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Cold Case: Lessons FromThe Lehman AutopsyThe SEC can learn from Anton Valukas, the Chicagoattorney who led a probe into Lehman—and uncoveredaccounting chicanery that regulators largely ignored

COMMENTARY

By Paul M. BarrettIn 2oo8, Anton R. Valukas, a trialattorney in Chicago, published afour-page stiletto thrust of an es-say entitled, "Arrogance: My FavoriteSin." The piece, included in a lawyers'guide to cross-examination, recountedValukas' delight in using understatedquestioning to tempt executives intomaking implausible statements ofthe sort that reliably alienate jurors."Frequently, the smartest witnesses—the most sophisticated and the mostarrogant—are most susceptible to thistype of examination," he wrote.

The piece reads today like a preambleto Valukas' voluminous autopsy ofLehman Brothers, which he performedas the court - approved bankruptcy ex-aminer in the investment hank's formalunwinding. Tlae 2,200-page Lehmanreport, released on Mar. 11, constitutestlie single most penetrating documentwe have on the recent misbehavior onWall Street. Valukas' earlier primersuggests why he did such an exemplaryjob: Although he heads a prestigiouscorporate law firm, Jermer & Block, the

former federal prosecutor just plainresents dissembling hy big shots inexpensive suits. Not coincidentally,Jenner, a pillar of the Chicago businesselite, sues Wall Street institutions asoften as it defends them.

In the Interest of preventing futureLehman disasters, we might ponderhow to transplant Valukas ' zeal intoWashington's financial beat cops. Thatcould help preclude the need to call himback again as corporate pathologist.

He'd be a hard man to clone. Duringa four-decade career, Valukas, 66, hasrepresented all manner of white - collarrogues. When called to public service,he used his knowledge ofthe market'sshadowy corners to prosecute well-heeled miscreants. In the late 1980s,as U.S. Attorney in Chicago, he sentagents disguised as commodity tradersto clean up the futures exchanges. Theprobe protected investors and led to aslew of indictments. Some called himthe Rudy Giuliani of the Midwest.

Unlike Giuliani, Valukas avoidedelective politics and returned to his lawfirm. He prospered at Jenner, not leastin his yearlong assignment as the Leh-man examiner. Backed by colleagues

from Jenner, he went over millionsof pages of documents, interviewedscores of witnesses, and hilled the Leh -man estate $38.4 million. I'dsay it wasmoney well spent. His findings willprovide the script for what's likely to bea theatrical airing in April, when Rep-resentative Barney Frank (D-Mass.)convenes his House Financial ServicesCommittee to interrogate Lehman'sformer CEO, Richard S. Fuld Jr., andother participants in the debacle.

DUBIOUS BEHAVIORWhat Valukas brought to the endeavorwas a no-nonsense lack of deferencetoward Wall Street game playing, saysFrancine McKenna, a former managingdirector at PricewaterhouseCoopers."That's a Chicago thing," addsMcKenna, herself a resident of the city.She now runs an investigative Web sitecalled Re: The Auditors. "The mindsetis: I've been around the block, I knowhow the game is played, and I'm notimpressed by fancy names," she says.

As the Lehman examiner, Valukasdoggedly unmasked the dubiousbehavior of executives once laudedas among Wall Street's conquering

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NEW BUSINESS

heroes. Fuld insisted to Valukas thathe knew nothing about the account ~ing trickery called Repo 105, whichwas used to hide the bank's financialdecline. Fuld's self-portrait—a veteranCEO blithely unfamiliar with theworkings of his company-was not justimplausible; it could support lucra-tive civil claims that he "was at leastgrossly negligent," as Valukas wrote.The examiner noted that Fuld's denialswere undercut by evidence that he wasthoroughly briefed on the chicanery,

Contacted by phone, Valukas de-clined to comment. Fuld's attorney,Patricia Hynes, has said her client toldthe truth and did nothing wrong.

There will be time enough to sort outlegal culpability for Lehman's demise.The [ustice Dept. is investigating, andcivil litigation is under way. Vaiukaslays out facts without playing judge orjury. "There are many reasons Lehmanfailed," he noted, "and the responsibil-ity is shared."

