A federal judge has thrown out most of the key claims in a class-action lawsuit against Ernst & Young over its audits of Lehman Brothers.
Judge Lewis Kaplan refused to throw out the claims in the suit against a group of Lehman executives and directors who were also defendants in the suit, but last week he dismissed Securities Act claims against Ernst & Young for its 2007 audits of the collapsed investment bank. E&Y was sued by investors for signing off on audits of Lehman, even though the bank used repurchase agreements known as “Repo 105” transactions to temporarily move assets off its books before reporting quarterly results, classifying the transactions as sales rather than borrowings.
The transactions technically accorded with U.S. GAAP and generally accepted auditing standards, although the Financial Accounting Standards Board has recently revised the standards in response to an outcry after Lehman’s accounting was brought to light by a bankruptcy examiner.
“Accounting firms like E&Y are subject to Securities Act Section 11 liability only if the alleged misstatement or omission occurs in a portion of a registration statement, or a report or valuation used in connection with the registration statement, prepared or certified by it,” wrote Kaplan. “The SEC, by rule, has provided that ‘a report on an unaudited interim financial statement . . . by an independent accountant . . . shall not be considered a part of a registration statement prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of’ Section 11. Accordingly, misstatements or omissions in a ‘report on unaudited interim financial information’ cannot give rise to accountant liability under Section 11(a)(4). As E&Y made the only otherwise actionable statements in reports on unaudited interim financial information, plaintiffs’ Securities Act claims against it fail.”
He also noted, “Bearing in mind that E&Y’s GAAS opinion, just like those rendered by all or substantially all accounting firms, is explicitly labeled as just that—an opinion that the audit complied with these broadly stated standards—more is necessary to make out a claim that the statement of opinion was false than a quarrel with whether these standards have been satisfied.”
However, the judge refused to dismiss a claim against E&Y for signing off on audits of the bank’s Q2 2008 financial statements, in which it said it was “not aware of any material modifications that should be made to the consolidated financial statements,” according to The New York Times. The firm has tried to have a lawsuit by the New York State Attorney General over the Lehman audits moved to Judge Kaplan’s court, according to Forbes.com.
Ernst & Young reacted positively to the ruling. “We are pleased that Judge Kaplan’s ruling dismisses most of the claims against us in this matter, and we strongly believe that we will ultimately prevail on the remaining claim,” said a statement forwarded by E&Y spokesman Charlie Perkins. “As we have said consistently, we stand behind our work on the Lehman audit and our opinion that Lehman’s financial statements were fairly stated in accordance with U.S. GAAP, applying the rules that existed at the time. Lehman’s audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry.”
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