The auditor disciplinary arm of the Financial Reporting Council (FRC) of the UK has concluded its investigation and on June 22, 2012 announced that Ernst & Young (EY) is not to be penalized for its audit of the November 30, 2007, financial statements of Lehman Brothers Holdings Inc (LBHI).
Executive Counsel considers that there is no realistic prospect that a Tribunal would make an adverse finding against Ernst & Young LLP in the UK or Members within that firm. The investigation will therefore be closed and no further action taken.
Coupled with an earlier announcement from the Securities and Exchange Commission (SEC) of the US that no legal proceedings are likely to be initiated against EY or its employees, this marks the end of one the darkest chapters in recent accounting and auditing history.
Although EY will not be penalized for failing to alert investors to LBHI’s sophisticated scheme to manipulate its financial statements, it has embarrassed itself and shamed all of us in the accounting and auditing industry.
EY has showed itself to be no better than Arthur Andersen. Ernst & Young, shame on you.
The FRC is the regulator and standard-setter in the UK responsible for corporate governance and financial reporting as well as the audit, accounting and actuarial professions. It is not a governmental unit, but a private organization. It operates in the public interest.
The FRC operates in a manner similar to the Financial Accounting Standards Board (FASB) and Public Company Accounting Oversight Board (PCAOB) of the US.
A unit of the FRC, Accountancy and Actuarial Discipline Board (“AADB”), has investigated Ernst & Young over the LBHI matter. This is its summary of the investigation:
- On 10th June 2010 the Accountancy and Actuarial Discipline Board (“AADB”) considered the matter of Lehman Brothers (“Lehmans”) and decided, pursuant to paragraph 5(8) of the AADB Accountancy Scheme (“the Scheme”), that the matter should be investigated by the AADB.
- Lehman Brothers Holdings Inc. (“LBHI”) sought Chapter 11 protection in the United States of America on 15thSeptember 2008. The US Bankruptcy Court nominated an Examiner, Anton R. Valukas, who published his report into Lehmans’ collapse on 11th March 2010. The report made criticisms of Lehmans’ auditor, Ernst & Young, for failing to question and challenge improper or inadequate disclosures in Lehmans’ financial statements. The Examiner’s criticisms specifically related to the use by Lehmans of transactions known as Repo 105 and Repo 108 transactions. The report did not specify whether the criticisms related to the primary auditor of LBHI, which was Ernst & Young in New York, or Ernst & Young generally.
- Repo 105s and Repo 108s were used by Lehmans to raise short term funds and, by virtue of compliance with US Financial Accounting Standard 140 (“FAS140”) which requires certain transactions to be treated as sales instead of financing transactions, enabled Lehmans to reduce its balance sheet and leverage ratios. The Examiner found that whilst the use of Repo 105/ 108 transactions may not have been inherently improper its sole function as employed by Lehmans was balance sheet manipulation.
- The scope of the AADB investigation was as follows:“The conduct of Members and a Member Firm in relation to: (a) the preparation and audits of the financial statements of Lehman Brothers Holdings Inc.and UK operations including Lehman Brothers International (Europe) for the year ended 30th November 2007;and (b) the use and accounting treatment of transactions known as “Repo 105s” and “Repo 108s” by Lehman Brothers Holdings Inc. and UK operations including Lehman Brothers International (Europe).”
- The focus of the investigation was the audit by Ernst & Young LLP in the UK (“EYUK”) of Lehman Brothers International (Europe) (“LBIE”) and of Repo 105 and Repo 108 transactions which were conducted through LBIE. EYUK audited the trial balance of LBIE prepared under US GAAP for consolidation into LBHI’s consolidated financial statements. The audit of LBIE’s trial balance formed the basis of a ‘Specific Scope Conclusion’ to Ernst & Young in New York.
- In the course of the investigation, the investigation team obtained and reviewed EYUK’s audit files; hard copy documentation; information from EYUK staff members’ laptops and emails, and information from other regulators. The team also interviewed EYUK audit team staff and former members of staff of Lehmans.
Debit and credit – - David Albrecht