Beyond the bank itself, Valukaspointed to evidence that Lehman'sauditor, Ernst & Young, committedmalpractice when it sat on a whistle-blower's warnings and failed to keepthe bank's board apprised of suspiciousexecutive conduct. Ernst bas deniedany professional failings or liability.

The regulators also bear blame inValukas' account. Some of the mostunnerving portions of his reportexplain that while Lehman failed tokeep investors informed, staff mem-bers from the Securities & ExchangeCommission and Eederal Reserve Bankof New York did know what was goingon - and shrugged their shoulders.

PUBLIC-SPIRITED PIT BULLGovernment overseers, some of whomworked on site in Lehman's offices in2008, had access to the bank's perti-nent records. Former Lehmanites toldValukas that the government didn'traise significant objections or directLehman to take corrective action.SEC spokesman John Nester said in aninterview witb Bloomberg News: "Weare looking closely at the examiner'sfindings as part of our ongoing reviewof the accounting and disclosures ofmajor financial institutions and theirrole in the financial crisis." This is the

same agency, of course, that yawnedat warnings about Bernard Madoff'sglobe-spanning Ponzi racket.

"The unavoidable question iswhether the SEC will hold someoneresponsible for what happened atLehman," says Michael J. Missal, apartner in Washington with the lawfirm K&L Gates. Missal, who makes aliving defending companies faced with

"THERE ARE MANYREASONS LEHMAN FAILED,AND THE RESPONSIBILITY

IS SHARED,"VALUKAS WROTE

government investigations, is anotherof those attorneys capable, when askedby a court, of transforming himselfinto a public-spirited, if generouslycompensated, pit bull. He publishedan impressive bankruptcy examiner'sreport of his own in 2008 in the case ofNew Century Financial, one of the sub-prime mortgage giants that, with WallStreet's assistance, recklessly inflatedthe housing bubble.

So, bow do we energize the regu-latory ranks witb the punch that aValukas or Missal brings to this kind ofwork ? One fantasy would be to replacewholesale tbe SEC's EnforcementDivision with lawyers drawn from tbestaffs of past high-level bankruptcyexaminers. In addition to the Lehmanand New Century cases, solid inves-tigative work was done in the wake ofEnron's collapse in 2001 and tbe 2005implosion of Refco, a large brokerage.

The obstacles to creating a regula -tory Delta Force are familiar ones:pay and prestige. "The law firms offermoney and status," says Max Stier,president of the nonprofit Partnershipfor Public Service. "Even when goodpeople come into government service,many soon leave through the revolv-ing door." Stier's Washington groupruns programs to enrich governmentcareers and encourage corporateemployees to try public service. Hehas held legal jobs in all three branchesand practiced with a Washington lawfirm. Stier acknowledges that govern-ment salaries will never compete withprivate-sector compensation. Heobserves that at many key agencies,the revolving door has spun all themore swiftly for the past generationas a bipartisan consensus celebratedthe notion that the financial marketseffectively police themselves andregulators should get out of the way.If we didn't know already, the Valu-kas report reminds us once and forall to drop that delusion. Done right,regulation promotes capitalism bydeterring excess and fraud. "Politi-cal leaders need to prioritize talent atagencies like the SEC, which histori-cally hasn't happened," says Stier.

One intriguing suggestion for howto put Stier's advice into action comesfrom Scott McCleskey, a former vice-president for compliance at Moody'sInvestors Service. In a Mar. 20 op-edin The New York Times, McCleskey,who now works for Complinet, a com-pliance-consulting firm, proposed thecreation for financial regulators of ananalog to the U.S. Foreign Service. Toomany SEC staff members are inexpe-rienced attorneys; the best ones tendto depart after a few years for privatepractice. McCleskey argued that theForeign Service model—with its spe-cialized training; attractive pensioneligibility after as little as 20 years onthe job; and long-term career tracks,allowing for variety and new chai -lenges-would draw more impressiveapplicants and cut down on turnover.

Perhaps President Barack Obamacould persuade Valnkas to take a sab-batical and serve as the first dean of anew Federal College of Financial Regu-lators. It wouldn't hurt to ask. BW I

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