Ernst & Young at risk over Lehman "accounting gimmicks"

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Deceptive financial practices and lax auditing lay at the heart of the 2008 collapse of US investment bank Lehman Brothers that helped to trigger the global economic crisis, says a US court examiner’s report.

Ominously for Ernst & Young, the report said the stakeholders in Lehman's remains may be able to seek compensation from the auditors for fees and expenses incurred "as a result of Ernst & Young's malpractice - for example, if an accountant’s negligence in the preparation or certification of financial statements results in litigation against the accountant’s client brought by purchasers of the client’s securities, the client may be able to recover the expenses of the litigation and the amount of any judgment or reasonable settlement.”

Anton Valukis’ 2,200 page forensic report accused senior management of “actionable balance sheet manipulation” and using “accounting gimmicks” to cover up the failing bank’s losses. It has been reported that the bank was in fact insolvent for weeks before filing bankruptcy in 2008.

“Lehman employed off‐balance sheet devices, known within Lehman as Repo 105 [2] and Repo 108 transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008,” said the report.

In a statement delivered today, Ernst & Young said: "Our last audit of the company was for the fiscal year ending November 30, 2007. Our opinion indicated that Lehman's financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view."

Lehman CEO denies fraud claims

Meanwhile Lehman Brothers’ chief executive Dick Fuld’s lawyers say he did not structure or negotiate the banks’ Repo 105 transactions which were used to be create a ‘materially misleading picture of the firm’s financial condition’ in 2007 – 2008, nor was he aware of their accounting treatment.

This was the claim from Patricia Hynes of Fuld’s legal team at Allen & Overy, who added that Fuld “throughout his career faithfully and diligently worked in the interests of Lehman and its stakeholders" in a statement to the Guardian [3].

The statement is at odds with claims in court appointed US examiner Anton Valukis’ report that Lehman’s global financial controller Martin Kelly had warned the bank’s chief officers that the transactions would lead to “reputational risk”

The off balance sheet transactions were used to temporary remove securities inventory from its balance sheet, boosting figures by as much as $50 bilion (£33billion) it has been reported. This technique was used for the sole purpose of manipulating Lehman’s accounts to give the impression that the bank was reducing its overall debt levels in 2008 when in reality the situation was quite the opposite, said Valukis’ report.

The report also revealed that Fuld tried to strike a rescue deal with Barclays in September 2008, but the FSA would not allow the British bank an exemption from seeking time-consuming shareholder approval.

Fuld appealed to US treasury secretary Henry Paulson to contact Prime Minister Gordon Brown after Chancellor Alistair Darling declined to get involved. Barclays eventually purchased the remains of Lehman’s Wall Street operation from receivership for $1.75bn. However, the report also found that Barclays received certain equipment and assets it was not entitled to subsequent to this deal. There are “colourable claims” against Fuld and three successive chief financial officiers, Chris O’Meera, Erin Callan and Ian Lowitt, according to the report.