Lehman Brothers, State Attorney, Ernst & Young to Meet in Court Room

Lucas Gilmore, “Big 4″ observer
December 20, 2010 /

This week might set the one more example of a lawsuit filed against a key player in the accounting industry as State Attorney General Andrew Cuomo found negligence on the part of Ernst & Young over the alleged fraud committed by Lehman Brothers to its investors, Wall Street Journal reported December 19, 2010.

The lawsuit allegedly charges Ernst & Young of standing by while Lehman Brothers misrepresented its financial status prior to the 2008 global economic crisis, making it appear healthier when it actually was on the verge of falling.

Mr. Cuomo’s office was one of initiating parties in successful Bank of America Corp. case, ended with $137 million charges from SEC.

The Big Four have already answered in November this year accusation from the House of Lords Economics Affairs Committee that they lacked pre-emptive warnings regarding the financial status of their clients, including Lehman Brothers. The accounting firms argued that it was beyond their business to do assessment over the financial statements of failing companies.

Various sources assess total audit fee received by Ernst & Young from Lehman between $100 and $160 million starting 2001 to 2008. In 2007, its global revenue hit US$21.1 billion compared with the $31million audit fee that the firm received from Lehman Brothers in the same fiscal year, which would not probably suffice for Ernst & Young to risk its global turnover.

The case in point is the repurchase agreement, called in Lehman Brothers financials as “Repo 105,” in which an entity transfers high liquid securities to another party and receives cash in exchange and makes agreement with the counterparty that the same asset will be returned or a fixed price will be paid in the future. Investigators of the collapsed bank found some $50 billion taken by Lehman Brothers off its balance sheet and being claimed as securities when the amount was actually sum of loans, which in effect made the investors to believe the bank was still safe at the time.

The Financial Accounting Standards Board revealed in November this year its plan of changing the accounting standard rules regarding repurchase agreement after the public criticized the repo rules for the role it played during the Lehman Brothers collapse.

According to Cuomo’s claims, Ernst & Young had first hand knowledge of Lehman Brothers’s repo transactions and approved it, giving the bank its opinion for the 2001-2007 audit period.

Ernst & Young, however, said that media hype over the repo transactions was wrong, Repo 105 transactions of Lehman Brothers are not suspicious, properly represented in the bank’s financial statements.

The financial standard SFAS 140 gives two cases in which repurchase agreement can be considered as a sale. It states that “(1) an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity (paragraphs 47−49) or
(2) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call (paragraphs 50−54).”

Ernst & Young has also claimed that the Repo 105 did not violate these requirements because securities were highly liquid and could be sold. However, in its 2007 audited financial statement, Lehman Brothers included footnote disclosure of off balance sheet commitments of almost $1 trillion, which could have alarmed the investors of the status of financial health of the bank.

Since Lehman announced bankruptcy, PwC is administering recovery of debts. In 2008 partners of the PricewaterhouseCoopers UK were appointed to administer four Lehman Brothers entities – LB UK RE Holdings Ltd, Lehman Brothers International (Europe), Lehman Brothers Limited and Lehman Brothers Holdings plc.

In its bankruptcy filing, Lehman Brothers claimed that as of its May 31, 2008 financial statement, total asset of the firm was $639 billion while total debt was $613 and accounts payable being about $71 billion. The bank’s short term debt was $163 billion, other current liabilities were about $29 billion, and its long term debt was about $350 billion.

PwC succeeded to cover ~£12 billion of these liabilities within last two years and were much more successful in getting the fee – £262 million for these 2 years.


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