Update 12/20/2010–According to Matt Taibbi:
It took more than two years, but there might finally be some capital sentences handed out for crimes committed during the financial crisis. That’s metaphorically speaking, of course. Like the accounting firm Arthur Anderson, whose head was sacrificed during the Enron debacle, the once-proud financial auditing firm Ernst and Young now looks poised to take a spin down the toilet of history thanks to its role in the Lehman Brothers debacle.
New York State Attorney General Andrew Cuomo is about to file civil fraud charges against E&Y for the work it did helping Lehman cook its books during 2007 and 2008. The short version of what happened goes something like this. Lehman Brothers, like all the other big banks on Wall Street in those years, was nearing insolvency and desperate for cash. In advance of its quarterly reports in 2007, the firm executed a series of something called Repo 105 transactions in an attempt to make their balance sheet look healthier than it was.
These Repo 105 transactions are just loans that Ernst and Young and Lehman Brothers conspired to book as revenue from sales. If I go to you and I ask you to lend me a hundred bucks to pay for Knicks tickets, that’s a loan, and you and I and the SEC and every investor on Wall Street all know I’m in debt to you, that I owe you a hundred bucks.
Here’s how Lehman Brothers paid for their Knicks tickets: a week before the game, they went to you and offered to you “sell” you their worthless puke-stained lava lamp for a hundred bucks, with the understanding that two days after the Knicks game, it would come back and “buy” the lamp back for the same $100 (plus a small commission for your trouble). And when Lehman pocketed that $100 from the initial transaction, they decided to call that not borrowing but a true sale, i.e. they booked that hundred bucks as revenue from an honest sale of a worthless piece-of-shit lava lamp.
In 2007 and 2008 Lehman would do this before the end of every quarter. They would “sell” billions of dollars of assets, typically bonds, to various companies, and use that money to pay down debt before the quarter’s end, so that they didn’t look so flat-ass broke to investors. Then, a week or so after the end of the quarter, they would go out and borrow more money, and then “buy” the assets back. The reasons they did this were myriad, but in most cases the assets they were “selling” were depressed in value at the time and could not have been sold at anything like face value had they really gone out on the market and tried. So instead of really “selling” these items on their balance sheet, they worked together with other companies to jury-rig these “repurchase” agreements that looked like sales but were actually loans.
Lehman was doing massive amounts of these deals every quarter. In the second quarter of 2008, they lightened up their balance sheets with $50 billion worth of Repo agreements. This technique, apparently known as “window dressing,” isn’t that much different conceptually from the Enron-style book-doctoring that used “independent” special purpose vehicles to hide liabilities. In this case Lehman didn’t use shell companies but instead scattered its dent in the financial atmosphere by booking loans as sales. Ernst and Young, which made over $100 million in fees between 2001 and 2008 working with Lehman, aided the process by signing off on Lehman’s crazy accounting. In the report by bankruptcy examiner Anton Valukas that came out last March, he describes how Ernst and Young threw up a brilliant “We’re not corrupt, we’re just incredibly stupid” defense when confronted with the question of the $50 billion in Repo 105s in the second quarter of 2008. The report (a PDF of which you can view here) talks about what E&Y’s Lehman auditor Hillary Hansen had to say when future E&Y whistleblower Michael Lee confronted her about the $50 billion in Repos:
During the Examiner’s interview of Hansen, Hansen recalled that while Ernst & Young questioned Lee about his May 16, 2008 letter, Lee “rattled off” a list of additional issues and concerns he held, one of which was Lehman’s use of Repo 105 transactions. Ernst & Young had no further conversations with Lee about Repo 105 transactions. Prior to her interview of Lee in June 2008, Hansen had heard the term Repo 105 “thrown around” but she did not know its meaning…
In other words, the lead auditor reviewing one of the world’s largest investment banks had no idea what a series of regularly-occurring billion-dollar transactions committed by her main client were, and apparently wasn’t interested. It also didn’t seem to bother E&Y that Lehman was not disclosing any of this to its investors in its SEC filings.
