Ernst & Young Faces Fraud Charges

Mirabile Dictu! Ernst & Young Faces Fraud Charges in Lehman Collapse

via : NakedCapitalism

I had given up on the idea that anyone associated with Lehman would be charged with fraud, even though it was blindingly obvious even before the investment bank failed that it was up to no good. So tonight’s report in the Wall Street Journal, that the New York attorney general Andrew Cuomo is about to file a lawsuit against Lehman accountants Ernst and Young, is welcome news indeed.

Your humble blogger was among the Lehman critics. It was pretty easy to connect the dots simply from public information, particularly the not credible marks on highly visible positions like real estate garbage barges SunCal and Archstone. If you are cooking the books in ways third parties can readily detect, it suggests you have run out of not-so-blatantly obvious things to mismark so as to not freak out investors about your unsavory financial condition. Another big red flag was the company’s simply not credible claim in 2008 that it had deleveraged across all geographies and all books when some were far more liquid than others.

But it was nevertheless astonishing to see the media fall for the most part run with the company’s PR, and even more stunning to see how large the black hole in the balance sheet turned out to be. We’ve pointed out repeatedly that even now, the excuses made – the impact of the disorderly collapse – and the use of Repo 105 still fail to explain the magnitude of the losses. And that means that significant accounting misstatements, aka fraud, were still being swept under the rug (and we aren’t alone in that view).

The suit appears to target only the famed Repo 105, a device Lehman used to move exposures off balance sheet at quarter end and thus look sounder than it really was. But any investigation into dubious accounting ought to open other cans of worms and could well lead to further charges.

From the Wall Street Journal:

New York prosecutors are poised to file civil fraud charges against Ernst & Young for its alleged role in the collapse of Lehman Brothers, saying the Big Four accounting firm stood by while the investment bank misled investors about its financial health…

The suit stems from transactions Lehman allegedly carried out to make its risk appear lower than it actually was…

The suit, led by Mr. Cuomo, New York’s governor-elect, could come as early as this week. It is part of a broader investigation into whether some banks misled investors by removing debt from their balance sheets before they reported their financial results to mask their true levels of risk-taking, a person familiar with the case said. The state may seek to impose fines and other penalties…

The attorney general’s investigation, which began after the bankruptcy examiner’s report, found that Ernst & Young specifically approved of Lehman’s use of Repo 105 transactions and provided the investment bank with a complete audit opinion from 2001 through 2007…

The Lehman bankruptcy examiner’s report also stated that there may be evidence to support negligence and malpractice claims against Ernst & Young regarding Lehman’s audits and its lack of response to a whistle-blower at Lehman who raised red flags about the repo trades.

One can only hope turning up the heat on Ernst & Young will lead to the prosecution of Richard Fuld. The buck is supposed to stop with the CEO, particularly when they are paid as many bucks as Fuld received. Given the scale of looting that took place in the runup to and after the crisis, there is no hope of getting the banking industry back in its proper role of supporting the real economy until we see some senior bank executives in orange jumpsuits.