Ernst & Young and Lehman Brothers: A Summary of Quotes, Stories and LinksBy Francine • Sep 16th, 2011 • Category: Pure Content, The Case Against The Auditors
On the third anniversary of the Lehman Brothers bankruptcy – September 15, 2008 – I’m reposting this piece from March 21, 2010 that has links to most of my stories on the subject up to that point.
Three posts that followed soon after the piece below include a nice quote in BusinessWeek and Part One and Part Two of my discussion of the Ernst & Young response to the release of the Lehman bankruptcy examiner’s report. The firm’s first move was to send a letter to an Audit Committee members group – always selling – before they made any full response to the media about the bankruptcy examiner’s report. I was the first media outlet to publish the letter.
Finally, in September 2010, on the second anniversary of the bankruptcy, I had the honor of sitting on a panel at the New York County Lawyers Association with Jenner & Block’s Anton Valukas, the Lehman bankruptcy examiner, and Floyd Norris of the New York Times.
I prepared a post, “Top Ten Things Lawyers Should Know About Auditors,” for that occasion.
The release of Anton Valukas’ Lehman Bankruptcy Examiner’s Report on March 11, 2010 threw a fresh match on the still smoldering remains of the 2008 failure. The mainstream media, regulators, legislators and the business community blamed everything but fraud for the financial crisis and everyone but the audit firms for preventing, warning, or mitigating the devastating impact of the crisis.
If you’ve been reading the stories on this site, however, you may have come to the conclusion that I did a long time ago:
There was widespread fraud at the highest levels and the Big 4 auditors will eventually be accused of malpractice and complicity for doing nothing to prevent it, to warn us, or mitigate the impact on stakeholders.
I’ve published several stories since 2007 on the mortgage originators that failed or were taken over and the lawsuits against their executives and auditors. This is not the first bankruptcy examiner’s report to provide a detailed litigation roadmap in a subprime/crisis era fraud and to point to auditor malpractice. The New Century Bankruptcy Examiner’s report made quite a splash, too, when it came out. It also provided a litigation roadmap and included a smoking gun set of emails that pointed to alleged complicity and malpractice by auditors KPMG.
From Kevin LaCroix’s D&O Diary site:
“…the new lawsuits follow more than a year after the February 29, 2008 581-page report of Michael Missal, the KPMG bankruptcy examiner, in which the examiner concluded that KPMG had “contributed” to certain of New Century’s “accounting and reporting deficiencies by enabling them to persist in, and in some instances, precipitating the Company’s departure from, applicable accounting standards.” A detailed review of the examiner’s report, including a link to the report itself, can be found here.
The examiner’s exhaustive review, which among other things specifically suggested the possibility of negligence claims against KPMG, was effectively a road map for the April 1 lawsuits. While the lawsuits might well have been filed even without the examiner’s report, few other prospective claimants considering “gatekeeper” litigation will have such a detailed script from which to compose their complaint.
The collapse of Refco is another ongoing case that will become quite relevant to the Lehman case. In Refco, the Bankruptcy Examiner did a thorough job of dissecting the fraud, including the nature of “roundtrip” transactions orchestrated for the sole purpose of temporarily manipulating the Refco balance sheet.
Refco is actually a much closer case to Lehman than the Enron case, notwithstanding the strong role of the long auditor relationship in all three. The nature of the Lehman transactions used to commit the alleged fraud, the likelihood of early guilty pleas by corporate executives in Lehman like Refco, the difficulty of success with claims against third party advisors such as law firms and audit firms for aiding and abetting the fraud are more similar to Refco than Enron.
My most recent stories about Lehman and Ernst & Young began a month ago with a prediction that fraud allegations would center around standard accounting manipulation techniques such as round trip transactions, channel stuffing, and parking.
“…premised on some of the oldest tricks in the book for manipulating revenue recognition and, therefore, reported profits and incentive compensation payouts including stock options - roundtrips, parking, and channel stuffing. In another variation on the theme, global trading company Refco used a round trip loan to repeatedly hide a related-party transaction incurred to delay disclosure of significant uncollectible accounts. It’s not like these techniques haven’t been used before (by AIG, for example) to offload risk and smooth earnings at quarter- and year-end.”
Although most media reports tended to pull out the tired tropes of Enron, off-balance sheet, and Sarbanes-Oxley, one journalist did pick up on my theory and analysis instead.
Without giving credit.
Some journalists questioned the wisdom of criminally prosecuting the Lehman executives. Without denying the potential for and the legal basis for prosecutions, John Carney of Clusterstock asked what purpose criminal prosecutions would serve.
I ask the opposite.
Whose interests would it serve to avoid criminal prosecutions?
My response to John Carney and a scathing indictment of his point of view by Ryan Chittum in The Audit, a Columbia Journalism Review (CJR) blog, earned me a substantial mention in a later post by Ryan at CJR. I also was linked to by Aaron Task in a summary of the controversy on his Tech Ticker site.
A post on March 9th anticipated a defense which may be used by Ernst and Young in the Lehman case, in particular given its status as a bankruptcy trustee’s case.
In addition to my Going Concern column written to comment on the John Carney/Ryan Chittum debate, I also wrote here on the major accusations against Ernst & Young in the Examiner’s Report.
I have also posted a letter Ernst & Young sent to Audit Committee members defending themselves against the numerous allegations in the Lehman Examiner’s Report.
The Financial Times FTAlphaville blog links to the Audit Committee Letter this morning.
The Times of London in the UK wrote a story this morning on the Audit Committee Letter with a link to re: The Auditors.
Accounting Web has the story here.
The UK’s Financial Reporting Council has begun an investigation into EYs role in the Lehman fraud. Expect to see much much more on this in the weeks to come. I wrote a short piece for Accounting Web UK to summarize the issues for their European audience.
I will be writing much more on this in the next few weeks. Topics I plan to address include looking more deeply into the valuation issues, which were barely touched on, the impact on the other large audit firms, the role of Lehman’s internal audit function, the specific accounting for the Repo 105 transactions, the relationship of this bankruptcy to the Lehman bankruptcy case in the UK, my prior theory about the fraud and additional theories for litigation.