My guess is that this suit is the beginning of the end for Ernst and Young and, who knows, may be the beginning of a series of investigations that ultimately take down the auditors and ratings agencies that made the financial crisis possible. Without accountants and raters signing off on all the bogus derivative math and bad bookkeeping, a lot of this mess would never have happened. Zero Hedge has an excellent piece detailing all the ass-covering and finger-pointing going on at Ernst and Young; check it out if you have time.
Update 12/20/2010–According to the Wall St Journal:
Auditors Face Fraud Charge: New York Set to Allege Ernst & Young Stood By as Lehman Cooked Its Books
New York prosecutors are poised to file civil fraud charges against Ernst & Young for its alleged role in the collapse of Lehman Brothers, saying the Big Four accounting firm stood by while the investment bank misled investors about its financial health, people familiar with the matter said.
State Attorney General Andrew Cuomo is close to filing the case, which would mark the first time a major accounting firm was targeted for its role in the financial crisis. The suit stems from transactions Lehman allegedly carried out to make its risk appear lower than it actually was.
The whistle-blower was Matthew Lee, a Lehman Brothers senior vice president. He had complained to his boss, and eventually wrote a letter in May 2008 to senior Lehman executives expressing concern that the Repo 105 transactions violated Lehman’s ethics code by misleading investors and regulators about the true value of the firm’s assets. Days later, Mr. Lee was ousted from the firm.
According to the Lehman bankruptcy examiner’s report, Ernst & Young auditors saw the letter, and later interviewed Mr. Lee after he was let go from Lehman. Ernst & Young previously said in a statement that Lehman management determined Mr. Lee’s “allegations were unfounded.” (Source)
Original Dregs of the Future blog post on March 16, 2010:
A 2,200-page examiner’s report into the collapse of the 158-year old institution, published last week, uncovered in forensic detail evidence that Lehman used “balance sheet manipulation” to mislead investors and regulators. (Source)
Aren’t highly paid CPA auditors supposed to warn us about this sort of thing?
Ernst & Young came under fire this week after the court-appointed examiner in the Lehman Brothers Holdings Inc bankruptcy said the audit firm did not challenge accounting gimmicks that allowed Lehman to hide some $50 billion in assets in 2008, while claiming it had reduced its overall leverage levels.
Ernst & Young said in a statement: “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 [because] after an exhaustive investigation the examiner made no findings in his report that Lehman’s assets or liabilities were improperly valued or accounted for incorrectly in Lehman’s November 30, 2007, financial statements.” (Source)
Standard Accounting: Ask Enron.
Accounting, what a scam profession…a method of keeping the books based upon “generally accepted principles” and subject to Congressional rule changes (when those “generally accepted principles” would declare the largest banks in the nation insolvent at the most inopportune time). The profession of financial accounting has disgraced and discredited itself in my eyes; they’re almost as big a bunch of liars and frauds as bond rating firms…
To think Lehman’s was the only big investment house to manipulate its balance sheet via repos would be naive. The whole point of accounting has become to find ways to crook the books without going to jail. Ask Barclays. (Source)
Just as a vampire can’t stand to be seen and thus avoids the light of day at all costs, as it is only able to operate by the deceptive cover of darkness, so the very nature of the institutions and operations by which the phantom wetikonomy functions must be kept hidden from the light of public awareness. The financial instruments of the wetikonomy are purposely crafted to be incredibly complex and hard to understand so as to hide and obfuscate the theft that is happening. Hiding the reality of what they are doing is one of the ‘chief features’ of wetiko finance. Replacing transparency with opacity, it has become standard account-ing practice in the wetikonomy to ‘cook the books’ so as to avoid being held account-able. If clearly illuminated and exposed to the light of collective disclosure and transparency, the shell-game and Ponzi scheme that IS the global financial system will be revealed to be the staggering and unlawful deception that it is. (Source)
- Ernst And Young Charged Civil Fraud Of Lehman Accounting (huffingtonpost.com)
- Prosecutors to sue Ernst & Young over Lehman collapse: report (financialpost.com)
- Ernst & Young may be sued over Lehman (msnbc.msn.com)
- NY to file civil fraud charges against Ernst & Young (americablog.com)
- Andrew Cuomo Is About To Announce Fraud Charges Against Lehman’s Accountant (businessinsider.com)