STATE PROSECUTORS have filed fraud charges against Ernst & Young in the US, Reuters has reported.
New York attorney general Andrew Cuomo filed the lawsuit against the firm over its audit of Lehman Brothers.
The firm had previously been criticised by court-appointed examiner Anton Valukas for their approval of Lehmans' use of repo transactions to raise capital.
Updated 22 December by Gavin Hinks
Reuters reports that a key factor in the attorney general's decision was that Ernst & Young is not being pursued by US financial watchdog, the Securities and Exchange Commission, even though the SEC is know to be investigating Lehman Brothers.
In June the disciplinary body for the UK accounting profession, the AADB, revealed it was investigating Ernst & Young over its conduct on the Lehman audits.
Cuomo's case rests on the allegation that Lehman engaged in a "massive accounting fraud" and that Ernst & Young aided the bank by approving an accounting treatment that produced a short-term reduction in the bank's debt - the so called Repo 105 transactions.
The writ issued by Cuomo's office said: "E&Y substantially assisted Lehman Brothers Holdings Inc. ...now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman's balance sheet in order to create a false impression of Lehman's liquidity, thereby defrauding the investing public."
It adds: "E&Y not only approved but consistently supported Lehman's Repo 105 policy, and advised Lehman that it could take advantage of a technical accounting rule, known as FAS 140, to treat these Repo 105
transactions, which in reality were short-term financings, as 'sales,' enabling Lehman to remove the securities from inventory on its financial statements until they were repurchased."
Comment was not immediately available from Ernst & Young but when the Valukas report was released in March this year the firm said its opinion was that Lehman accounts for the year ending November, 2007 were in line with US GAAP.
Updated 22 December 10.41 by Gavin Hinks
A detailed statement issued by Ernst & Young said: "We intend to vigorously defend against the civil claims alleged by the New York Attorney General.
"There is no factual or legal basis for a claim to be brought against an auditor where the accounting for the underlying transaction is in accordance with the Generally Accepted Accounting Principles (GAAP). Lehman's audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry.
"Lehman's bankruptcy occurred in the midst of a global financial crisis triggered by dramatic increases in mortgage defaults, associated losses in mortgage and real estate portfolios, and a severe tightening of liquidity. Lehman's bankruptcy was preceded and followed by other bankruptcies, distressed mergers, restructurings, and government bailouts of all of the other major investment banks, as well as other major financial institutions. In short, Lehman's bankruptcy was not caused by any accounting issues.
"What we have here is a significant expansion of the Martin Act. Although the Martin Act is almost 90 years old, we believe this is the first time that an Attorney General is attempting to use this law to assert claims against an accounting firm, rather than the company that took the alleged actions.
"We look forward to presenting the facts in a court of law."
E&Y must be just so unlucky. They were on watch at Anglo Irish too. It is dreadful that the public have such high expectations of auditors and now want them to be accountable. Still - it will keep lawyers in work for many years.
Posted by: EC Hunt, 22 Dec 2010 | 09:25
I've only been working with EY for a few months but it will definitely be very interesting to see how this pans out. EY certainly sound pretty confident. Let's hope it's not misplaced - ultimately the accounting treatment used is perfectly acceptable in legal terms and used by banks the world up to dress up their accounts at period ends. It looks like the US just wants someone to blame, which it looks like the SEC arent prepared to do
Posted by: Jonny, 22 Dec 2010 | 12:00
It will indeed be interesting to watch this. So far, to my own poor understanding, the defence seems to be "Well, the rules say they could do this, so we let them" which is very much a "rule-based" approach (the American tick the box approach to auditing in a nutshell). Who is to know if the old-fashioned British approach would have worked out differently? But at least there would have been a chance if "substance" of these transactions or a "fair" understanding of the accounts had been allowed to override "form".
Posted by: George, 22 Dec 2010 | 12:50
The whole business is murky - scapegoats are desperately needed. The SEC may know that most US bank auditors received assurances from the US government of a blank cheque bail-out from the public purse. UK auditors certainly did. http://www.accountancyage.com/aa/accountancy-matters-blog/1930227/banks-auditors
Posted by: slightly optimistic, 22 Dec 2010 | 13:19
What on earth are the previous commentators thinking? The fact remains that Lehmans went down whilst EY was sitting in the audit chair. A great many innocent investors lost money whilst the Directors and Managers of Lehmans were window dressing the fin stats at each quarter end and EY was (apparently) merrily signing off and collecting its fees. Question - did the various sets of fin stats show a true and fair view? Never mind the mumbo jumbo allegiance to American GAAP or anybody else's GAAP. If the fin stats were not fairly presented then EY are rightly on the hook and should be held accountable. Go to it Mr Cuomo and fear not !
Posted by: Julian Ashby, 22 Dec 2010 | 21:23
What I would like to know why did FRC not review Lehman's audit as part of its selection. This clearly shows the gutless and useless FRC not reviewing public interest entities at big four. We have not seen any result from the ongoing, pointless investigation by AIDB of Repo 105 transaction at Ey which they have been doing for the last six months. We demand to know what AIDB has been doing, what have they come up with so far. FRC as always will not come up with anything even if EY files for bankruptcy protection in the US. Shame on this UK regulator, we must be reminded that this transaction was manufactured by Linklaters (Uk law firm) and blessed by EY in the UK for inclusion in the consolidated accounts in the US.
Posted by: Naveed Butt, 22 Dec 2010 | 22:32
Lets not blame the Brits here - the ultimate decision on whether Repo 105 was acceptable sat with the lead audit team in the US who report to the shareholders. This team was well aware of the issues.
Lets not have Mr Waxman blaming the Brits as he did with BP!
Posted by: ECHunt, 24 Dec 2010 | 10:59
The audited published accounts of Lehman clearly portrayed lehman as highly volatile and risky entity. That's it. Government or bank regulators were lazy not take action against this bank full of toxic assets. Auditors job is to audit and now to evaluate business models. Whoever blames auditors clearly have an expectation gap about auditors role and duties.
Posted by: Acid, 25 Dec 2010 | 21:41
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