IF THERE’S ONE legal case accountants will be watching this year it will be the law suit against Ernst & Young for its audit of Lehman Brothers. The man in charge is the newly elected New York attorney general Eric Schneiderman.
What’s happened ?
In December we learned that the then New York attorney general Andrew Cuomo had launched a law suit against E&Y for its conduct as auditor of the collapsed giant investment bank Lehmans. The allegations were bold and came as another blow to the firm which has already faced a barrage of public comment on its role.
But Cuomo has moved on and Schneiderman, fresh from election success and enthusiastic to make his mark, is now in charge.
The attorney general is essentially the “people’s lawyer”, according to Schneiderman, who used his swearing-in to send a message that he intends to maintain the reputation for aggressive legal action that the attorney general’s office earned under Cuomo as Wall Street’s policeman.
Schneiderman is a graduate of the Harvard Law School and former New York State senator. A Democrat, he rose from legal clerk to partner at international law firm Kirkpatrick Lockhart. His most notable legal work was as counsel to a community crime prevention programme representing tenants and householders as they attempted to evict drug dealers and clear crack dens. He has also worked on gun control, is pro-choice and has campaigned for environmental legislation.
He has worked for reform of New York state government and supported legislation to raise the minimum wage.
But it is the E&Y case, connected as it is to the biggest collapse of the financial crisis, that will attract all the headlines.
The 32-page lawsuit, filed in December, claims that the firm “substantially” assisted Lehman in perpetrating a “massive accounting fraud”. It adds: “Ernst & Young assisted Lehman in defrauding the public about the company’s deteriorating financial condition, particularly its leverage.”
The claim says that E&Y not only “approved” but “consistently supported” the use of notorious Repo 105 transactions that allowed Lehman to move tens of billions of dollars in assets from its balance sheet in a bid to make its financial position appear healthier.
Former attorney general Cuomo commented: “This practice was a house-of-cards business model, designed to hide billions in liabilities in the years before Lehman collapsed.”
E&Y has denied the allegations, saying there was no factual or legal basis for a claim.
What happens next?
Schneiderman will now have to get his head around the arcane technicalities of Repo 105 transactions and the finer points of the US’ accounting rule FAS140, which Lehmans claims allowed the repo deals to take place.
That said, the critical issue for Schneiderman will be selecting the lawyers to lead the case. They will need aggression, determination, a strong public persona and an ability to untangle the accounting standards and the finances.
Schneiderman will no doubt reserve himself for the role of public face of the prosecution.
This will be no walk in Central Park. E&Y will not roll over on this lawsuit, its reputation hangs on it.
Past experience shows the firm is able, and willing, to fight its corner both in public and in the courts. E&Y’s defence of its role as auditor of Equitable Life is just one example of how the firm has seen off a legal challenge. We can expect E&Y to exhibit just as much aggression in defending itself as the attorney general’s office will in bringing the case.
But E&Y may not be the real target. Already speculation has emerged that a deal might be struck that would see the firm aid future prosecutions of Lehman directors. E&Y has some leverage.
Prosecuting a case that potentially threatened its future would not be good for the markets. Regulators are bound to make this point in a way that it can be heard by the attorney general’s office.
Schneiderman, though, will not want to be seen as capitulating. Cue some fancy political footwork and jockeying for the best position ahead of a deal. This legal action has got a very long way to run.
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