Over on the the AECM listserv, several of us are fans of Ed Ketz (Penn State prof) and his Accounting Cycle column at SmartPros. For example, when Bob Jensen passes along the link to Ketz’s latest editorial, he always labels it “Ketz Me If You Can.” Tom Selling (Accounting Onion), sometimes calls his editorials, “The Betz From Ketz.” For my part, I occasionally feature Ketz on these pages, saying to myself, “Letz Getz Ketz on this.”
Today, Ed Ketz published an absolute must read editorial on his Accounting Cycle, “NY v. Ernst & Young: Who Cares Whether Lehman Brothers Followed GAAP?“
Ketz starts off by saying that Ernst & Young intends to fight the civil lawsuit alleging fraud in the Lehman Brothers case. I’ve noticed the same thing. In anticipation of a trial, E&Y has petitioned to have the case heard in federal district court instead of a New York state court. Based on pretrial statements, E&Y has repeatedly mentioned that Lehman Brothers was following GAAP, so technically no rules were broken.
Ketz notes that the current case is very similar to the 1960s Continental Vending case (US v Simon 425 F.2d 796). In this case three auditors from Lybrand, Ross Brothers, and Montgomery were charged with criminal fraud. Ketz writes:
While agreeing with the facts presented by the federal prosecutors, the defendants relied on a number of expert witnesses, all of whom stated that the deficiencies mentioned above were not part of generally accepted accounting principles. The trial judge issued directions to the jury that negated this perspective by maintaining that “the ‘critical test’ was whether the financial statements as a whole ‘fairly presented the financial position of Continental as of September 30, 1962, and whether it accurately reported the operations for fiscal 1962.” The jury found the defendants (auditors) guilty. The auditors appealed, but the circuit court affirmed the decision. The auditors then appealed to the Supreme Court, but it denied certiorari. [emphasis mine]
I think Ed Ketz’s analysis is sound. Although we can’t foresee the judge’s rulings in this case, E&Y is at risk here. Based on what I have read in the the Valukas report and the NY court complaint, it is my opinion that Lehman Brothers adopted its accounting practices with the intention to deceive investors and regulators. As such, their accounting shenanigans are absolutely repugnant to me. What’s more, I believe that E&Y auditors were aware of this motive, and blessed the accounting anyway. Technically correct or not, Lehman Brothers intended for its financial statements to not fairly present the results of operations. And E&Y opined that they did fairly present.
Will the jury be allowed to base its decision on the fairly presented issue? Tune in later.
Debit and credit – – David Albrecht