As the Wall St. Journal earlier predicted, today the New York
Attorney General sued accounting firm Ernst & Young LLP (“E&Y”),
charging the firm with helping Lehman Brothers Holding, Inc. (“Lehman”)
engage in an accounting fraud involving the surreptitious removal of
tens of billions of dollars of fixed income securities from Lehman’s
balance sheet in order to deceive the public about Lehman’s true
liquidity condition. (Contrary to some earlier reports, the complaint
does not name individual defendants.)
The Attorney General’s lawsuit claims that for more than seven years
leading up to Lehman’s bankruptcy filing in September 2008, Lehman had
engaged in so-called “Repo 105” transactions, explicitly approved by
E&Y. The transactions purpose was to temporarily park highly liquid,
fixed-income securities with European banks for the sole purpose of
reducing Lehman’s financial statement leverage, an important financial
metric for investors, stock analysts, lenders, and others interested in
Lehman.
Specifically, Repo 105 transactions involved transfers by Lehman of
fixed income securities to European counterparties in return for cash -
often at the end of a financial quarter - with the binding understanding
that Lehman would shortly repurchase the equivalent securities from
these counterparties only a few days later for more money. Lehman then
used the cash to pay down liabilities and improve its leverage and
balance sheet metrics, while failing to disclose to the investing public
the obligation to repurchase the securities at a higher price. Lehman
did so, with E&Y’s explicit approval, by characterizing these
financing transactions as “sales.” Indeed, the sole purpose of
characterizing these transactions as “sales” was to reduce Lehman’s
leverage on its financial statements and public filings, thereby
deceiving the investing public.
The
complaint alleges that E&Y was fully aware of
Lehman’s fraudulent Repo 105 transactions, specifically approved of
Lehman’s use of them, and gave Lehman an unqualified audit opinion every
year from 2001 to 2007, despite knowing that they concealed the Repo
105 transactions. Further, the lawsuit alleges that in 2007 and early
2008, when Lehman was facing demands to reduce its leverage, Lehman
rapidly accelerated its use of Repo 105 transactions, removing up to $50
billion from its balance sheet on a quarterly basis without disclosing
the use of the Repo 105 transactions.
The complaint also alleges that E&Y failed to object when Lehman
misled analysts on its quarterly earnings calls regarding its leverage
ratios, and that E&Y did not inform Lehman’s Audit Committee about a
highly-placed whistleblower’s concerns about Lehman’s use of Repo 105
transactions.
The Attorney General seeks the return of the entirety of fees E&Y
collected for work performed for Lehman between 2001 and 2008,
exceeding $150 million, plus investor damages and equitable relief.
By
Barbara Black
