Ernst & Young faces legal action over Lehman books
Leading accountancy firm Ernst & Young is facing legal action for its alleged role in "window dressing" the accounts of Lehman Brothers as it careered toward collapse.
New York attorney general Andrew Cuomo is reportedly preparing to sue the firm as early as this week.
The case would be the first against a major accounting firm over its role in the credit crisis.
Mr Cuomo, who was elected governor last month, may file the lawsuit this week. The suit would relate to Ernst & Young's audits of Lehman transactions aimed at downplaying its liabilities; however, a settlement is still possible.
Lehman, once the fourth-largest investment bank, failed in September 2008 because of risky real estate bets and too much debt, which it tried to hide from investors, according to bankruptcy examiner Anton Valuka's report.
Mr Valukas, in the report, said Ernst & Young could be accused of "professional malpractice" for its role as auditor.
Mr Cuomo's office has been investigating the accountant's role in Lehman's use of repurchase agreements or 'repos' to bolster the bank's accounts.
The suit is part of a broader investigation into whether banks misled investors by using strategies, branded "window dressing" by critics, to temporarily shift debt off their books. The case comes nine months after a damning report into the Lehman's collapse that said the accountancy firm failed to challenge "materially misleading" reports filed by the bank's management.
The scheme under fire from Mr Cuomo was first detailed in March by Mr Valukas, the bankruptcy examiner investigating Lehman's bankruptcy.
According to Mr Valukas's 2,200-page report, the bank used repos to move $50bn (€38bn) in loans off its balance sheet shortly before its collapse.
Lehman labelled those transactions as securities sales, the transactions -- known as 'Repo 105' -- were carried out on a quarterly basis in 2007 and 2008, according to the bankruptcy examiner.
"The balance sheet manipulation was intentional, for deceptive appearances," Mr Valukas wrote.
He called Repo 105 "window dressing", an "accounting gimmick" and a "drug", and concluded that Ernst & Young had failed to reach "professional standards" and could face legal action.
The balance sheet manipulation was intentional, for deceptive appearances, had a material impact on Lehman's net leverage ratio and caused financial reports to be misleading, Mr Valukas wrote of the defunct New York-based company.
Higher leverage undermines a firm's capacity to absorb financial shock. Responding to the Valukas report in March, Ernst & Young said leverage ratios reported in Lehman's management discussion and analysis "were the responsibility of management, not the auditor. They are not part of the audited financial statements."
The accounting firm has been named in at least one class action lawsuit accusing former Lehman chairman Dick Fuld and other executives of misleading investors by using devices such as Repo 105.