It wasn't even a verdict. Just a decision by New York
Federal Court Judge Lewis Kaplan in one Lehman failure cases Ernst & Young
is fighting. A decision to allow substantially all of the allegations against
Lehman executives and at least one of the allegations against Ernst & Young
to move forward to discovery and trial.
That is, if there's not a settlement first.
Yesterday I wrote up my analysis of the decision by Judge
Kaplan for my column "Accounting Watchdog" at Forbes. In the interest of time
and space, I stuck to commenting on the Ernst & Young portion of the
Judge Kaplan dismissed the majority of the allegations
against Ernst & Young. It's the same thing auditors are always dismissed
for. The only thing that's new about the judge's opinion is an indictment
of the accounting standards themselves.
The Third Amended Complaint points to several General
Standards ("GS"), interpretive Statements on Auditing Standards ("AU"),
and Statements of Fieldwork that allegedly are part of GAAS and that E&Y
allegedly violated. Many 288 of those standards are couched in rather general
and in some cases inherently subjective terms. They require, for example, that
the auditor plan the audit engagement properly, use "due professional care,"
exercise "professional skepticism," and "assess the risk of material
misstatement due to fraud" - all matters as to which reasonable professionals
planning or conducting an audit reasonably and frequently could disagree.
Bearing in mind that E&Y's GAAS opinion, just like
those rendered by all or substantially all accounting firms, is explicitly
labeled as just that - an opinion that the audit complied with these broadly
stated standards - more is necessary to make out a claim that the statement of
opinion was false than a quarrel with whether these standards have been
Or is this really news?
Richard Posner during oral
arguments in Fehribach v. Ernst & Young LLP, 493 F.3d 905 (7th Cir. 7/17/07) (pdf),
"Posner: The auditor's responsibility
... so far as the company is concerned ... is to make sure the [numbers] are
accurate.... You don't need an auditor to tell you your market is
collapsing.... The auditors are not supposed to have business
insight. They're counters. They're not supposed to make predictions
about how your markets are doing. They're supposed to reconcile your
books and indicate you're not a going concern because your debt is too high and
Do you think the auditor is supposed to know
about market power?... An auditor is not an economic consultant who goes
out and figures out what the market trends in an industry are!...Your trends?
That's what the company knows. [Plantiff's Attorney: You're right.
Here's what the auditor's responsibility under SAS 59...]
That is too vague for me..."
To his credit, Judge Kaplan does leaves one important one
allegation for Enst & Young still to defend:
Ernst & Young had reason to know that Lehman's 2Q
2008 financial statements could be materially misstated because of the
extensive use of Repo 105 transactions.
John McDermott of FT Alphaville does a good job explaining why:
Kaplan dismisses the majority of the specific allegations
against the auditors but writes that one particular incident means that the
case against them cannot be thrown out [when] he stops to ask another question
on Repo 105:
In other words, have plaintiffs sufficiently
alleged that E&Y knew enough about Lehman's use of Repo 105s to
"window-dress" its period-end balance sheets to permit a finding that E&Y
had no reasonable basis for believing that those balance sheets fairly presented
the financial condition of Lehman?
The answer: yes, in one case.
Plaintiffs rely for this purpose on precisely
the same alleged red flags discussed previously in connection with E&Y's
GAAS opinion - the "true sale" opinion, the netting grid, and the Lee interview.
The first two are no stronger in this context than in that. The Lee
interview, however, is a different matter.
The "Lee interview" pertains to warnings allegedly made
Lee, Lehman's SVP for Global Balance Sheet and Legal Entity
Accounting, that Ernst & Young were told of a $50bn repo 105 move in
June 2008 but did not pass on the full information to Lehman's board. Thus, it
failed to fulfill GAAP requirements as part of its Q2 2008 auditing.
I've been saying for a while that there's too much
deflective focus on the accounting for Repo
105 and not enough on the disclosure. And I took particular exception early
on to Ernst & Young's handling of the Matthew Lee "whistleblower"
Read this article in its entirety at the re: The Auditors, a blog
by Francine McKenna.
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