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online.wsj.com | A federal judge released a scathing report on the collapse of Lehman Brothers Holdings Inc. that singles out senior executives, auditor Ernst & Young and other investment banks for serious lapses that led to the largest bankruptcy in U.S. history and the worst financial crisis since the Great Depression.

U.S. Bankruptcy Judge James Peck unsealed the 2,200-page report Thursday, after court-appointed examiner Anton Valukas spent more than a year and $38 million investigating the events surrounding the downfall of the 158-year-old firm.

The report, which contains fresh allegations, depicts a firm careening out of control as the markets began to crack in 2007. In particular, the report's sections on Lehman's efforts to manipulate its balance sheet provide previously unknown details on the investment bank's efforts to stave off collapse.

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Lehman's top executives, including CEO Richard Fuld, were aware of accounting chicanery and failed to disclose it, the report said. Above, Fuld testifies before the House Oversight and Government Reform Committee in October 2008.

As Lehman spiraled toward failure during the course of 2008, its financial plight was "exacerbated" by alleged misconduct of the investment bank's executives, the report said.

Still other forces helped to tip Lehman over the brink in its final days, Mr. Valukas wrote. Investment banks, including J.P. Morgan Chase & Co., made demands for collateral and modified agreements with Lehman that hurt Lehman's liquidity and pushed it into bankruptcy.

Mr. Valukus, chairman of law firm Jenner & Block, devotes more than 300 pages alone to balance sheet manipulation, accusing Lehman of using accounting methods to move assets off its books.

In the report, Mr. Valukus detailed a "materially misleading" approach Lehman took to how it funded itself. He focused on the "repo" market, in which firms sell assets in exchange for cash to fund operations, often just overnight or for a few days.

The examiner said that Lehman—anxious to maintain favorable credit ratings—engaged in an accounting device known within the firm as "Repo 105" to essentially park $50 billion of assets away from Lehman's balance sheet and reduce leverage ratios.

In an ordinary repo transaction, Lehman would raise cash by selling assets with a simultaneous obligation to buy them back within days, according to the report. The transactions would be accounted for as financings, and the assets would remain on Lehman's balance sheet.

In a Repo 105 transaction, Lehman did the same thing. But because the moved assets represented 105% or more of the cash it received in return, accounting rules allowed the transactions to be treated as "sales" rather than financings. The result: Assets shifted away from Lehman's balance sheet, reducing the leverage ratios it reported to investors.

"In this way, unbeknownst to the investing public, rating agencies, Government regulators, and Lehman's Board of Directors, Lehman reverse engineered the firm's net leverage ratio for public consumption," says the report.

Lehman's own global financial controller, Martin Kelly, told the examiner that "the only purpose or motive for the transactions was reduction in balance sheet" and "there was no substance to the transactions." Mr. Kelly warned former Lehman finance chiefs Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed "reputational risk" to Lehman if their use became publicly known.

In an interview with the examiner, senior Lehman Chief Operating Officer Bart McDade said he had detailed discussions with Mr. Fuld about the transactions and that Mr. Fuld knew about the accounting treatment.

In a Nov. 2009 interview with the examiner, Mr. Fuld said he had no recollection of Lehman's use of Repo 105 transactions but that if he had known about them he would have been concerned, according to the report.

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Erin Callan, Lehman's former financial chief, in an April, 2008, interview.

"Fuld's denial of recollection must be weighed by a trier of fact against other evidence," the report states.

Mr. Valukus' report is among the largest undertaking of its kind. Those singled out in the report won't face immediate repercussions. There have been no criminal prosecution of Lehman executives over the firm's demise. Rather, the report provides a type of roadmap for Lehman's bankruptcy estate, creditors and other authorities to pursue possible actions against former Lehman executives, the bank's auditors and others involved in the financial titans collapse.

One party singled out in the report is Lehman's audit firm, Ernst &Young, which allegedly did not raise concerns with Lehman's board about the frequent use of the repo transactions. E&Y met with Lehman's Board Audit Committee on June 13, one day after Lehman senior vice president Matthew Lee, raised questions about the frequent use of the transactions.

E&Y, the report says, did not raise the issue with the board, the report alleges.

"Ernst & Young took no steps to question or challenge the non-disclosure by Lehman of its use of $50 billion of temporary, off-balance sheet transactions," Mr. Valukas wrote.

In a statement, Mr. Fuld's lawyer, Patricia Hynes Allen & Overy, said "Mr. Fuld did not know what those transactions were—he didn't structure or negotiate them, nor was he aware of their accounting treatment," the statement said.

The statement went on to say the "Repo 105" transactions were done "in accordance with an internal accounting policy, supported by legal opinions and approved by Ernst & Young, Lehman's independent outside auditor."

An Ernst and Young statement blamed Lehman's collapse on "a series of unprecedented adverse events in the financial markets." It said Lehman's leverage ratios "were the responsibility of management, not the auditor."

Ms. Callan didn't respond to a request for comment. An attorney for Mr. Lowitt said any suggestion he breached his duties was "baseless." Mr. Kelly could not be reached Thursday evening.

As Lehman began to unravel in mid 2008, investors began to focus their attention on the billions of dollars in commercial real estate and private-equity loans on Lehman's books.

The report said that while Lehman was required report its inventory "at fair value", a price it would receive if the asset were hypothetically sold, Lehman "progressively relied on its judgment to determine the fair value of such assets."

But while the report found that some real estate was "not reasonably valued" in 2008 it "did not find sufficient evidence to support a colorable claim for breach of fiduciary duty in connection with any of Lehman's valuations."

In the days before Lehman collapsed, its lenders grew increasingly nervous that the collateral Lehman had posted against the money it borrowed was "not worth nearly what Lehman had claimed it was worth," the report says.

On Sept. 11, JP Morgan decided demanded an additional $5 billion to be delivered that day. Lehman posted the collateral the next day.

Around the same time, JP Morgan, which acted as a clearing bank for Lehman, determined that a security known as Fenway, which Lehman valued at $3 billion, had fallen in value.

The report found that "existence of a colorable claim – but not a strong claim – that J.P. Morgan breached the implied covenant of good faith and fair dealing by making excessive collateral requests to Lehman in September 2008