OPENING UP LIABILITY OF ACCOUNTANTS TO INVESTORS —

MORTGAGE BOND BUYERS, LEHMAN STOCKHOLDERS AND HOMEOWNERS —

“MASSIVE ACCOUNTING FRAUD” CITED

READ ARTICLE IN FINANCIAL TIMES WITH LINKS TO OTHER STORIES

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EDITOR’S ANALYSIS: There are two parties whose job it was to know that their clients were committing massive fraud in the illusory securitization of receivables than ran the gambit from non-existent to highly improbable to pledged more than once — to diverted from the proper recipients and credited to nobody. Those two parties are definitely the auditing firms of the investment bankers who pulled off this horrible stunt and the rating firms without whose supposed “due diligence” it would not have been possible. Arguably one could add the so-called “trustee” of the empty pools of assets and maybe the “Trustees” who obtained title on Deeds of Trust under false pretenses from homeowners.

The question on everyone’s mind has been will they get away with it? Are they too big to prosecute? Are they too enmeshed with government to be at any risk? The final answer is months if not years away. But he growing trend is clear. Chicanery at the legislative and regulatory level might have been within their grasp, but although the wheels of justice grind at a double proverbial snail’s pace, the trend doesn’t look good for ANYONE who had ANYTHING to do with the GRAND ILLUSION which we have all called securitization and derivatives.

The inescapable suspicion that is growing into a presumption is that the entire affair is a farce treated as reality long enough to make people believe it. It appears the one thing thing that seems to have escaped the perpetrators whom we wish to see doing their “perp walk” proclaiming their innocence, is that the questions would not end. The questions continue despite their mightiest efforts to dismiss them as irrelevant. And the questions are getting better and better and more pointed as to exactly what DID happen here for the last ten years.

Judges don’t like stupid claims or stupid defenses and if they spot one or more they use varying techniques to not only throw them out but to discourage others from using them. So the initial reaction of the judicial system was highly cynical and skeptical — it just wasn’t reasonable to assume that the largest and oldest financial institutions in the country would put themselves and the world at peril intentionally. But as Arthur Conan Doyle’s Holmes points out, once you have eliminated all of the likely explanations, then the only one left, no matter how implausible, is the the right one like it or not.

How far this liability will extend for the auditors and rating agencies also remains to be seen. But we know that any reasonable man would be able to reason out that if they knew Lehman was actually broke, and they knew Lehman was committing accounting and reporting violations intentionally, and if they knew they were doing business with Lehman, they would probably have not entertained consummating the deal.

Thus institutional investors would not have bought mortgage bonds, equity investors would not have bought Lehman stock and homeowners would not have bought a financial product masquerading as a loan without looking several times “under the hood” so to speak. They all would have moved on with greater suspicion of everyone who offered them similar “deals.”

The case for fraud in the execution and fraud in the inducement, deceptive lending, illegal sale of securities, and stockholder fraud is quite strong in the Lehman case — and so might it be for the rest of the megabank players in the GRAND ILLUSION we called “securitization.”

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Ernst & Young sued over Lehman

By Kara Scannell in New York

Published: December 21 2010 18:54 | Last updated: December 22 2010 00:37

New York prosecutors accused Ernst & Young of helping Lehman Brothers engage in a “massive accounting fraud” by approving a move that temporarily reduced the investment bank’s debt and gave investors an impression it was in a stronger financial condition.

The civil lawsuit, filed in a New York state court, alleges the auditing firm “substantially” helped Lehman mislead investors from 2001 until the brokerage firm’s 2008 bankruptcy filing by signing off on the accounting sleight of hand.

EDITOR’S CHOICE

E&Y suit hinges on Lehman use of Repo 105 – Dec-22

Lex: Ernst & Young / Lehman Brothers – Dec-21

FT Alphaville: Cuomo’s coruscating complaint – Dec-21

In depth: Lehman Brothers – Nov-23

Lehman creditors unveil rival bankruptcy plan – Dec-16

Lex: Auditors – Nov-25

The strongly worded lawsuit goes further than accusing Ernst & Young of misconduct. It alleges Lehman engaged in a “massive accounting fraud” by using the accounting treatment, known as Repo 105.

The office of New York Attorney General Andrew Cuomo does not name any former Lehman officials in the lawsuit, leaving open the question of whether additional charges will be filed against any former Lehman officials.

The lawsuit is the first legal action taken by the government involving Lehman Brothers’ collapse. The use of Repo 105 was first exposed by Anton Valukas, a court-appointed bankruptcy examiner appointed to investigate the firm’s collapse. Mr Valukas published an extensive report last March detailing the use of Repo 105 and alleging Ernst & Young could be liable for malpractice.

Lehman began using Repo 105 to take advantage of an accounting rule change that permitted certain repurchase agreements to be treated as sales, if the bank had a ‘true sale’ letter from a law firm saying it gave up control of the assets, the lawsuit alleges.

Ernst & Young approved the treatment of Repo 105 as sales, which authorities allege were really short-term financings since the securities were quickly bought back by the bank.

That classification allowed Lehman to remove the securities from its financial statements giving the impression that it had lowered its debt. Lehman did not disclose the Repo transactions to investors.

Lehman used Repo 105 to “park tens of billions of dollars” with European banks around quarter ends to reduce debt on the brokerage firm’s balance sheet and gave investors a “false” impression of its financial health, the lawsuit alleges. For its services, Ernst & Young made $150m in fees between 2001 and 2008. Mr Cuomo is seeking the return of all these fees plus damages.

As the bank’s financial condition worsened during the financial crisis, it increased the frequency and size of transactions. Repo 105 was used to move $36bn off its balance sheet in August 2007 and $50bn at the second quarter of 2008.

Ernst & Young said the suit had no “legal or factual basis” and vowed to “vigorously defend against” the claims. “Lehman’s bankruptcy was not caused by any accounting issues,” the firm said.