Watchdog opens investigation of E&Y over Lehman

Ernst & Young faces fresh scrutiny into its audit of Lehman Brothers after the UK’s accounting watchdog announced it would investigate the alleged use of accounting gimmicks by the collapsed US bank.

The Accountancy & Actuarial Discipline Board (AADB) said it would probe the final years before the bank’s demise, focusing on the use of particular repurchase transactions, known within Lehman's as Repo 105s, allegedly used to displace assets during sensitive reporting periods.

In a statement, the AADB said it would investigate the conduct of E&Y members in the audit of Lehman Brothers UK arm, Lehman Brothers International (Europe). It will also investigate the treatment of Repo 105 transactions used to shift $120bn (£79.6bn) off the bank’s balance sheet in the years leading to its collapsed.

The move follows a March announcement by the Financial Reporting Council (FRC), which oversees the AADB, to “ascertain the facts” on how repo-transaction were audited.

The publication of US court appointed examiner Anton Valukas report in March first brought to light Lehman’s use of Repo 105 transactions, and suggested there may be colourable claims brought against E&Y. The firm has since been named as a defendant in a US amended class action.

E&Y has defended its audit throughout and said it stands by the work it did for the bank. In a statement, the firm said it would cooperate fully with the AADB investigation.

Following the release of the Valukas report the US Securities and Exchange Commission (SEC) wrote to two dozen US financial institutions seeking an explanation of their use of similar repurchase transactions.

The US audit watchdog, the Public Company Accounting Oversight Board is also widely believed to be investigating the audit, despite being legally bound from commenting on active investigations.

A PCAOB investigation into Lehman's UK activities risks being blocked by the EU, which is trying to pressure the US into sharing confidential documents amassed during its inspections of audit firms.

Further reading:

Lehman investigation blocked by US-EU regulator stand-off

Transatlantic audit row between regulators rages

Barnier: we’re not blocking US watchdog