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Ernst & Young sued for an alleged Lehman accounting fraud



The lawsuit from US attorney general Andrew Cuomo claims that Ernst & Young did not tell Lehman's board about a whistleblower's concerns about the endorsed "Repo 105" transactions that made Lehman seem to have more cash than it actually did. It also claims that the accounting firm failed to object when Lehman misled analysts during its earnings calls about its leverage ratios.

The civil lawsuit, which seeks more than $150 million, is the first law enforcement action to stem from Lehman's failure claims that one of the big 4 accounting firms, Ernst & Young helped Wall Street investment bank Lehman Brothers conceal its deteriorating financial condition before the historic collapse that probably caused the international financial crisis.

Ernst & Young said in a statement that it would defend itself against Cuomo's claims. The firm said "there is no factual or legal basis" for the suit since it had followed legal accounting standards in auditing Lehman's books.

Repo 105
Like most accounting rules, the provision applicable to the Repo 105 transactions, called SFAS 140, is subject to interpretation. Taking a liberal view of its requirements would support the conclusion that Lehman complied with the letter of the rule. And it will be difficult for the attorney general to establish that the accounting treatment violated GAAP. By complying with those rules, one could argue, the accountants had no further obligation to make Lehman to treat the transactions differently or to disclose more about the repo 105 transaction.

The allegations centered on fraudulent trades that allowed Lehman to window-dress its balance sheet before filing quarterly financial reports. The boomerang trade was referred to as "Repo 105," short for repurchase, since Lehman agreed to buy back the assets before selling them, hiding this crucial information from the investing public.

Repo 105 can be described as follows: Shortly before releasing quarterly financial results to the public, Lehman would transfer assets to European banks. It would receive cash in return. This cash made it seem as though Lehman had less leverage. Shortly after the publication of the reports, the European banks would sell the assets back to Lehman for a premium.

Too few to fail
The transaction would make the firm seem like it had less leverage - a measure of how much debt a company has compared to how much cash it has. Investors, analysts and regulators often view excessively high leverage as a warning sign about a company's financial condition.

The attorney general is not seeking to indict E&Y, the second largest accounting firm in the USA. Instead, he is seeking damages - based on the fees it got from Lehman - that E&Y or its malpractice insurer or somebody else easily could cover, probably because with the demise of the audit company Arthur Andersen the number of international audit companies are now limited to 4, violating the US antitrust guidelines and therefore they are too few to be allowed to fail.