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.”