Ernst & Young Said to Face Fraud Lawsuit Over Lehman Audits
By Karen Freifeld and Linda Sandler - Dec 20, 2010 9:26 AM CT
Ernst & Young LLP may be sued for fraud by New York Attorney General Andrew Cuomo for allegedly helping Lehman Brothers Holdings Inc. mislead investors, according to a person familiar with the matter.
Cuomo, who was elected governor last month, may file the lawsuit this week, said the person, who wasn’t authorized to speak publicly about the case. The suit would relate to Ernst & Young’s audits of Lehman transactions aimed at downplaying its liabilities, the person said, adding that a settlement is still possible.
Richard Bamberger, a spokesman for Cuomo’s office, declined to comment. Charles Perkins, a spokesman for Ernst & Young, declined to comment. The Wall Street Journal reported on the potential lawsuit earlier today.
Lehman, once the fourth-largest investment bank, failed in September 2008 because of risky real estate bets and too much debt, which it tried to hide from investors, according to bankruptcy examiner Anton Valukas’s report. Valukas, in the report, said Ernst & Young could be accused of “professional malpractice” for its role as auditor.
Repo 105 transactions are a form of short-term financing that Valukas said Lehman used to move as much as $50 billion off its balance sheet temporarily to show investors it wasn’t carrying too much debt.
The Repo 105 transactions were sale and repurchase agreements, so that Lehman was obligated to buy them back, swelling its leverage again.
Material Impact
“The balance sheet manipulation was intentional, for deceptive appearances, had a material impact on Lehman’s net leverage ratio” and caused financial reports to be misleading, Valukas wrote of the defunct New York-based company. Higher leverage undermines a firm’s capacity to absorb financial shock.
Responding to the Valukas report in March, Ernst & Young said leverage ratios reported in Lehman’s management discussion and analysis “were the responsibility of management, not the auditor. They are not part of the audited financial statements.”
The accounting firm has been named in at least one class action lawsuit accusing former Lehman Chairman Richard Fuld and other executives of misleading investors by using devices such as Repo 105. One suit, based on Valukas’s 2,200-page report, was filed April 23 on behalf of retirement funds including the Alameda County Employees’ Retirement Association in Oakland, California, and the Government of Guam Retirement Fund.
Omissions
The Lehman executives asked a judge in June to dismiss the suit, denying in court papers that the investors had lost money on Lehman securities because of misstatements and omissions in offering documents.
Lehman’s accounting for Repo 105 transactions conformed to generally accepted accounting principles and was approved by Ernst & Young, they said in a filing in federal court in Manhattan.
Ernst and Young also asked the judge in June to dismiss the class action suit. “We are confident in our ability to successfully defend ourselves against claims arising from our work with Lehman,” spokesman Perkins said in an e-mail at the time. “We firmly believe our work met all applicable professional standards.”
The investment bank, which had been using the repos since 2001, ramped them up in mid-2007, breaching internal limits, the Valukas report shows. Lehman’s former president, Herbert “Bart” McDade, commented on them in an April 2008 e-mail exchange, after he was asked whether he knew about their effect on the balance sheet, Valukas said. “I am very aware,” McDade wrote back. “It is another drug we r on.”
Repo 105 Transactions
The U.K. accounting regulator, the Financial Reporting Council, said earlier this year it was investigating Ernst & Young’s auditing of so-called Repo 105 transactions. The deals helped Lehman downplay its leverage in late 2007 and 2008 by temporarily moving assets off the firm’s balance sheet, Valukas said.
The bankruptcy case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The class action lawsuit is In re Lehman Brothers Equity/Debt Securities Litigation, 08-cv-05523, U.S. District Court, Southern District of New York (Manhattan).
To contact the reporters on this story: Karen Freifeld in New York at kfreifeld@bloomberg.net; Linda Sandler in New York at lsandler@bloomberg.net.
To contact the editor responsible for this story: David Rovella at drovella@bloomberg.net
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