From The Times
March 13, 2010
Linklaters and Ernst & Young face action over Lehman Brothers collapse
Alexandra Frean, Alex Spence
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Two of the City’s biggest names were battling last night to protect their reputations after an explosive new report on the collapse of Lehman Brothers threatened both with potentially crippling lawsuits.
Linklaters, one of the world’s premier law firms, and Ernst & Young, the accountancy giant, were both criticised in an investigation that accused the latter of “professional malpractice”.
It has emerged that a whistleblower at Lehman, whose collapse in 2008 defined the credit crunch, repeatedly warned auditors about the use of acounting methods that removed debt from its balance sheet.
Matthew Lee, a senior vice-president at the firm, sent a letter to managers on May 16, 2008, four months before the bank’s collapse. He warned that the use of “Repo 105” transactions to conceal the parlous state of the company’s balance sheet could be unethical.
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Ernst & Young, Lehman’s auditor, investigated the claims and were advised by Mr Lee less than a month later that Lehman used $50 billion of Repo 105 transactions temporarily to move bad loans — which it classes as assets — off their balance sheet, effectively concealing much of its debt. A series of lawsuits is expected after the report into the collapse accused the accountant of taking no action.
The report is by Anton Valukas, of Jenner & Block, who was appointed as examiner by the judge handling the bankruptcy to investigate any potential fraud or mismanagement. His 2,200- page report examines in detail the actions that led to Lehman’s demise.
When Lehman filed for bankrupcty on September 15, 2008, with about $600 billion in debt, its collapse contributed to the freezing of credit markets worldwide and to the global recession.
The Valukas report paints a damning picture of the bank’s final two years, branding it a hothouse institution so obsessed with growth that senior executives said openly that they did not want to hear “too much detail” about the risks they might face in case it held them back.
While Mr Vulakas found that Dick Fuld, Lehman’s chief executive, and other senior executives may have been unwise and shown poor judgment in their attitude to risk, he concluded that their actions in this regard were not so “reckless and irrational” as to give rise to a breach of fiduciary duty.
But his finding that they may have a case to answer on the Repo 105 transactions is expected to fuel litigation against the bank and its accountants.
Most notably, the report concludes that Ernst & Young was wrong to agree to the bank’s misleading accounts, knowing what it did about the Repo 105 transactions.
“Colorable claims exist that Ernst & Young did not meet professional standards, both in investigating Lee’s allegations and in connection with its audit and review of Lehman’s financial statements,” the examiner said.
He said “colorable” meant a claim for which there was enough credible evidence to support a finding in court. As for Mr Fuld, he was “at least grossly negligent” for allowing the firm’s continued use of Repo 105 transactions in this way, Mr Valukas concludes.
“Unbeknownst to the investing public, rating agencies, government regulators, and Lehman’s board of directors, Lehman reverse engineered the firm’s net leverage ratio for public consumption,” Mr Valukas states.
Mr Fuld’s lawyer said last night that the former Lehman boss did not know what the Repo 105 transactions were or their accounting treatment.
The report also names Christopher O’Meara, Lehman’s head of risk, and two former chief financial officers, Erin Callan and Ian Lowitt. The report reveals that they were also warned by Martin Kelly, Lehman’s former global financial controller, that the lack of economic substance to Repo 105 transactions meant “reputational risk” to Lehman if their use became known.
The report also reveals that Linklaters approved the Repo 105 transactions for Lehman, after the bank was unable to find any US lawyers willing to do so.
A spokesman for Linklaters confirmed that the firm gave Lehman its legal opinion on several transactions, but said it was not aware of any “facts or circumstances that would justify any criticism”. He added: “The examiner, who did not contact the firm during his investigations, does not criticise those opinions or say or suggest that they were wrong or improper.
Mark Molumphy, a partner at Cotchett Pitre & McCarthy, a San Francisco firm that is representing local authorities in California that lost more than $200 million after Lehman Brothers collapsed, said that the report unveiled a lot of new evidence in support of his clients’ claims — particularly internal documents and e-mails.
A court hearing on April 1 will be held to decide whether all of the documents referred to in the report can be made public. At present they are being held back on legal technicalities.
Mr Molumphy said his firm would go to court on Monday to amend its claim to include fresh evidence uncovered by Mr Valukas’s investigation.
