No charges have yet been filed by either the Securities and Exchange Commission or the Justice Department against former Lehman Brothers executives, or the bank’s auditors at Ernst & Young, over Lehman’s use of so-called Repo 105 repurchase transactions, and the prospects appear to be dimming that they ever will be.
The Wall Street Journal reported Saturday that SEC officials are growing ever more doubtful that they can build a strong enough case against the bank or its former auditors. The SEC hasn’t issued any Wells notices yet against E&Y or former Lehman executives indicating that any civil charges are imminent. The Justice Department generally will avoid filing criminal charges in such a case if the SEC isn’t filing civil charges.
Lehman’s bankruptcy examiner Anton Valukas first identified the suspicious repurchase agreements in his bankruptcy report last March and said they could be used as a “colorable claim” to build a case against several of Lehman’s former executives and auditing firm (see Lehman’s Accounting Sleight of Hand Was Less Than Magical).
Indeed, lawsuits have been filed by some of the bank’s former shareholders against E&Y because of its audits of the failing bank. Lehman used the 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 as though the bank had less debt than it actually had. The transactions should have been recorded as financings, but Lehman instead claimed them as sales by twisting accounting standards to its liking.
E&Y pointed out, however, that its last audit of Lehman was for the year ended Nov. 30, 2007 (see Ernst & Young Defends Lehman Audits). It blamed Lehman’s bankruptcy on the rapidly moving financial crisis, along with a collapse in the bank’s liquidity caused by declining asset values and a loss of market confidence in Lehman.
New York Attorney General Andrew Cuomo nevertheless filed suit against E&Y over the Lehman audits last December on the basis of the state’s Martin Act, shortly before leaving office to become governor (see Cuomo Sues Ernst & Young over Lehman Audits). His complaint cites instances going back to 2001 of the firm issuing unqualified audit opinions despite the bank’s use of similar repurchase agreements.
His successor, Eric Schneiderman, must now decide whether to proceed with the lawsuit while the SEC and the Justice Department find themselves in a similar quandary. Trying to prove a case to a jury against an auditing firm and banking executives over a set of murky accounting standards may be difficult to do, especially when the defendants can point to letters from Lehman’s British law firm attesting to the legality of the transactions, which Lehman had shifted to its European counterparts.
In addition, the U.S. Financial Accounting Standards Board and the International Accounting Standards Board have been working since the Valukas report to tighten up the standards for similar types of transactions, indicating that the accounting rules might have been less than watertight back in 2007.
Still, the prospect of Lehman’s former executives emerging unscathed is sure to fuel public anger over the way Wall Street was left essentially unpunished in the aftermath of the financial crisis. While there is no doubt that a variety of outside factors contributed to the downfall of Lehman, the bank’s aggressive attempts at window dressing its quarterly earnings would seem to warrant a case.