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Ernst & Young Sued for Civil Fraud in Lehman Brothers Collapse

Source: WSJ

Posted on 21 Dec 2010

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Accusing one of the nation's largest accounting firms of helping Lehman Brothers Holdings Inc. hide its financial weakness from investors for about seven years before the bank finally collapsed in September of 2008, New York Attorney General Andrew Cuomo filed a lawsuit against Ernst & Young for civil fraud.

Ernst & Young knew about, supported and advised Lehman on its "Repo 105" transactions, a type of debt the bank took on, but labeled as sales, which made the firm appear to investors less risky than it really was, according to the complaint. The audit firm also stood by while Lehman misled analysts and investors on conference calls and in financial filings about its levels of risk, particularly after the firm's stability began to crack after the credit crisis began in 2007, said the complaint.

Ernst & Young substantially assisted Lehman Brothers Holdings Inc., now bankrupt, to engage in a massive accounting fraud," Mr. Cuomo wrote in his complaint.

Ernst & Young declined to comment.

The accounting firm blessed Lehman's Repo 105 transactions from the time Lehman became one of the firm's most prominent clients in 2001, Mr. Cuomo said in his complaint. The accounting firm collected over $150 million in fees from Lehman between 2001 and 2008, he said in the complaint.

In Lehman's Repo 105 transactions, the company shifted as much as $50 billion of assets off of its balance sheet to foreign banks at critical financial reporting periods with a promise to buy back the securities at a premium price days later, Mr. Cuomo said in the complaint. With the cash held in the meantime, Lehman would pay down other debts, appearing to have less leverage and be in better financial condition.

Ernst & Young also approved of the plan to use Repo 105 early on, said the complaint. Lehman hatched the idea for Repo 105 in 2001 in order to "reduce the balance sheet," according to a memo from Lehman to E&Y that is quoted in Mr. Cuomo's complaint. An Ernst & Young partner, Kevin Reilly, testified to

Mr. Cuomo that he believed the policy was "acceptable."

The suit alleges that Ernst & Young was aware that Lehman Brothers Repo 105 transactions overstepped accounting rules, and that the firm ignored warnings from both Lehman Brothers employees and from Ernst & Young staff about the propriety of the transactions.