in aiding Lehman Brothers in an accounting fraud by use of

Repo 105 transaction to improve the financial situation of the firm during the year-end

balance sheet. Ernst & Young, the only third party privy 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, Ernst & Young may be accused of being responsible for gross

negligence and lack of corporate responsibility.

As an accounting firm, Ernst & Young is charged with certifying that companies deliver

accurate and reliable information to shareholders. In this regard, Ernst & Young failed

completely, as executives were aware of behind-the-scenes bookkeeping and the extent to

which it was occurring. In this situation, concern for ethical behavior was of minimal or

nonexistent concern. Therefore, the company’s shareholders were deliberately deceived for

the purpose of preserving a paycheck, and in that regard, the team of accountants who chose

not to act disappointed more than just their company; they let down the entire industry and

each of the right-minded professionals within it.

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CONCLUSION

The failure of Lehman brothers was not only because of losses in its derivative portfolio and

lack of liquidity but also because of bad management choices and policy decisions. Its demise

was the cumulative effect of a number of missteps perpetrated by several individuals and

parties.

Fuld was obstinate and when the time came to recognize his error, he did not assume

responsibility or admit wrongdoing. He had an opportunity in 2007 to voice concerns about

his bank’s short-term financial health and its heavy involvement in risky loans, and he

squandered it in favour of communicating to investors and Wall Street that no foreseeable

concerns existed.

Additionally, while the immediate effects of admitting a shaky outlook would have been

negative, two repercussions must have been considered. First, large capital investors would

have been appreciative of the transparency, and after getting past the initial shock, they would

have taken action to get the bank back on track. Second, had the general public — including

the federal government — been aware of the situation and the actionable measures being

taken to rectify it, more intellectual and financial aid would have been available to minimize

losses and potentially avoid total collapse.

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This was not the case, however, and by 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. Had he acted more prudently,

Lehman Brothers’ story may have ended differently.

The story of Lehman Brothers’ demise is unfortunate, and not just because its collapse meant

the end of a Wall Street institution. The real tragedy lies in the lack of ethical behavior of its

executives and professional advisors. They made conscious decisions to deceive and

manipulate, and the consequences proved too dire to preserve the historic investment bank’s

existence. The perennial lesson of the Lehman Brothers case is that no matter how dire the

circumstances may appear, transparency and accountability are paramount. Right action up

front may sting initially, but as history has repeatedly shown, gross unethical business

practices rarely endure in the long term. A global financial crisis such as that of 2008 may not

be prevented from happening again. What can be improved, in large measure through ethics

education, is how corporations behave. Wall Street should take note of the case of Lehman

Brothers to ensure history does not find a way to repeat itself.

No matter the situation, all the problems have to be disclosed to the employees within the

organization and to the stakeholders outside the organization. Without proper communication,

such crisis is sure to repeat.

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REFERENCES

http://www.ibtimes.com/death-lehman-brothers-what-went-wrong-who-paid-price-who-

remained-unscathed-through-1405728

http://www.investopedia.com/articles/economics/09/lehman-brothers-

collapse.asp?ad=dirN&qo=investopediaSiteSearch&qsrc=0&o=40186

http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp

http://sevenpillarsinstitute.org/case-studies/the-dearth-of-ethics-and-the-death-of-lehman-

brothers

http://www.ft.com/cms/s/0/1fed9c58-9085-11e1-9e2e-00144feab49a.html?his

http://www.aljazeera.com/news/americas/2008/10/20081062278398207.html

https://en.wikipedia.org/wiki/Bankruptcy_of_Lehman_Brothers.html