Whither Ernst & Young and Linklaters?

By Felix Salmon
March 12, 2010
renewed attention on Lehman Brothers (be sure to check out Antony's piece on the report), it's worth wondering what might happen to Ernst & Young, in the US, and to Linklaters, in the UK.

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Blogging’s going to be light-to-nonexistent today, since it’s a travel day for me. But with all the renewed attention on Lehman Brothers (be sure to check out Antony’s piece on the report), it’s worth wondering what might happen to Ernst & Young, in the US, and to Linklaters, in the UK.

Linklaters was the chief enabler of the notorious repo 105 transactions, giving a ludicrous-on-its-face opinion that they were a “true sale”. And this just isn’t credible:

In a statement, Linklaters said Friday that Valukas’ report doesn’t suggest the legal opinion it gave under English law was wrong or improper.

“We have reviewed the opinions and are not aware of any facts or circumstances which would justify any criticism,” the law firm said.

There’s been a lot of noise, of late, about how banking became corrupted when it ceased to be a profession, and that lawyers and doctors somehow remained noble. But these lawyers don’t seem very noble to me.

And if anything E&Y is in even worse shape, given this:

The Examiner concludes that there are colorable claims that Ernst & Young did not meet professional standards either in investigating these allegations and in connection with its audit and review of Lehman’s financial statements.

Enron brought down Arthur Andersen. Will Lehman do the same for E&Y? Or even Linklaters?


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We await your return and perhaps some kind of recanting of the ridiculous statement you made.

Many people have been bothering you for weeks and months regarding CDS counterparties and then you broke your silence on that with this made-up statement:

“Indeed, it’s the long-only investors who are on the other side of the trade — institutional investors who wrote CDS rather than buying bonds, because the yield was higher or because they simply couldn’t locate bonds to buy, or just because CDS are more liquid. For those investors, CDS are bond substitutes, and they’ll buy a CDS for the full cash value of the amount being protected, just as they would a bond. They’re not leveraged.”

Of course you invented this explanation. It cannot be true.

If the end-underwriters of CDSs were merely bond buyers who “buy a CDS for the full cash value of the amount being protected” as you say then the value of the CDS market would be billions and not trillions.

If this is not a made-up statement, please show us some evidence, any at all, that it is true. This is like Stephen Glass, online edition.

Posted by DanHess | Report as abusive

Enron brought a lot of entities down, and it’s the sad fact that no decisive repercussions were filed in a timely way by aggrieved parties (e.g. State of California) which left the door wide open for a succession of emulators who are only now being – at worst – singly chastised, yet seldom held to full scrutiny and account.

The enormity of Enron is still with us in mutations such as [insert names of just about all TBTFs, their bond-raters, lawyers and accountants here] and it’s never going to go away as long as there is the slightest civil tolerance for white collar crimes that are “too big to prosecute”.

Posted by HBC | Report as abusive

Before we go too hard on the lawyers, let’s note that Lehman went to Linklater’s because no U.S. firm would give them the opinion they wanted. Given that they were trying to move billions of assets off-balance-sheet, it’s safe to assume that they shopped around pretty aggressively in the U.S. for a way to do so and would have paid well for it. Nationwide, lawyers said “That’s nice, but we have laws”. I also assume that English lawyers aren’t simply more corrupt than U.S. lawyers, so there must be some aspect of English law that makes the transactions defensible – perhaps England should remedy it.

Ernst and Young, on the other hand, said it was fine to temporarily transfer U.S. assets to Europe in order to evade U.S. accounting rules and disclose materially misleading leverage levels – without even flagging that the company was doing something unusual in a footnote that no one would read. That’s seriously problematic. If your principal place of business is in the U.S. and you hold assets there, dropping them overseas for a few days so you don’t have to talk about them to investors frustrates the entire purpose of accounting.

Posted by najdorf | Report as abusive

Given the Arthur Andersen precedent, there is no valid reason that E&Y should not face an equal or more drastic fate. If they do not, I think it will be clear that the accounting death penalty is off the table.

Posted by MattJ | Report as abusive

I thought it was the conviction for obstruction of justice, in regards to shredding evidence related to the Enron audits, that led to the downfall of Arthur Andersen.

Posted by slessard | Report as abusive

Biglaw has long since been corrupted. Big firms are all about profit maximization. Professionalism is a fairy tale that some of the older lawyers continue to recite to themselves.

Posted by slowlearner | Report as abusive

According to ‘The Lawyer’ Magazine, “Linklaters is also E&Y’s principal corporate adviser” , did this close relationship play any role?

Posted by sian | Report as abusive

Linklaters are in the clear I would bet. They’re a law firm, not an accountancy firm, and it’s mentioned in the report that they specifically didn’t give an opinion on the status of Repo 105 under US GAAP (why would they?). Their opinion was about whether it constituted a true sale under English law (it is a bit irksome that the report keeps referring to “UK law”, although the only people who will really care are any passing Scots). They even specifically said that their true sale opinion would be invalidated in cases of sham transactions. E&Y should probly be worried a bit more, because they did give advice on the actual transactions in question. But even they might get off, because while it’s very very prescriptive, US accounting law isn’t actually very good at closing down loopholes and doesn’t have a catch-all “true and fair view” to rule out bed&breakfast transactions.

Posted by dsquared | Report as abusive

Felix, I think the point you are missing is that under English law the transaction IS (probably) a true sale. English law is different from NY law, which is why no NY firm would issue the opinion.

There’s nothing “ludicrous” about a law firm in a different jurisdiction giving an opinion that couldn’t be given in the US on account of the two countries having different laws.

Posted by Ed2010 | Report as abusive

If you value competition you want E&Y to survive, there are 4 major accounting firms right now: EY, PWC, Deloitte and KPMG. Grant Thorton is a distant fifth.

These firms make amazing amounts of cash and the average partners income would make you cry. If you think that EY should go down becaue Andersen went down well thats just foolish. Three large firms would only increase the profits of these firms. Competition is slim these days.

Andersen went down because there was a crisis of confidence, not because their audit proceedures were faulty or anything systematic. Each office and you could argue each partner have certain independence to customize an audit to their liking. One partner, or a handful of partners or even an office being lazy or even corrupt does not mean an entire GLOBAL accounting firm should suffer a similar fate.

These firms are in every major city in the world – do the Toronto, Sydney, Moscow, Madrid, Johanesburg E&Y offices have anything to do with Lehman in NYC?

Andersen never should have failed…neither should E&Y. Do you know how many partners at Andersen were reprimanded, who lost their CPA license? Very very few.

They should go after those responsible for the shoty auditing with everything they’ve got but the firm itself should not fail as a result.

Posted by BHOlied | Report as abusive