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16. Based on the letter, should E&Y be in the clear of any wrongdoing related to the Repo 105 and 108
transactions and reporting? Provide your reasons for and against.
It is going to be very difficult to prove that E&Y took the wrong decisions. Likely, the accounting
17. If an auditor explains a problem to the Chair of an Audit Committee, is there any further obligation
on the part of the auditor to ensure that the full board have been notified and why?
The auditing standards do not explicitly separate the audit committee from the rest of the board
18. Organizations who use the Enterprise Risk Management (ERM) framework, should work through the
following stages: review on the internal environment, identification of the organization’s risk
appetite or objectives, risk identification and measurement, risk assessment, risk response,
providing risk information and communications, and risk monitoring. In which of these did LB fail?
Who was to blame for the failure?
The 2004 Enterprise Risk Management Framework, provided by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), explains the general ideas behind enterprise
risk management:
The COSO framework proposes the following good principles of enterprise risk management:
• “Aligning risk appetite and strategy – Management considers the entity’s risk appetite in
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• Enhancing risk response decisions – Enterprise risk management provides the rigor to
identify and select among alternative risk responses – risk avoidance, reduction, sharing,
and acceptance.
In addition, the COSO guidance on “Effective Enterprise Risk Management Oversight:
The Role of the Board of Directors” (2009), highlights that the company’s board of directors has
a preeminent role in the risk management process. The board of directors should:
• “Understand the entity’s risk philosophy and concur with the entity’s risk appetite. Risk
appetite is the amount of risk, on a broad level, an organization is willing to accept in
pursuit of stakeholder value. Because boards represent the views and desires of the
organization’s key stakeholders, management should have an active discussion with the
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LB’s risk management process had severe deficiencies in risk assessment, risk mitigation and in
risk oversight.
• Problems with risk assessment: The risk assessment process is critical to take adequate
actions to mitigate risks and LB failed to properly assess the risks of its over-levered
19. How should the U.S. Bankruptcy Examiner’s Report be regarded – as a neutral set of findings or as a
signpost intended to point creditors in the direction of potential recoveries? What are the
implications of each?
In several parts of the Examiner’s Report, the term “Colorable Claims” (i.e., potential claims) is
used, highlighting one of the main objectives of the Report; however, the facts and conclusions
contained in the Report are the result of a thorough and professional investigation.
According to the Examiner’s Report, the Examiner’s mandate included the following (p. 28):
“the Examiner is to “investigate the acts, conduct, assets, liabilities, and financial condition
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more than five million documents, estimated to comprise more than 40,000,000 pages (p. 31)
the Report explains that:
“Documents were reviewed on at least two levels. First level review was conducted by
Similarly, in planning the review, the Examiner sought advice from other experts (p. 35):
“the Examiner spoke with examiners from other large bankruptcy proceedings, including
WorldCom, SemCrude and Refco, and obtained their advice on best practices.”
Also, interviews with former LB’s employees and other parties were conducted with objectivity
(p. 36):
“To assure accuracy, all interviews were conducted by at least two attorneys, one of whom
20. After the Enron and WorldCom fiascos, regulators sought to avoid future misrepresentation by
enacting the Sarbanes-Oxley Act (SOX) in 2002. Why didn’t SOX prevent Lehman’s use of Repo 105
and 108 misrepresentations? Does that mean that SOX is a failure?
SOX could not have prevented a situation where management, directors and auditors were
aware and in agreement about an accounting interpretation. This case highlights some
Useful Articles, Links, and Videos:
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American Institute of Certified Public Accountants (AICPA). “AU 316 Consideration of Fraud in a Financial
Statement Audit SAS No. 99.” 2002
Committee of Sponsoring Organizations of the Treadway Commission (COSO). “Effective Enterprise Risk
Management Oversight: The Role of the Board of Directors” 2009.
“Examiner’s report.” See Report of Anton R. Valukas, Examiner (below).
Financial Accounting Standards Board. “Summary of Statement No. 140. Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities-a replacement of FASB Statement
No. 125” 2000.
International Auditing and Assurance Standards Board (IAASB). “ISA 240 The Auditor’s Responsibilities
Report of Anton R. Valukas, Examiner, Lehman Brothers Holdings Inc., Chapter 11 Case No. 08–
13555(JMP) (Jointly Administered), United States Bankruptcy Court, Southern District of New
4. Goldman Sachs’ Conflicts: Guilty or Not? (Chapter 8, pages 640-647)
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What this case has to offer
This case exposes Goldman Sachs’ roles in regard to the ABACUS deal, where credit unworthy subprime
mortgages were securitized and sold to poorly informed investors, insured by AIG, and bet against by
Goldman Sachs’ traders. The investment banking firm appears to be involved in a conflict of interests by
Teaching suggestions
An interesting way to introduce this case is to talk about the size and consequences of the financial crisis
of 2008. Next, I ask students what the potential causes of the financial crisis were and whether or not it
was an avoidable problem. Ultimately, this case highlights how a combination of inefficient oversight,
Discussion of ethical issues
1. Based on the conflicts of interest raised in the case, has Goldman Sachs, in effect, shorted itself?
Explain why and why not.
