To: Professor KomissarovSubject: Current Events #2Date: March 7th, 2011Masking Debt In The Balance SheetsLarge bank firms are using clever ways to lure prospecting investors. By window dressing, temporarily lowering debt levels prior to quarter-end reports [ CITATION Rap10 \l 1033 ], the firms look better on the balance sheet than if a report was taken mid-quarter. This business maneuver is executed by stalling repurchase agreements until after the quarter-end reports are released. Once the reports are out, the firm will rapidly confirm the repurchase agreements, boosting the firm’s debt to higher levels than reflected on the balance sheets. Window dressing was sparked in light of the financial crisis that peaked out two years ago and brought skepticism to investors already weary about the high levels of debt in these firms[ CITATION Rap10 \l 1033 ]. Masking this debt by stalling repurchase agreements is not illegal, but it does blind the public from seeing potential company liabilities. This means that an investorusing quarter-end reports to analyze the core activities and overall health of a firm may be relying on financial statements that have fallen below reliability. To solve this problem, the SEC should tighten regulations on how much debt a firm can accrue before it is reported. To closer analyze the causes and effects of window dressing, let’s take a look at three factors provoking stronger regulations on debt masking, and how tightening these regulations would uphold the integrity of financial reporting. Peaks and ValleysSo how severe are large banks distorting the amount of liabilities they report? Associated with the article is a chart titled “Masking Risk” that displays billions of dollars of debt taken out by the group of large banks. On average, the firms lowered their debt by 42% from the peaks in the middle of the quarter, to the valleys right before end of quarter statements are released (Federal Reserve Bank of New York; WSJ Research). This means that billions of dollars of debt, according to the chart approximately 200 billion at times, was shed in order to falsely increase the health of the company. Investors who buy shares in the firm have the risk of losing their investments, very similar to the Lehman Brothers Holdings Inc. case.Future Indicator: Lehman Brothers Holdings Inc.The Lehman Brothers Holdings Inc. was a company that used an accounting technique dubbed “Repo 105” to take 50 billion dollars in assets off of its balance sheet[ CITATION Rap10\l 1033 ]. How did this affect investors? The balance sheet indicated that the core activities of thecompany had much more stability than was actually present, but the “Repo 105” accounting strategy that was used eventually caught up with the firm and Lehman Brothers went bankrupt. Investors that were masked from the risk of the company lost their assets and were left with nothing. If the SEC does not regulate window dressing to a reasonable level, the Lehman Brothers scenario may be an indicator of what is to come. SEC Investigations1The Securities and Exchange Commission has been proactive in analyzing how window dressing is affecting the integrity of the financial sector; however it is hard to revise a strategy that is legal under current business law. According to the article, the SEC staff believes that the balance sheet fluctuations happening with the large banks are natural course of business events, but how that information is presented to investors is also important [ CITATION Rap10 \l 1033 ].Additionally, the SEC also viewed the banking firms under the light shed from the Lehman Brothers case in bankruptcy court to investigate the firms’ accounting practices, and the results unveiled errors that summed billions of dollars of misreported debt [ CITATION Rap10 \l 1033 ].So what can the SEC do to tighten regulations on a practice that has been proven to harm the integrity of financial reporting?SolutionIn order to defragment the balance sheets of the banking firms, the SEC needs to set a threshold regulation on the amount of debt reported by the firms. A threshold regulation would require that any fluctuation in debt above a set level would render informing the public. By making massive debt acquisitions public knowledge, investors would know the health of the coreoperations in a firm, be able to lower the chances of a spontaneous company collapse, give companies incentives not to boost their debts in between quarters, and uphold the trusted integrity of financial reporting to the public.