Lehman BrothersAccounting giant Ernst & Young is expected to face civil fraud charges by New York prosecutors over its alleged role in the spectacular collapse of Lehman Brothers, according to a Wall Street Journal report. The lawsuit could come as early as this week and would mark the first time a Big Four accounting firm has been charged in regard to the financial crisis.

But for some it may come as no surprise that prosecutors are targeting Ernst & Young. In fact, it may have seemed inevitable.

Earlier this year, DailyFinance explained that a Lehman Brothers bankruptcy examiner report outlining Lehman's use of a financial maneuver called repurchase agreements, or "Repo 105," to artificially dress up its financial quarterly reports was a "roadmap" to such charges. The bankruptcy examiner also alleged that Ernst & Young engaged in professional malpractice and negligence by failing to discount the use of Lehman's Repo 105 and for failing to handle a whistleblower complaint about its use from a senior Lehman vice president. Ernst & Young allegedly dropped the ball and never reported the whistleblower's allegations to Lehman's audit committee.

An Illusory Financial Improvement

New York prosecutors apparently picked up where the bankruptcy examiner left off and delved deeper into the Lehman and Ernst & Young relationship. The investment bank reportedly used Repo 105 between 2001 through 2008 -- a time when Ernst & Young collected roughly $100 million in auditing fees, according to the Journal report. Lehman's bankruptcy racked up a historic $639 billion in assets.

Under Repo 105, Lehman would borrow cash for a short period, such as a week, and use the funds to temporarily pay off a portion of its liabilities. The investment bank characterized these transactions as securities sales rather than loans, according to the examiner's report, even though the transactions didn't quality for sales and Lehman's liabilities weren't truly going down.

This maneuver had the affect of artificially lowering Lehman's reported debt at the end of the quarter and making the investment bank appear to be in better financial standing without cluing investors into the reason why. Ernst & Young didn't provide investors with any guidance, either. Between 2001 to 2007, the accounting behemoth issued an all-is-well audit opinion for Lehman, one of its largest clients.

In addition to Ernst & Young and Lehman Brothers, New York Attorney General Andrew Cuomo (and governor-elect) is reportedly looking at other institutions and their debt removal prior to a quarter's close and whether the results misled investors, according to the Journal.

The Ernst & Young-Lehman entanglement could add fuel to the debate of whether an independent government agency should be created to generate Corporate America's financial reports, rather than leaving it up to company executives who, in essence, write their own report cards.

Increase your money and finance knowledge from home

Basics of Diversification

Learn one of the fundamental concepts of building a portfolio.

View Course »

Asset Allocation

Learn the most important step in structuring an investment portfolio.

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

Oh no, don't make the government responsible for checking up on these big corporations. There intentions were never to defraud the unkowing public, after all these companies would never do anything so atrocious, LOL. Does anyone other than me wonder why the world has so many questions as to why they should trust America. When you have a government who does nothing but lie to it's citizens and corporations who do the same to their stockholders it's no wonder they don't trust us. I'm an American and I don't trust anything my government tells me either. The saddest part of this is there is nothing we citizens can do about it anymore. Fixed elections paid for by big corporations who care nothing about us and politicians who go along with it, for fear the corporations will tell all about who is getting paid off by them. Beware of the wolf in sheeps clothing.

December 20 2010 at 3:56 PM Report abuse rate up rate down Reply

Think, "Bernie Madoff". This scheme, over 8 years, is a ponzi setup for companies, allegedly aided and abetted by the accounting firm.

December 20 2010 at 1:39 PM Report abuse +2 rate up rate down Reply

When I took accounting courses I thought my classmates were quite intelligent. I did not reflect upon their morals. It is a shame that a small percentage of economic psychopaths ((that they) recognize each other so readily) and then conspire to do so much damage.

December 20 2010 at 12:20 PM Report abuse +2 rate up rate down Reply

This issue does highlight the tenuous relationship between an audit firm and its largest audit client. Perhaps a mandatory change of auditors periodically (maybe every three years?). Of course, this would entail some additional cost, as the new audit firm familiarized itself with the client. In my opinion, it might be worth the extra cost and strengthen the auditor's position in areas where it disagreed with management but was reluctant to issue a negative opinion for fear of losing the client.

