Leading accountancy firm Ernst & Young is facing legal action for its alleged role in "window dressing" the accounts of Lehman Brothers as it careered toward collapse.
New York attorney general Andrew Cuomo is reportedly preparing to sue the firm as early as this week. The case would be the first against a major accounting firm over its role in the credit crisis.
Cuomo's office has been investigating the accountant's role in Lehman's use of repurchase agreements or "repos" to bolster the bank's accounts. The suit is part of a broader investigation into whether banks misled investors by using strategies, branded "window dressing" by critics, to temporarily shift debt off their books.
The case comes nine months after a damning report into the Lehman's collapse that said the accountancy firm failed to challenge "materially misleading" reports filed by the bank's management.
The scheme under fire from Cuomo was first detailed in March by Anton Valukas, the bankruptcy examiner investigating Lehman's bankruptcy. According to Valukas's 2,200-page report the bank used repos to move $50bn (£32bn) in loans off its balance sheet shortly before its collapse. Lehman labelled those transactions as securities sales, the transactions – known as "Repo 105" – were carried out on a quarterly basis in 2007 and 2008, according to the bankruptcy examiner.
"The balance sheet manipulation was intentional, for deceptive appearances," Valukas wrote. He called Repo 105 "window dressing", an "accounting gimmick" and a "drug" and concluded that E&Y had failed to reach "professional standards" and could face legal action.
According to Valukas, Matthew Lee, a Lehman accounting executive and bank employee for 14 years, raised concerns about Repo 105 and the bank's accounts with E&Y. Lee detailed his worries in a letter in May 2008, four months before the collapse. The accountant took "virtually no action," according to Valukas.
Lehman was one of E&Y's biggest clients before its collapse in September 2008. Cuomo's investigation comes as other regulators including Britain's Accountancy and Actuarial Discipline Board, the investigative and disciplinary arm of Financial Reporting Council, continue to probe E&Y's Lehman role.
A spokesman for the firm declined to comment although at the time of the report it said that it had investigated Lee's allegations but "there were no material issues identified".
Cuomo's office did not return calls for comment. Cuomo was recently elected governor of New York and finishes his term as attorney general at the end of the year. The Lehman case is likely to be handed over to his successor, Eric Schneiderman, if it is not filed before the year end.
Bankers have defended their use of repos, which were widely used by other finance firms. Kaushik Amin, the former head of liquid markets in Lehman's fixed income division, told Valukas' investigators: "If the examiner thinks we were using Repo 105 to manipulate the balance sheet, he is smoking dope," according to the lawyers present at the interview. Citigroup, Bank of America and insurance giant AIG have recently admitted to classifying billions in repos as sales in recent months.
Lehman, once the fourth-largest investment bank, failed in September 2008, triggering a global collapse in the financial system. Cuomo's action would be pursued through the civil and not the criminal courts. So far no senior executive associated with the credit crisis has faced criminal action.
