A Broadening of Professional Liability?

New York Attorney General Andrew Cuomo may be filing a civil lawsuit, as early as this week, against giant accounting firm Ernst & Young for its role in the collapse of Lehman Brothers - E&Y allegedly stood by while Lehman misled investors about its financial health, which ultimately led to its collapse. 

A lawsuit would be the first major action by a prosecutor in connection with the collapse of Lehman Brothers in September 2008 - E&Y was the firm’s auditor.  It also would mark the first time a major accounting firm was targeted for its role in the financial crisis.  The suit stems from so-called "repo" transactions Lehman allegedly carried out to make its risk appear lower than it actually was. 

The action by the attorney general is certain to raise questions about whether other charges, civil or otherwise, are to come against former Lehman executives and others.

That’s largely because the attorney general’s investigation appears to be following a road map laid out in a 2,200-page report into the firm’s collapse by an examiner appointed by the bankruptcy court.  The report, made public in March after more than a year of research, was scathing in its criticism of former top executives at Lehman, especially its CFO's.  The report also was very critical of Ernest & Young in its role as auditor to the firm. 

Repo 105 Accounting Maneuver.   By this transaction, Lehman was able to remove move as much as $50 billion of assets from its balance sheet - temporarily - giving the appearance that the firm had reduced its debt levels.  E&Y first learned of Lehman’s use of Repo 105 in 2001, according to the report.  In June 2008, 2 accounting partners with Lehman SVP Matthew Lee, who had written a letter the previous month to top executives at the firm about his concerns over “accounting improprieties.”

At that meeting, Mr. Lee reportedly told the two about the practice of Repo 105, which cited notes of the interview from one of the partners.  Mr. Lee said that Lehman had moved $50 billion of inventory off its balance sheet at the end of the 2nd quarter through Repo 105 transactions and that the assets returned to the balance sheet about a week later.  The following day, E&Y reportedly spoke with Lehman’s audit committee, though it didn't disclose Mr. Lee’s claims about Repo 105.  Nor did it do so when it reviewed the second-quarter financial statements on July 8.

British accounting authorities have also been investigating Ernst & Young over its audit of Lehman.   [NYTimes, WSJournal, 12/20]