December 20 2010 at 11:27 AM Report abuse +1 rate up rate down Reply
1 reply to kenneth's comment

Nice idea, Kenneth, but unfortunately, difficult to execute. Having been involved in negotiating my company's audit fee contracts with outside auditors, I can tell you that your consideration is a constant in the negotiating process. Today, it's a question of whose interests are the auditors serving ---management who obtains its compensation from achieving its intended results, maybe,in part, from close workings with the auditor or the shareholders who would be better served by an arm's length relationship but potentially at management expense? Supposedly, the two interests should be allied but that is not always reality. I can tell you that management's interests( although not always evil) usually come first.

Also,a change in auditors raises a red flag and inevitably underscores the issues of what is wrong and who went wrong. So what management wants to answer that every time you make a change especially if the auditors are accommodating management's needs. On the other hand,if a process is adopted to change auditors, which I believed must be SEC mandated, for reasons noted above, it would send a notice to all that the object of the auditing process is to maintain a constant arm's length relationship between the interests of company and the auditor for the betterment of the investing community. Three years may be too short a time to become familiar with company's w/w operations and a more extended period of say 7-10 years may be needed. But today, long term contracts are the norm and once established they are reluctantly given up and guarded religiously by both. No outside auditor in charge of a significant company account would want to answer to his management why the account was lost. He knows he will be shown the door. He knows what company management wants and what he needs to do to get it for them. End of client-auditor arm's length relationships.

December 20 2010 at 1:51 PM Report abuse +1 rate up rate down Reply

What happened to professionalism and Accounting Principles that they teach in colleges! Where were the auditors and why has the FED whose has oversight not done their jobs to control the misdeeds of Wall Street!

December 20 2010 at 11:25 AM Report abuse +1 rate up rate down Reply

In the 80s I worked for a large international accounting firm. At first I was proud to be associated with such a reputable profession. Then I found out what was really going on. Bogus financial stateents, money under the table etc. The firm was sued by the feds, partners and principles paid large fines and the firm was elimiated. I got out before the stuff hit the fan, went to work for another firm and witnessed the same behavior. All a bunch of crooks.

December 20 2010 at 11:03 AM Report abuse +3 rate up rate down Reply

I can see the sentence: Naughty, naughty, don't do it again, unless you feel like it.

December 20 2010 at 10:56 AM Report abuse rate up rate down Reply

What should be outlawed MERS, dervative trading /hedge funds. if an investor doesn't have the cash to play upfront, should not be allowed in the game.
REPO 105 -- where's the general accounting standards board did they die?

December 20 2010 at 10:56 AM Report abuse +1 rate up rate down Reply

I think the whole banking industry/ratings company's and auditors should be investigated from Barney/Timmy Geithner & Finance Banking Commitee down to the temp's hired to do the predatory lending loan papers. It's time to rein in these crooks. Not only are the US taxpayers picking up the slack but it's now spread gloabally -- the UK has bailed out 3 major banks, and COUNTRIES are bankrupt. the banking sector has given the US a big black eye. Thanks to the to big to fail banksters, S.Korea has initiated a dervative fee on all foreign investments by out of country banks. Brought on by this toxic dervative crap, S. Korea is protecting itself.

December 20 2010 at 10:53 AM Report abuse +3 rate up rate down Reply

About time someone recognized that outside auditors also played a role in the shenanagans Wall Steet employed. It was impossible for the Public Accounting firms, such as ERNST & YOUNG, who review the books of account and audit the financial statements not to know what was going on and when it is uncovered that there is wrong doing they have a moral and ethical obligation to disclose it to Company management and to the shareholders. Good work by the NY legal system-- it restores some faith that someone is looking out for the shareholder and the small investor. P.S.I am an ex- auditor.

December 20 2010 at 10:47 AM Report abuse +5 rate up rate down Reply
1 reply to woiet's comment

will any partners in the former Lehman Bros. be held accountable

December 20 2010 at 1:12 PM Report abuse +1 rate up rate down Reply