Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Ernst & Young hits back over Lehman report

by
12th Apr 2010
Save content
Have you found this content useful? Use the button above to save it to your profile.

Ernst & Young has defended its audit work for client Lehman Brothers in a letter sent last week by several audit partners to the firm's key clients, and vowed to fight any legal action from regulators or creditors.

The US bank examiners’ report set off a storm of media coverage, during which the auditors were implicated for seemingly condoning the use of controversial Repo 105 transactions (described as an ‘accounting gimmick’).

The bank examiner’s report concluded that “there is sufficient evidence to support a colorable claim that: (1) certain of Lehman’s officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports and (2) Ernst & Young, the firm’s outside auditor, was professionally negligent in allowing those reports to go unchallenged. The Examiner concludes . . . that a colorable claim of professional malpractice exists against Ernst & Young.”

Our US sister site AccountingWEB.com reports that in a letter to clients, Ernst & Young argued: "Lehman's bankruptcy was the result of a series of unprecedented adverse events in the financial markets. [Its] bankruptcy was caused by a collapse in its liquidity, which was, in turn, caused by declining asset values and loss of market confidence in Lehman. It was not caused by accounting issues or disclosure issues.”

Defence
The key tenets of Ernst & Young’s defence were as follows:

  • Statements were presented in accordance with US GAAP and accurately portrayed Lehman Brothers as a ‘leveraged entity operating in a risky and volatile industry’.
  • Lehman’s 2007 audited financial statements included footnote disclosure of off balance sheet commitments of almost $1 trillion.
  • Reports that Repo 105 transactions were 'sham transactions' designed to offload Legman's 'bad assets' were described as 'inaccurate'. "The Repo 105 transactions involved the sale by Lehman of high quality liquid assets (generally government-backed securities), in return for which Lehman received cash," said the letter.
  • Repo 105 transactions were accounted for as sales rather than financings because effective control of the securities was surrendered to the counterparty in the arrangement.
  • Ernst & Young objects to media reports that the decline in Lehman’s reported leverage from its first to second quarters of 2008 was a result of an increased use of Repo 105 transactions.
  • On the subject of the whistleblower letter sent in May 2008 by former Lehman vice president Matthew Lee, Ernst & Young said the letter had been sent to Lehman's management originally and when it became aware of the letter it discussed the matter with Lehman's Audit Committee on “at least three occasions during June and July 2008”.
  • While the letter briefly referenced Repo 105 transactions, Lehman’s senior executives didn’t advise E&Y of any reservations about them. E&Y argues that the bank’s bankruptcy in September 2008 prevented the auditor from completing its assessment of the allegations.

So far, neither the SEC nor the US Justice Department has taken any action against either the former Lehman executives or E&Y. After speaking at a hearing of the House Appropriations Subcommittee on Financial Services, SEC Chairman Mary Schapiro wouldn’t comment on whether the SEC is investigating Lehman or its auditor, E&Y. "Our review of activity during this period is taking us down a broad path, and we're looking broadly," she said, according to The Wall Street Journal.
 
The SEC wasn't aware of an accounting method, dubbed Repo 105, that allegedly allowed Lehman to hide some of the risks it took before collapsing in 2008, Schapiro added. The SEC announced that it has sent a letter to 20 financial institutions asking if they have used similar tactics to obscure debt levels.

Related articles: 
Auditors under fire following Lehman revelations
Nowhere to hide: Accounting firms face increased scrutiny after Lehman report
Lehman collapse: The story so far

Tags:

Replies (1)

Please login or register to join the discussion.

avatar
By vyriix
12th Apr 2010 14:22

Alvin

Prepares the popcorn and sit back to watch a classical movie. Wonders how will the public respond to this. 

Thanks (0)