Audit expert Francine McKenna offers her opinion on this week's Lehman Brothers revelations and their impact on the audit profession.
It’s not every day that the Big Four accounting firms – Deloitte, KPMG, PricewaterhouseCoopers, and Ernst & Young - provide so much gossip about spectacular criminal and civil law violations. The publication of the Lehman bankruptcy examiner’s report last Thursday unleashed a firestorm of analysis and speculation not only of the deeper causes of the global financial crisis but the future of the auditors. The report makes damning accusations against Ernst & Young, auditors of Lehman Brothers:
"The examiner concluded that sufficient evidence exists to support colorable claims against Ernst & Young LLP for professional malpractice arising from Ernst & Young’s failure to follow professional standards of care with respect to communications with Lehman’s Audit Committee, investigation of a whistleblower claim, and audits and reviews of Lehman’s public filings. (Bankruptcy Examiner’s Report V3, Pg 1027)".
The financial crisis is now about accounting fraud and auditor malpractice.
The report reveals, amongst other sins, balance sheet manipulation by Lehman’s top executives. Their approach is as surprising as it is simplistic. The transactions at the center of the controversy, Repo 105s, have been widely characterized as a sort of Enron-esque off-balance sheet machination. They moved assets off the balance sheet in a technical sleight of hand by representing the contracts as sales. The treatment was an obscure exception to SFAS 140. This technique was used to “window-dress” the bank’s leverage ratios before the quarter end in order to placate ratings agencies and other critics.
In reality, Repo 105s are not off-balance sheet entities but good old-fashioned “round-trip” transaction shenanigans. This was garden variety accounting manipulation by the highest levels of the corporation, accomplished with the acquiescence of the impotent auditors.
Reuters is now reporting that the UK Financial Reporting Council has asked Ernst & Young for data about its accounting and auditing of the Repo 105 transactions. Lehman could not obtain legal approval for the transactions in the US, so it went to Linklaters, a UK firm who advised that the transactions should be completed by the Lehman UK subsidiary in order to comply with their letter of approval.
Francine McKenna has more than 25 years of experience in a range of industries in the consulting and professional services environment. She is managing editor of the specialised news site, re: The Auditors, which focuses on the business of the Big 4 audit firms and provides essential updates on accounting regulation, auditing, and strategy combined with high-quality, independent, original reporting on the accounting industry.