Tuesday, December 21, 2010

NY case alleges Ernst & Young fraud as Lehman auditor

NY case alleges Ernst & Young fraud as Lehman auditor
Dec 21, 2010

New York prosecutors accused accounting firm Ernst & Young of helping to conceal Lehman Brothers Holdings Inc's financial problems before it collapsed in 2008.

The following are highlights from the civil fraud complaint filed by the office of New York Attorney General Andrew Cuomo in New York State Supreme Court:

- Ernst & Young approved Lehman's policy on Repo 105 transactions created in 2001 that allowed Lehman to park tens of billions of dollars of highly liquid fixed income securities with European banks for the sole purpose of reducing Lehman's balance sheet leverage.

- Senior Lehman personnel, including Kristine Smith, discussed the proposal with Kevin Reilly, the E&Y "engagement partner" in charge of E&Y's relationship with Lehman, and with E&Y partners William Schlich and Matthew Kurzweil.

- E&Y knew Lehman was treating the transfer of tens of billions of dollars of securities in Repo 105 transactions as "sales," not "loans" according to the complaint.

- Rather than expose this fraud E&Y year after year gave clean opinions on Lehman's financial statements even though they concealed massive Repo 105 transactions.

- In 2006, one of E&Y's auditors, Bharat Jain, became concerned about the heavy use of the Repo 105 transactions.

In a September 7, 2006, email to his senior manager, Jennifer Jackson, Jain noted that he would "like to know what is our thought process behind how much of these Lehman should do from reputational risk, etc. perspective. Are we comparing to other competitors, are we referring to any industry publications, any regulatory guidance, etc.?"

- In May 2008, E&Y was given a copy of a letter to senior financial executives at Lehman from Matthew Lee, an executive responsible for Lehman's global balance sheet, which raised serious questions about Lehman's financial statements.

- In June 2008, Lee told Schlich and another E&Y partner, Hillary Hansen, that Lehman was removing $50 billion in fixed income securities from its balance sheet each quarter by purporting to "sell them" to European counterparties.

-- Hansen raised concerns about Repo 105 with Schlich "who casually dismissed the concerns" by telling Hansen that they were being properly recorded as sales.

- In subsequent meetings about Lee's allegations, Repo 105 was not even mentioned even though E&Y had been instructed to tell Lehman's audit committee about Lee's concerns.

- E&Y misrepresented Lehman's compliance with applicable accounting standards, the complaint said.

- It said E&Y failed to challenge public statements by Lehman's management concerning the reductions in leverage that E&Y knew had been accomplished largely by the use of Repo 105 transactions.

(Compiled by Grant McCool; Editing by Gary Hill)

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