The ultimate target of the lawsuit may be Lehman’s former bosses
Ernst & Young sued over Lehman
Dec 29th 2010 | NEW YORK | from PRINT EDITION
WAS the collapse of Lehman Brothers in 2008 aided by a fraudulent cover-up of balance-sheet shenanigans? Andrew Cuomo, New York’s outgoing attorney-general and incoming state governor, thinks so, and has filed suit against Ernst & Young, Lehman’s auditors.
Mr Cuomo alleges that E&Y committed fraud by signing off on an accounting manoeuvre used by Lehman, known as Repo 105. Under this scheme, towards the end of each quarter Lehman temporarily swapped some of its assets for cash with another bank or investor, but booked this as if it were a permanent sale of the assets. By doing this, it and the other banks that used this manoeuvre in the run-up to the credit crunch made themselves look less indebted in their quarterly results.
The lawsuit seeks penalties equal to all the fees E&Y has earned from Lehman (about $150m) plus unspecified damages which could amount to the same again or more. E&Y says: “We look forward to presenting the facts in a court of law.” However, both sides have an incentive to settle. Jury trials over accounting matters are unpredictable, given their technical nature and jurors’ limited expertise.
The auditing firm says that it obeyed the principles laid down by America’s Financial Accounting Standards Board. In particular, E&Y will argue that one of the board’s rules, FAS 140, allowed it to certify Repo 105 the way it did. However, a report into Lehman’s bankruptcy last March, by a court-appointed examiner, said that while E&Y had become “comfortable” with Lehman’s use of Repo 105, it did not examine the extent to which the investment bank used the manoeuvre or the extent to which this flattered its reported figures. E&Y, fearing a fat-cat-hating “runaway jury” imposing colossal penalties, would probably rather not take its chances at trial. But neither can Mr Cuomo be sure of winning.
E&Y is questioning Mr Cuomo’s use of the Martin Act to bring his case. This state law is a powerful one (and beloved of Mr Cuomo’s predecessor as attorney-general, Eliot Spitzer), since it does not require proof of any intent to defraud. But in its nearly 90 years in force the act, says E&Y, has never before been used against auditors, as opposed to the company that had taken the alleged actions.
One possible outcome is a settlement in which E&Y agrees to co-operate with the prosecutors in cases they may bring against Lehman’s former executives. If so, the fines and sanctions suffered by the auditing firm and its partners may be stiff but not ruinous.
After all, no one wants to cause the fall of another big accounting firm. In 2002 Arthur Andersen was found criminally liable for its shredding of documents and other actions linked to its audits of Enron, a collapsed energy giant. Though Andersen’s conviction was later overturned, the firm was already gone. With just four big accounting firms remaining, and none of the next tier big enough to take up the slack, the corporate world cannot easily handle another accounting-firm failure. This is another reason to suspect that the authorities’ real intent is not a credibility-busting hammer blow against E&Y, but perhaps one against Lehman executives instead.
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