Lehman shifted risk to shadow firm - report

NEW YORK (CNNMoney.com) -- Lehman Brothers operated a side business that allowed the defunct brokerage to transfer risky investments off its books in the years leading up to its collapse, according to a report published Tuesday.

The firm, called Hudson Castle, appeared to be an independent company, but played an important "behind-the-scenes role" at Lehman, the New York Times reported, citing an internal document and interviews with former Lehman employees.

The report said Hudson was one-quarter owned by Lehman, which controlled its board of directors and staffed it with former employees. However, none of this was disclosed, according to the Times.

Hudson is part of a "vast financial system" that operates largely beyond the reach of banking regulators, the newspaper said. But banks can use such entities to raise cash by trading investments and, at times, make their finances look artificially strong.

The report said Lehman conducted several transactions greater than $1 billion with Hudson vehicles, but added that it is unclear how much money was involved since 2001.

Critics charge that this type of creative financing allowed Lehman and other major banks to temporarily transfer risky investments in subprime mortgages and commercial real estate, the report said.

While most of the deals done through operations such as Hudson are legal, the report points out that bank examiners have recently raised questions about other dubious accounting practices at Lehman.

Lehman, with billions of dollars in bad bets tied to the housing market, became the largest bankruptcy in U.S. history when it collapsed in 2008. The demise of the firm helped trigger a financial crisis that resulted in a deep recession.