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Ernst & Young Defends Lehman Audits

March 25, 2010

Ernst & Young has sent a letter to its clients defending its audits of Lehman Brothers in the wake of a bristling report by a bankruptcy examiner probing the causes behind Lehman’s collapse.

The report, by Jenner & Block chairman Anton Valukas, highlighted Lehman’s use of what it called “Repo 105” transactions to shift $50 billion worth of assets off its balance sheet at the end of the first and second quarters of 2008 to make it seem to investors that the bank had less debt than it actually had (see Lehman’s Accounting Sleight of Hand Was Less Than Magical).

Valukas noted in his report that Lehman’s outside auditing firm, Ernst & Young, was aware of the problematic transactions, but did not question the investment bank’s use and nondisclosure of the transactions to investors. He also noted that there were “colorable causes of action” that could allow investors to file suit over the accounting irregularities and other factors that led to Lehman’s collapse.

E&Y, in an effort to quell worries about possible lawsuits, dispatched a letter that has appeared on both the re:The Auditors blog as well as Reuters.

E&Y noted that its last audit of Lehman was for the year ended Nov. 30, 2007. “Our opinion stated that Lehman's financial statements for 2007 were fairly presented in accordance with U.S. GAAP, and we remain of that view,” said the firm. “We reviewed but did not audit the interim periods for Lehman's first and second quarters of fiscal 2008.”

The firm also tried to put the investment bank’s troubles in context. “Lehman's bankruptcy was the result of a series of unprecedented adverse events in the financial markets,” said the firm. “The months leading up to Lehman's bankruptcy were among the most turbulent periods in our economic history. Lehman’s bankruptcy was caused by a collapse in its liquidity, which was in turn caused by declining asset values and loss of market confidence in Lehman. It was not caused by accounting issues or disclosure issues.”

In addition, E&Y took aim at unspecified media reports, labeling them “inaccurate,” and even took a swipe at the bankruptcy examiner’s report, noting that it is simply “a feature of U.S. bankruptcy law.”

Be that as it may, E&Y appears to be trying to avoid becoming another big lawsuit target, and its defense is reminiscent of KPMG’s protestations two years ago after another bankruptcy examiner, Michael Missal, issued a similarly damaging report on its audits of subprime lender New Century Financial.

It is certainly understandable that the Big Four would want to defend themselves from lawsuits so they don’t go the way of Arthur Andersen, but it’s also important for bankruptcy examiners to uncover the accounting-related causes behind the collapse of entities like Lehman and New Century, especially when they lead to ripple effects across the economy.

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