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CHAPTER 15 Law: Incomplete Sale ≡ Secured Borrowing

In any nation that honors the rule of law, it is the law that determines all rights and protections of debtors, creditors, and owners. By law, auditors must ignore generally accepted accounting standards when those rules result in financial statements that fail to fairly state the financial condition of an enterprise. To assure compliance, financial statements must report what an entity owns (assets) and what it owes (liabilities) in order to accurately determine its equity (net worth).

The laws of mathematics prove that the level of a financial institution’s leverage is the primary determinant of that institution’s ability to survive as market conditions change. It is axiomatic, therefore, that debt must be reported accurately.

Where in this is there room for creating an off-balance sheet liability? To state the premise is to state fraud. The very words “off-balance sheet” are themselves duplicitous.

If it’s a liability it is obviously necessary that it be reported on-balance sheet. The two concepts—off-balance sheet and liability—cannot exist together. When an asset is sold, both the upside and downside of the asset must be sold for the sale to be complete. In the 1925 opinion by Louis Brandeis, the U.S. Supreme Court ruled that any incomplete sale or pledge of any asset “imputes fraud conclusively.” Lack of completion creates ambiguity, allowing two measures of ownership—the essence of fraud.

Thus, unless dominion over ...