MANHATTAN (CN) – Ernst & Young reaped $150 million in fees while helping Lehman Brothers defraud investors, New York Attorney General Andrew Cuomo claims in Supreme Court. The accountants allegedly turned a blind eye as the now-bankrupt bank hid tens of billions of dollars in securities that should have been on its balance sheet.
Filing suit under the Martin Act, Cuomo says the bank’s so-called “Repo 105” transactions occurred with guidance from its accountants at Ernst & Young (E&Y).
“E&Y knew every significant aspect of Lehman’s Repo 105 transactions, and knew that the Lehman financial statements violated Generally Accepted Accounting Principles (“GAAP”), which require that such statements (a) not be misleading, (b) fairly disclose the company’s financial position, and (c) not omit material information necessary to fairly present the financial position,” according to the complaint. “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.”
Ernst & Young said in a statement that the nearly 90-year-old Martin Act has never before been applied to an accounting firm rather than the company that committed the alleged fraud.
The firm denied Cuomo’s charges and says its accounting complied with GAAP.
“Lehman’s audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry,” Ernst & Young said in a statement. “Lehman’s bankruptcy was preceded and followed by other bankruptcies, distressed mergers, restructurings, and government bailouts of all of the other major investment banks, as well as other major financial institutions. In short, Lehman’s bankruptcy was not caused by any accounting issues.”
Cuomo says Lehman improved balance sheet “metrics” by paying down its liabilities with cash it received in exchange for investment-grade securities. The bank often repurchased the same securities “within a short time, often just a few days.”
“These transactions, hatched in 2001, 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, and painting a false picture of an important financial metric for investors, stock analysts, lenders, and others involved with Lehman,” according to the complaint.
Ernst & Young both approved and supported the transactions, and helped Lehman use an accounting loophole to treat the short-term financings as “sales,” according to the complaint.
Cuomo says this accounting fix enabled Lehman to remove the securities from inventory on its financial statements until they were repurchased.
Although Lehman executives warned management about the improper transactions, Cuomo says the bank used them aggressively and concealed them with the help of its accounting firm.
“Rather than expose this fraud as auditors must, E&Y expressly ‘approved’ this practice in 2001, and, year after year thereafter, E&Y gave clean opinions on Lehman’s financial statements even though the statements concealed the massive Repo 105 transactions,” according to the complaint. “Moreover, at a time when disclosure was most warranted, when Lehman was facing severe liquidity problems in 2007 and 2008, and its leverage was too high in the view of the financial community on which Lehman depended for capital, the fraud grew even larger.”
Instead of reducing its leverage, Cuomo claims Lehman began “frantically accelerating the use of Repo 105 transactions, which gave the false impression of reduced leverage.”
“At the end of each quarter from 2007 until Lehman’s collapse in September 2008, Lehman used the Repo 105 transactions to transfer up to $50 billion of fixed income securities for the sole purpose of reducing reported leverage,” according to the complaint.
As the bank was trying to stave off collapse by any means necessary, Cuomo says Ernst & Young turned its back on the investing public.
“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,” according to the complaint.
In contradiction of its obligations, Ernst & Young lied that Lehman’s financial statements complied with GAAP, Cuomo claims.
“E&Y sat by silently while Lehman deceived the public by concealing the Repo 105 transactions and misrepresenting the company’s leverage,” according to the complaint. “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.”