Treasury Today Country Profiles in association with Citi

Ernst & Young facing law suit over Lehman “house of cards”

The accounting giant is accused of explicitly endorsing “a business model designed to hide billions in liabilities in the years before Lehman collapsed” and helping to “hide this crucial information from the investing public,” according to New York state attorney general Andrew Cuomo. Ernst & Young say “there is no factual or legal basis” for the claim.

Mr Cuomo seeks to recover the fees Ernst & Young collected from its work with Lehman Brothers, amounting to an estimated $150m from 2001 to 2008, as well as investor damages. The case is being brought under the Martin Act – a New York law against financial fraud – which Ernst & Young believes has always been used against companies suspected of fraud and not their auditors, calling the move “a significant expansion of the Martin Act.”

The key to the allegations are ‘Repo 105’ transactions. Repurchase agreements involving fixed-income securities were arranged with European counterparties. The cash generated initially – before the re-purchase of the securities – was used to reduce leverage on financial statements, it is claimed. In these statements, the transactions appeared to be sales, and Lehman looked more attractive to investors than was actually the case, continues the accusation.

It is now alleged that Ernst & Young “was fully aware of Lehman’s fraudulent Repo 105 transactions, specifically approved of Lehman’s use of them, and gave Lehman an unqualified audit opinion every year from 2001 to 2007, despite knowing that they concealed the Repo 105 transactions.” It is claimed that “up to $50 billion was removed from the bank’s balance sheet on a quarterly basis” without disclosing the repurchase agreements.

Ernst & Young disputes the claims, telling Treasury Today: “There is no factual or legal basis for a claim to be brought against an auditor where the accounting for the underlying transaction is in accordance with the Generally Accepted Accounting Principles (GAAP). Lehman’s audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry.

“Lehman’s bankruptcy occurred in the midst of a global financial crisis triggered by dramatic increases in mortgage defaults, associated losses in mortgage and real estate portfolios, and a severe tightening of liquidity. Lehman’s bankruptcy was preceded and followed by other bankruptcies, distressed mergers, restructurings, and government bailouts of all of the other major investment banks, as well as other major financial institutions. In short, Lehman’s bankruptcy was not caused by any accounting issues.

“We look forward to presenting the facts in a court of law.”