Has Another One Bit the Dust?

Today, December 21, 2010, the Attorney General of the State of New York filed civil suit against Ernst & Young for fraud in connection with financial reporting by Lehman Brothers.

Does this mean that we have entered the era of the Big 3?

The charges (Ernst-Young-Complaint) were filed by New York Attorney General Andrew M. Cuomo on behalf of the citizens of New York.  Here are a few key excerpt (with my highlights on key wording):

E&Y substantially assisted Lehman Brothers Holdings Inc. (“Lehman,” or the “Company”), now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public.

The allegations conclude with:

E&Y knew every significant aspect of Lehman’s Repo 105 transactions, and knew that the Lehman financial statements violated Generally Accepted Accounting Principles (“GAAP”), which require that such statements (a) not be misleading, (b) fairly disclose the Company’s financial position, and (c) not omit material information necessary to fairly present the financial position. As the public auditor for Lehman, E&Y had the absolute obligation to ensure that Lehman’s financial statements complied with GAAP and did not mislead the public.  Instead of fulfilling this obligation, E&Y gave a clean opinion each year, erroneously stating that Lehman’s financial statements complied with GAAP. E&Y sat by silently while Lehman deceived the public by concealing the Repo 105 transactions and misrepresenting the Company’s leverage. By doing so, E&Y directly facilitated a major accounting fraud, and helped Lehman mislead the public as to its true financial condition. E&Y, which reaped over $150 million in fees from Lehman, must be held accountable for its role in this fraud.

In the complaint, Cuomo alleges that Lehman Brothers was engaging in Repo 105 transactions from 2001 until 2008 (date of Lehman bankruptcy) with full knowledge and approval of Ernst & Young.  Allegedly, Ernst & Young knew the motivation for the Repo 105 transactions was to distort the financial statements.  Also, allegedly Ernst & Young knew that in practice Lehman’s transactions violated the terms of the Linklaters letter of safe harbor.

Until settled in a court of law, Ernst & Young stands legally innocent.  However, if these charges are true, then I simply can’t imagine that any investor would view any Ernst & Young audit opinion as credible.  Even if Ernst & Young escapes these charges, my faith in the firm has been shaken to the core.

Debit and credit.