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SEC enforcement lawyers, who have struggled for more than two years to find definitive evidence that the company and its leaders violated securities laws, are concerned that a legal attack on Lehman's accounting practices would likely fail, the people said, speaking anonymously.
Instead, the enforcement staff may recommend that the agency take the rare step of publishing a so-called report of investigation, also known as a 21(a) report.
The commission would have to vote on whether to issue a report and it's still possible the SEC may decide to bring legal claims in court, the people say. The 21(a) reports, which lay out allegations of misconduct without imposing penalties, have been issued only six times in the past decade, according to the SEC's website.
"The SEC can claim that this is decisive action and that they're on record as to the wrongdoing. It doesn't meet the inevitable resistance that civil action meets - the possibility of failure," said Robert Hillman, a professor at the University of California, Davis, School of Law.
Lehman spokeswoman Kimberly Macleod declined to comment. Lawyer Patricia Hynes, acting for Lehman ex-chief executive officer Richard Fuld, and lawyer Robert Cleary, for former finance chief Erin Callan, didn't respond to emails. Florence Harmon of SEC declined to comment.
Lehman, which filed the biggest bankruptcy in US history in September 2008, was faulted with its former executives in a report by court-appointed examiner Anton Valukas, who said they misled investors with "accounting gimmicks".
Valukas said Lehman used the technique, known as Repo 105s, to hide billions of dollars in assets and artificially reduce the firm's leverage. The ruse may not have violated accounting rules, making it hard for the SEC to pursue fraud claims.
If the SEC decided it could not bring a case, airing its findings might be the best option for fending off criticism from lawmakers and investors who say the agency hasn't been aggressive in pursuing wrongdoing that fuelled the financial crisis, Hillman said.
James Cox, a securities law professor at Duke University School of Law, said it would be "disappointing" if the SEC didn't bring fraud charges against Lehman and its executives.
The rebuke was "about the least harmful sanction anybody could get".
Congress gave the SEC discretion to publicise findings of investigations in the Securities Exchange Act of 1934. The reports were meant to be a flexible tool to shine a spotlight on questionable conduct that might not support an enforcement action, said former SEC lawyer Steve Crimmins.
"It was adopted to help get the SEC where it needed to go when the path was not all that clear," Crimmins said. "The reports tend to be used in borderline situations, where the SEC feels the need to speak out about the broader significance of something but for whatever reason feels it's just not right to bring a case."
While the agency continues to weigh the possibility of bringing civil fraud claims, it faces several hurdles, according to the people.
In April, the Financial Accounting Standards Board changed its rule for how firms have to account for the short-term transactions that let Lehman temporarily remove about $50 billion in assets from its balance sheet by treating them as sales. The board's move may bolster the defence that the rule, not Lehman's application of it, was faulty.
Since Lehman was defunct, any enforcement action would likely target individuals, such as Fuld and Callan, said Cox.
"The executives had to sign off that the financial statements fairly presented the firm's financial position," Cox said. "Even though the Repo 105s were perhaps in technical compliance with GAAP, they were distorting the true economic image of the firm."
Ernst & Young, Lehman's auditor, was sued in December by then-New York Attorney-General Andrew Cuomo, who's now governor, for signing off on Lehman's quarterly financial statements. The firm disputes the claims and hasn't been accused of wrongdoing by federal regulators.
Last month Ernst & Young said regulators had made "a series of changes to accounting and disclosure rules" since the financial crisis that, "with the benefit of hindsight, are significant improvements to the system ... prior to Lehman's demise".
The SEC could also focus on whether Lehman's executives deceived investors by falsely describing the treatments being used, two people said.
In September, the SEC proposed a rule that would require companies to provide "a comprehensive explanation of short-term borrowings". Defence lawyers could argue that the change shows that Lehman's disclosures weren't deficient under current rules.
In response to Valukas' report, Ernst & Young said Lehman's management discussion and analysis "were the responsibility of management, not the auditor".
In testimony to Congress last year, Fuld said Lehman shouldn't be criticised for complying with existing repo accounting rules. He also said he had "absolutely no recollection whatsoever" of hearing about the Repo 105s.
Defence lawyers for Lehman would likely try to turn any allegations by the SEC back on the agency. Referring to his interviews of executives, Valukas wrote that "a recurrent theme in their response was that Lehman gave full and complete financial information to government agencies" and that regulators "never raised significant objections or directed that Lehman take any corrective action".
SEC examiners monitored Lehman's financial health as part of the Consolidated Supervised Entities programme, which had been set up in 2004 to guard against the collapse of systemically important investment banks.
The voluntary programme was halted after Lehman declared bankruptcy. "So much of what went on here was neither clearly legal nor clearly illegal," Hillman said. "It fell through the cracks in this case, and that makes civil actions very, very difficult.
"The 21(a) report would be an opportunity for the SEC and everyone else to move on."
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