Arguably, Goldman Sachs has no direct responsibility to protect its clients wishing to enter into a
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In its market-maker role, or selling securities as underwriter, the firm is only responsible for
disclosing potential risks related to the transaction. The CEO of Goldman Sachs defended the
three roles of the company as underwriter, market maker, and trader separately:
• First, as explained in Chapter 8, buyers may rely on the underwriter, Goldman Sachs,
and the rating agencies to do their due diligence and examine the structuring of each
securitized mortgage portfolio. Some investors might examine the securitization
• Second, Goldman Sachs acted not only as an underwriter, but also as a market maker,
serving as a counterparty selling CDOs to AIG, the largest mortgage insurer in the world.
In its market maker role, Goldman Sachs was dealing with a highly specialized and
knowledgeable financial institution that should have been aware of all the significant
risks.
Separately, the arguments seem to make sense, and Goldman’s operations were within the
applicable U.S. laws; however, the problem is that by combining the three roles, Goldman
appears hypocritical and in possession of inside information about the true risks and rewards of
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2. How should Goldman Sachs have handled each conflict of interest?
Chapter 2 (also Chapters 5 and 6) provides some guidance about the mechanisms to avoid a
conflict of interest. To remedy the concerns over a conflict of interest, three general approaches
should be considered: (1) avoidance, (2) disclosure to those stakeholders relying on the decision,
and (3) management of the conflict of interest so that the benefits of the judgment made
outweigh the costs.
• Goldman could have avoided this conflict, although it seems unlikely. Avoidance is the
preferred approach if the appearance of having a conflict of interests can be avoided as
well as the reality. The appearance of having a conflict can often be as harmful to the
• Goldman could have managed its conflict of interest in a better way, making sure that
controls and high ethical standards prevented the firm from “selling crap” to its clients
The first step in the process of managing to defend against these influences is to ensure that all
employees are aware of their existence and consequences. This can be done through codes of
conduct training. The second step is to create an understanding of the reasons: why the
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3. If Goldman Sachs really is innocent of all conflicts, why has the firm’s reputation suffered?
The firm’s reputation likely suffered from the perceived presence of conflict of interests.
Ultimately, investment banking is a business based not only on financial expertise, but also on
4. Referring to the outrage over the apparent abuse of AIG, Farzad and Dwyer ask the question:
If the firm could just write a multibillion-dollar check to erase the outrage – deserved or not – over
the AIG payout and be done with the public agony, wouldn’t it just do it? What would your answer
be? Provide your reasoning for and against.
During the Congressional Hearing investigating the involvement of Goldman Sachs in the crisis,
Senator Tom Coburn asks whether or not the firm warned regulators about potential problems,
and Goldman’s CEO Lloyd Blankfein answers that he only had “very general and high level”
conversations with senior people at the Department of Treasury, without touching on specific
points about the crisis ahead.
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5. Is it appropriate for Goldman Sachs to “bet against their clients” through their investment activities?
It is certainly legal, but it appears as unethical. Goldman Sachs appears to have known that the
MBS market was going to collapse. The firm switched from a long position in the ABX index (an
6. One of Goldman’s main arguments in their defense is that their intentions were good – they did
what they did in response to client requests, thus facilitating markets and making the world a better
place.
a. Is the ‘good intention’ argument sufficient to claim actions following from it are ethical? Why
and why not? Remember the saying: ‘The road to hell is paved with good intentions.’
b. Is there something in addition to good intentions that Goldman Sachs would have been wise to
consider in its decision making?
Arguably, Goldman Sachs executives did not foresee the extremely negative consequences of
7. How would you have advised Goldman Sachs’ executives to have handled this crisis better?
Goldman could have taken the following steps to handle the crisis better:
• The firm could have accepted some guilt and offer an apology, at least for the apparent
conflict of interest;
Business & Professional Ethics for Directors, Executives & Accountants, 8e
8. What would an appropriate level of bonus payments be for Goldman Sachs as a whole?
It is difficult to set an appropriate level of compensation for Goldman Sachs’ executives.
Compensation packages have to be adequate to attract and retain talent, while motivating
adequate risk-taking behavior. Often, the level of compensation is determined by the Board of
Directors with the aid of one or several compensation consultants.
9. Would bonuses paid in Goldman Sachs stock be more appropriate than those paid in cash?
The typical compensation package for executives includes a cash salary, cash bonuses, stock and
stock option bonuses, pension, and other benefits. The composition of the compensation
package should motivate a good mix of short and long term effort towards creating value for the
company’s shareholders.
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Useful Articles, Links, and Videos
Martin, Roger (Spring 2009). “Undermining Staying Power: The Role of Unhelpful Management