E&Y launches defence of Lehman audit

Ernst & Young has launched a defence of its work as auditor of collapsed investment bank Lehman writing letters directly to clients, according to Reuters.

Ernsy & Young were accused of negligence in their audit of Lehman in a 2,000 page report published two weeks ago by the US bankruptcy examiner Anton Valukas.

(Click here to see our Lehman special report).

The firm's response, according to Reuters, has seen some partners write to clients informing them that the lead audit partner "promptly" called the chairman of Lehman's audit committee when he learned of a key letter from a whistleblower about accounting at the bank.

The E&Y letter, seen by Reuters, reportedly says that the lead partner insisted that the Lehman management inform the watchdog, the Securities and Exchange Commission, and the Federal Reserve Bank of the letter.

E&Y say that the letter was discussed with the Lehman audit committee at least three times.

Criticism of Lehman in the examiner's report centered on the accounting treatment of so called Repo 105 transactions.

These involve the short-term sale of assets in order to raise cash. The deals come with an agreement to buy the assets back at a later date. As a result the assets remain on the seller's balance sheet because control of the assets has not been surrendered.

In Lehman's case the bankruptcy examiner claimed the bank used a technicality to get risky assets off its balance sheet. This was achieved by offering assets worth 105% of the cash received in consideration. Because this would not cover the cost of buying the assets back, control is said to have been lost, under US rules, and the assets could be taken off the balance sheet temporarily, even though Lehman would pay to take them back later. The difference between the price received for the assets and the sum paid to take them back is called the 'haircut'.

The E&Y letter to clients said the firm believes it "will prevail" if the examiner's claims turn into court action against the firm.

Reuters reports that the letter also reveals that the time leading up to the collapse of Lehman was, for E&Y, "among the most turbulent periods in our economic history."

The letter insists the failure of Lehman came about as a result of a collapse in liquidity caused by declining asset values and a loss of market confidence. The firm reportedly insists it was not as a result of accounting or disclosure issues.

The examiner's report said that there could be "colorable claims" against the auditor.