Opinion

Felix Salmon

Cuomo lashes out at Ernst & Young

By Felix Salmon
December 21, 2010

Say what you like about Andrew Cuomo, he gives good complaint:

E&Y substantially assisted Lehman Brothers Holdings Inc., now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public…

Not only were the transactions concealed, but Lehman’s financial statements affirmatively, and falsely, stated that the only securities subject to repurchase (“repo”) agreements were “collateralized agreements and financings” (i.e., loans), even though, as E&Y well knew, Lehman was treating the transfer of tens of billions of dollars of securities in Repo 105 transactions as “sales,” not “loans.” Rather than expose this fraud as auditors must, E&Y expressly “approved” this practice..

As the financial crisis deepened in 2007 and 2008 and Lehman’s liquidity problems intensified, E&Y was aware that Lehman was dramatically increasing the Repo 105 transactions in a desperate effort to stave off collapse. At a time when it was critical for investors to make informed decisions as to whether to keep or buy Lehman stock, E&Y assisted Lehman in defrauding the public about the Company’s deteriorating financial condition, particularly its leverage…

As the public auditor for Lehman, E&Y had the absolute obligation to ensure that Lehman’s financial statements complied with GAAP and did not mislead the public. Instead of fulfilling this obligation, E&Y gave a clean opinion each year, erroneously stating that Lehman’s financial statements complied with GAAP. E&Y sat by silently while Lehman deceived the public by concealing the Repo 105 transactions and misrepresenting the Company’s leverage. By doing so, E&Y directly facilitated a major accounting fraud, and helped Lehman mislead the public as to its true financial condition. E&Y, which reaped over $150 million in fees from Lehman, must be held accountable for its role in this fraud.

E&Y knew this was coming—we all did—but despite that fact, its only public reaction so far has been to refuse to comment. That doesn’t look good, and it forces us back to what the company said in the wake of the Valukas report—that its work as Lehman auditor “met all applicable professional standards,” whatever that’s supposed to mean.

If I had to guess, I’d wager that there will be a large settlement—more than $150 million, anyway—and that E&Y will avoid admitting blame and also avoid criminal prosecution. One notable thing about the complaint is that the only defendant is Ernst & Young LLP; there are no named individuals on the list. So E&Y’s partners are probably safe too. Sadly.

Comments
8 comments so far | RSS Comments RSS

Can we assume there were no former Arthur Anderson employees working at E&Y, or would that be pathetically naive?

Posted by EricVincent | Report as abusive
 

Why do you use terms in your headlines such as “lashes out” in lieu of “criticizes” or “accuses”? It implies a degree of excessive emotion (even physicality) rather than legal justification.

Posted by PR1 | Report as abusive
 

“Can we assume there were no former Arthur Anderson employees working at E&Y, or would that be pathetically naive?” In Austalia, E&Y hoovered up the Arthur Andersen audit business.

And, off topic, (but not really): Felix, thanks for your wit, balance and perspicacity in 2010. Your site: one of the best. Best wishes for the holidays!

Posted by crocodilechuck | Report as abusive
 

Mr Cuomo presumably knows the difference between liquidity and leverage?

Posted by Danny_Black | Report as abusive
 

@crocodilechuck:

Thanks for the confirmation.

Posted by EricVincent | Report as abusive
 

@crocodilechuck:

Thanks for the confirmation.

Posted by EricVincent | Report as abusive
 

You do know that there isn’t going to be “criminal prosecution” and that it is a civil suit? Very likely to settle out of court too.

As an auditor, E&Y has to follow the auditing standards set by US GAAS and it seemed like they did follow the standards that were set at the time. Post-financial crisis; there were some major changes to these standards.

They have a public response now.. You should take a look.

Posted by leona123 | Report as abusive
 

The core issue here is who pays for the audit. It’s the same issue as the credit rating agency mess.

The SEC should perform annual audits on all exchange listed companies and bill them for the time the same way the FDIC audits banks. If you are allowed to shop your audit around to the accounting firm most willing to bend the rules than you are always going to have Enron style blow-ups.

Even if a govemental agency did the auditing you would still have some problems… but I’d bet they would be more infrequent than under the current system where companies essentially pay a firm to swear to shareholders their annual reports aren’t works of fiction.

Posted by y2kurtus | Report as abusive
 

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