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Ernst & Young sued over Lehman collapse

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22nd Dec 2010
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Ernst & Young LLP has been sued by the New York state attorney for its role in the alleged accounting fraud involving the surreptitious removal of tens of billions of dollars of fixed income securities from the Lehman Brothers balance sheet to deceive investors about the bank’s liquidity.

New York attorney general Andrew Cuomo’s lawsuit against the Big Four accountant claims that in the years leading up to Lehman’s 2008 bankruptcy Ernst & Young “substantially assisted” transactions that moved so-called toxic assets offshore to help the bank reduce the liquidity ratios used by regulators and investors.

“This practice was a house-of-cards business model designed to hide billions in liabilities in the years before Lehman collapsed,” said Cuomo. “Just as troubling, a global accounting firm, tasked with auditing Lehman’s financial statements, helped hide this crucial information from the investing public. Our lawsuit seeks to recover the fees collected by Ernst & Young while it was supposed to be using accountable, honest measures to protect the public.”

The lawsuit alleges the auditing firm substantially helped Lehman engage in a “massive accounting fraud” and mislead investors from 2001 until 2008 by consistently supporting Lehman’s “Repo 105” policy.

The Repo 105 transactions were highlighted as accounting gimmicks in March this year by US federal court investigator Anton Valukis.

The complaint claims the use of Repo 105 had no independent business purpose and were designed solely to enable Lehman to manage the company’s financial balance sheet metrics.

The lawsuit alleges Lehman started using the accounting sleight of hand to take advantage of a rule change that allowed certain repurchase agreements to be treated as sales if the bank had a “true sale” letter from a law firm saying it gave up control of the assets.

In March 2001 Lehman approached Linklaters to seek an opinion under English law. Linklaters issued a letter that set forth certain circumstances under which transactions could be categorised as “sales”, including limits on the use of Repo 105 transactions.

The law firm has since received negative press treatment for releasing an opinion under English law that characterised the arrangements as true sales rather than transfers by Lehman with a charge back in favour of the transferrer.

Lehman used the Linklaters opinion repeatedly and did not disclose the repo transactions to investors, so giving the impression that it had lowered its debt.

The lawsuit claims Repo 105 “allowed Lehman to park tens of billions of dollars of highly liquid fixed income securities with European banks for the sole purpose of reducing Lehman’s balance sheet leverage, and painting a false picture of an important financial metric for investors, stock analysts, lenders, and others involved with Lehman”.

The complaint also states the public auditor had the absolute obligation to ensure that Lehman’s financial statements complied with the generally accepted accounting principles (GAAP).

Ernst & Young issued a response that it will “vigorously defend against” the claims and that the lawsuit has no “legal or factual basis” for a claim where the accounting for the underlying transaction is in accordance with GAAP.

“Lehman’s audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry”, the auditor added.

Over the eight year period Ernst & Young made US$150m in fees and Cuomo is seeking the return of all these fees plus damages.

While the Financial Reporting Council has sent in train an investigation into the accounting of the transactions in the UK, until now no regulator or official in the US has pursued the matter against Lehman or its auditor.

Further reading
Lehman collapse: The story so far
NY Attorney General's complaint

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Replies (4)

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By carnmores
22nd Dec 2010 10:48

Hooray

if you want the huge fees you gotta factor in the risk

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By am831207
27th Dec 2010 10:36

E & Y LLP sued

the question is who regulates the regulator?

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By am831207
27th Dec 2010 10:36

E & Y LLP sued

the question is who regulates the regulator?

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By carnmores
27th Dec 2010 10:45

interesting

 but not sure i know what you are getting at

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