New York attorney general Andrew Cuomo is reportedly planning on filing a lawsuit alleging securities fraud against accounting firm Ernst & Young in connection with the Lehman Brothers bankruptcy, the first such action against a major accounting firm for its role in the credit crisis.
E&Y has been under investigation for its role in standing by, while Lehman used certain tactics to temporarily shift debt of its balance sheet. A report issued in March by bankruptcy examiner Anton Valukas provided details of the scheme, called Repo 105, which was used to move about $50 billion in loans off its balance sheet, shortly before the firm collapsed.
The move was intended to show investors and regulators that the firm wasn’t carrying too much debt. The Repo 105 transactions were sale and repurchase agreements, meaning that Lehman was obligated to buy them back, increasing it liabilities again. At the time, Lehman classified the repos as securities sales.
“The balance sheet manipulation was intentional, for deceptive appearances,” Valukas concluded. He called Repo 105 “window dressing” and an “accounting gimmick” and said that E&Y had breached its “professional standards” by helping downplay the firm’s liabilities. Valukas predicted that E&Y could face legal action over the transaction.
The report also pointed to a letter written by Mathew Lee, an accounting executive and a 14-year Lehman employee. In May 2008, Lee wrote that he was worried about the bank’s use of Repo 105; the bank collapsed four months later.
Harvey Miller, Lehman’s lead bankruptcy attorney said the Valukas report was “the spark that ignited” Cuomo’s interest in bringing a lawsuit.
Legal experts say that prosecutors may try to single out individual auditors rather than file a massive lawsuit against the accounting firm. The last time the government did so was in connection with the Enron collapse in 2001; the world’s largest accounting firm then, Arthur Andersen LLP, collapsed as well in its wake, leaving only four major accounting firms to handle audits of major companies in the U.S.
Lehman, once the fourth-largest investment bank, went under in September 2008, and set off a chain reaction in global financial markets.