Auditors Ernst & Young and law firm Linklaters – both of whom are UK-based – have taken a good kicking in a scathing new report about the collapse of Lehman Brothers. It suggests EY could be sued for ‘professional malpractice’ over its failure to challenge some of the dubious accounting practices that allowed Lehman to survive as long as it did – which were given the legal thumbs-up by Linklaters. Lawyer Anton Valukas, the author of the 2,200-page report, also reckons there may be grounds for legal action against Lehman’s former top brass (including its much-despised CEO Dick Fuld) for breach of fiduciary duty. All the accused are denying it, of course – but this has the potential for some serious muck-raking…
The accusations are all about Lehman’s accounting procedures towards the end of its life – but don’t let that put you off, because it’s actually quite interesting. Basically Valukas claims that Lehman’s senior management cooked the books to make it look like the bank’s debt pile was shrinking – whereas in fact up to $50bn was just shifted off-balance-sheet with the help of a clever accounting trick called ‘Repo 105’ (a bit like the UK’s public/ private finance initiatives, perhaps?).
This meant the bank’s senior management gave investors a false impression of the financial health of the company – and as a result, there is ‘sufficient credible evidence’ for claims against Fuld, head of risk Christopher O’Meara, CFO Erin Callan and her replacement Ian Lowitt. Fuld’s lawyer told the BBC that he knew nothing about these Repo 105 transactions – presumably hoping to argue that he was actually just criminally incompetent, as opposed to being legally negligent.
The British interest comes with the involvement of Ernst & Young, who provided the last audit of Lehman. Valukas suggests that EY had received various warnings about all the dodgy dealings going on at Lehman, but ‘took virtually no action to investigate’. This, he said, was ‘professionally negligent’; for its part, EY insists its last audit was ‘fairly presented’ in line with the rules. Meanwhile Linklaters is accused of providing a legal opinion to justify the use of Repo 105 under English law – after all the big US law firms refused to touch it with a bargepole.
And that’s not all. Valukas also suggests that big Wall Street banks, including JP Morgan and Citigroup, raided Lehman’s coffers for $16bn just as it was teetering on the brink – thus helping to push their long-time rival over the edge. Apparently Fuld tried to get Gordon Brown to overrule the FSA and let Barclays effect a full rescue, but the White House refused to help. And even Barclays itself allegedly took assets it wasn’t entitled to when it bought the rump of Lehman’s Wall Street operation, including office equipment and client records.
It remains to be seen whether any of this threatened legal action will actually materialise. But it’s fair to say that nobody involved in this unpleasant episode emerges from this report with a lot of credit.
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