Lehman investigation blocked by US-EU regulator stand-off

The US investigation into Lehman Brothers’ UK audit risks being hobbled by an ongoing transatlantic row over information sharing.

The US audit regulator, the Public Company Accounting Oversight Board (PCAOB) is locked in a dispute with its European counterparts over audit-related information sharing, which threatens to curb a US investigation into the audit of Lehmans’ UK subsidiary.

Under European law, information, often in the form of highly confidential working papers, can only be shared with foreign regulators if “there are working arrangements on the basis of reciprocity agreed between the competent authorities”.

The EU argues that reciprocity does not exist because Washington currently blocks access to the confidential working papers relating to US auditors. As a result the EU does not permit access by US watchdogs to European auditors.

In the US, the PCAOB said it assists non-US regulators investigating US audit firms, but will not allow access to its own inspection documents. EU regulators however say they need these internal documents to conduct thourugh investigation.

Lehman Brothers International Europe (LBIE) – the collapsed US bank’s European subsidiary, based in London – played a key role in approving so called repo 105 transactions at the heart of financial misconduct allegations. Lehmans’ US parent transferred funds to LBIE to conduct the repo transaction.

The PCAOB is legally bound to keep its investigations secret. When asked whether inquiries of the Lehman audit were being frustrated a spokeswoman said: “For the years 2009 and 2010, the PCAOB has been denied access to information necessary to conduct inspections of firms in the UK and other European Union countries… In previous years, the PCAOB was able to conduct joint inspections in some EU Member States, but in February 2009, the EU barred further joint inspections pending resolution of the information-sharing issue.”

The UK’s audit watchdog, the Financial Reporting Council (FRC), is also inspect­ing E&Y’s treatment of repo transactions in the Lehman audit, according to a statement released in March. However, both the FRC and the PCAOB are not able to share information, owing to the international stand-off between the two.

The PCAOB must, by law, inspect auditors either every three years, or annually, depending on how many US companies they audit. However, more than 40 nations have blocked inspections, claiming they compromise national sovereignty or violate local laws.

Joseph Carcello, a member of the PCAOB’s Investor Advisory Group, said the Lehman’s case might be one inspection that is held up. “Some of the more problematic accounting issues did happen in Lehmans’ UK-based subsidiary,” he said.

“The PCAOB is taking a route called quiet diplomacy – trying to convince the regulators to cooperate. The sense that I get, over the last couple of years, is that positions have hardened, so absent of any change they don’t seem to be moving closer to negotiate.”

Paul George, head of the FRC’s Professional Oversight Board, said it would be “inappropriate” to comment on the Lehman inspection. Asked about the stalemate, he said there should be information sharing “in both directions”.

“We believe the PCAOB should be able to rely upon the work that we do in inspecting UK auditing firms registered with them – that there is appropriate sharing of information between us,” he said.
The PCAOB has reserved its right to revoke an audit firm’s US registration if it can not inspect the firm, but is reluctant believing this would unfairly punish firms and potentially escalate the issue to a diplomatic level.

Instead, it is trying to pass reforms, under the vast US financial reform bill, which would free up confidential information for foreign regulators like the FRC.

However, Carcello believes the “audit work done in those [foreign] subsidiaries is not being inspected”.

Lehmans timeline

September 2007 Lehmans takes $700m (£350m) hit from exposure to sub-prime securitised debt; Eric Callan appointed CFO.

June 2008
Callan leaves after disastrous quarterly results; named alongside another ex-CFO, Chris O’Meara, in a lawsuit alleging failure to disclose the firm’s exposure to sub-prime meltdown.

September 2008 Lehmans files for bankruptcy protection in the US; European administrator. Tony Lomas from PwC said insolvency could be “larger and more complex than Enron”.

November 2008 US investment pool sues E&Y and former Lehmans executives for $150m for alleged fraud and misleading accounting practices.

April 2009 PwC earns £77m from Lehman on its work as administrators.

12 March 2010 Bankruptcy Court-appointed examiner Anton Valukas criticises E&Y over its audit work, and Lehmans over its accounting for repo transactions; E&Y said it did not help or set up repos.

30 March SEC investigates accounting for repos.

6 April Lehman collapse contributed to funding issues.

8 April PCAOB warns auditors against clients’ “significant unusual transaction”.

15 April UK auditors call for bigger role in company audits.

28 April EU finance chief Michel Barnier calls for debate on a Europe-wide audit regulator.

7 May ASB raises concerns over IASB rules that could encourage “financial structuring” opportunities.