A separate class action case brought by a Scottish pension fund in New York is also likely to be strengthened by the findings. The Lothian pension fund, which handles £3 billion in retirement funds belonging to local govenrment workers in Edinburgh, is acting as lead claimant on behalf of investors that lost money on Lehman-related sub-prime investments. Its lawyers declined to comment last night.
As for Ernst & Young, it could now face attempts by investors to claw back the fees it pocketed for auditing Lehman Brothers’ books — $31 million in 2007 alone — in addition to claims for substantial damages.
A spokesman for E&Y said: “Lehman’s bankruptcy, which occurred in September 2008, was the result of a series of unprecedented adverse events in the financial markets. Our last audit of the company was for the fiscal year ending November 30, 2007. Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.”
Ernst & Young declined to comment further. Privately, the firm is understood to be determined to defend itself against any follow-on action. It will be conscious of the destruction of Arthur Andersen, an erstwhile rival as a global auditor, by its involvement in the fall of energy company Enron.
Full report: http://lehmanreport.jenner.com
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15 Comments
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K David wrote:
E&Y need to go down.
And the ratings agencies with them.
March 13, 2010 3:04 PM GMT
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ashok lal wrote:
One cannot even say that the auditors were asleep at the wheel.
March 13, 2010 2:51 PM GMT
RECOMMEND? (2)
A NON wrote:
I can't imagine these 2 firms offering sufficient amounts to settle out of court with the poor investors. I expect the mother of all court battles, 2 battling for their survival and thousands battling for their life savings.
March 13, 2010 2:47 PM GMT
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Sian Brown wrote:
And who is Ernst & Young's main law firm??? You guessed it... Linklaters... doesn't smell too good :(
March 13, 2010 2:21 PM GMT
RECOMMEND? (3)
Simon Lambert wrote:
The problem is that the accountancy profession is self-regulated.
Self-regulation equals no regulation.
Auditors/accountants will sign-off on almost anything----as long as their fees are paid.
We need transparent independent regulation. However, in my opinion it is now too late: the whole system is blown-----there are just too many Madoff's, Enrons, MG/Rovers, Lehmans, Worldcom etc etc etc losses that have not yet been revealed for the system (Capitalism) to absorb.
March 13, 2010 11:13 AM GMT
RECOMMEND? (4)
Pat Sheehan wrote:
The Law is to be blamed in this case.
It is outrageous that we allow the same firm to audit the same large company time after time.
We've had too many cases like this one where it has been plain to see that the pickings for, say, a bank audit, have been too huge for the auditors' integrity to be a realistic expectation.
I've often wondered how often has your ordinary lad from the big accountancy firm had to choose between keeping in with a crooked client or returning to his firm to face the sack (for some other reason of course).
We badly need a law to prohibit the same firm from auditing the same large company within, say, a five year timespan.
And I'm afraid I've got to add that we should also legislate to prevent audit firms from offering other services.
March 13, 2010 2:49 AM GMT
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Mark Elliott wrote:
Please people let us be clear here there is a very important distinction between accountants and auditors. Those who can account do those that can't audit. Auditing is the last refuge for failed accountants. They are supposed to be the accounting police but in my career as a senior financial professional I have not seen one who could ask the crucial relevant questions necessary for a proper professional audit. Too often they rely on the work of teams of newly graduated staff who haven’t a clue what they are doing. The managers and partners who supervise are only interested in collecting their huge fees and keeping the client happy so they get keep the job next year. A good accountant can outwit an auditor any day. There is no contest it's like shooting fish in a barrel. That’s why they are completely socially worthless. This is an opinion I have shared with my auditor colleagues on more than one occasion.
March 13, 2010 1:05 AM GMT
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Bill Williams wrote:
Unfortunately for Mr Fuld, Sarbanes Oxley ensured he can't plead ignorance of the repo 105 transactions. Good.
March 13, 2010 12:47 AM GMT
RECOMMEND? (2)
Lancelot Stilwell wrote:
Why has it taken so long for the Lehman collapse to hit the headlines? Read the book "A colossal failure of common sense" published in 2009, and learn all
March 13, 2010 12:42 AM GMT
RECOMMEND? (2)
John Harry wrote:
I have read that Lehman first shopped the large American law firms for this opinion and were unsuccessful. That tells me that this opinion must have been simply beyond the pale. Most of the large American law firms will do about anything if the price is high enough. If true, that would make Linklaters the most unethical law firm in the world.
March 13, 2010 12:33 AM GMT
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