Beware of 20/20 Hindsight

Following the rules without considering the ultimate objective is not enough.  The Valukas report to the bankruptcy court on Lehman Brothers  points out that the accounting rule Lehman used, “Repo 105”, to remove assets from its balance was legal and not questioned by its accountants.  Yet it was a gimmick that disguised the true magnitude of its liabilities,  It gave investors a skewed look at Lehman,  and now it may result in liability for some of its executives and its outside accounting firm.

In all of this mess, where was the board?  Was the audit committee unaware of these activities?  Did the board understand the true nature of the threat to the company?  Did the board communicate sufficiently with management?

At the moment, we can only speculate about the answers to these questions.  However, for boards that may wonder whether their company is next, considering how to nip the problem in the bud is important.  In some ways, that brings us to the board’s annual assessment of effectiveness and the annual retreat that should follow it.  When structured skillfully, these assessments help directors surface issues and determine what, if anything, they collectively may not know.  Boards that treat the annual assessment as a check-the-box exercise risk a situation similar to the late Lehman’s.  In so doing, they fail to surface issues to which they need to pay attention and which unattended may come back to haunt them.

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