Ernst & Young and Lehman Brothers: A Summary of Quotes, Stories and Links

On the third anniversary of the Lehman Brothers bankruptcy – September 15, 2008 – I’m reposting this piece from March 21, 2010 that has links to most of my stories on the subject up to that point.

Three posts that followed soon after the piece below include a nice quote in BusinessWeek and Part One and Part Two of my discussion of the Ernst & Young response to the release of the Lehman bankruptcy examiner’s report.  The firm’s first move was to send a letter to an Audit Committee members group – always selling – before they made any full response to the media about the bankruptcy examiner’s report. I was the first media outlet to publish the letter.

Finally, in September 2010, on the second anniversary of the bankruptcy, I had the honor of sitting on a panel at the New York County Lawyers Association with Jenner & Block’s Anton Valukas, the Lehman bankruptcy examiner, and Floyd Norris of the New York Times.

I prepared a post, “Top Ten Things Lawyers Should Know About Auditors,” for that occasion.


The release of Anton Valukas’ Lehman Bankruptcy Examiner’s Report on March 11, 2010 threw a fresh match on the still smoldering remains of the 2008 failure. The mainstream media, regulators, legislators and the business community blamed everything but fraud for the financial crisis and everyone but the audit firms for preventing, warning, or mitigating the devastating impact of the crisis.

If you’ve been reading the stories on this site, however, you may have come to the conclusion that I did a long time ago:

There was widespread fraud at the highest levels and the Big 4 auditors will eventually be accused of malpractice and complicity for doing nothing to prevent it, to warn us, or mitigate the impact on stakeholders.

I’ve published several stories since 2007 on the mortgage originators that failed or were taken over and the lawsuits against their executives and auditors. This is not the first bankruptcy examiner’s report to provide a detailed litigation roadmap in a subprime/crisis era fraud and to point to auditor malpractice. The New Century Bankruptcy Examiner’s report made quite a splash, too, when it came out. It also provided a litigation roadmap and included a smoking gun set of emails that pointed to alleged complicity and malpractice by auditors KPMG.

From Kevin LaCroix’s D&O Diary site:

“…the new lawsuits follow more than a year after the February 29, 2008 581-page report of Michael Missal, the KPMG bankruptcy examiner, in which the examiner concluded that KPMG had “contributed” to certain of New Century’s “accounting and reporting deficiencies by enabling them to persist in, and in some instances, precipitating the Company’s departure from, applicable accounting standards.” A detailed review of the examiner’s report, including a link to the report itself, can be found here.

The examiner’s exhaustive review, which among other things specifically suggested the possibility of negligence claims against KPMG, was effectively a road map for the April 1 lawsuits. While the lawsuits might well have been filed even without the examiner’s report, few other prospective claimants considering “gatekeeper” litigation will have such a detailed script from which to compose their complaint.

The  collapse of Refco is another ongoing case that will become quite relevant to the Lehman case. In Refco, the Bankruptcy Examiner did a thorough job of dissecting the fraud, including the nature of “roundtrip” transactions orchestrated for the sole purpose of temporarily manipulating the Refco balance sheet.

Sound familiar?

Refco is actually a much closer case to Lehman than the Enron case, notwithstanding the strong role of the long auditor relationship in all three. The nature of the Lehman transactions used to commit the alleged fraud, the likelihood of early guilty pleas by corporate executives in Lehman like Refco, the difficulty of success with claims against third party advisors such as law firms and audit firms for aiding and abetting the fraud are more similar to Refco than Enron.

My most recent stories about Lehman and Ernst & Young began a month ago with a prediction that fraud allegations would center around standard accounting manipulation techniques such as round trip transactions, channel stuffing, and parking.

“…premised on some of the oldest tricks in the book for manipulating revenue recognition and, therefore, reported profits and incentive compensation payouts including stock options – roundtrips, parking, and channel stuffing. In another variation on the theme, global trading company Refco used a round trip loan to repeatedly hide a related-party transaction incurred to delay disclosure of significant uncollectible accounts.  It’s not like these techniques haven’t been used before (by AIG, for example) to offload risk and smooth earnings at quarter- and year-end.”

Although most media reports tended to pull out the tired tropes of Enron, off-balance sheet, and Sarbanes-Oxley, one journalist did pick up on my theory and analysis instead.

Without giving credit.

Some journalists questioned the wisdom of criminally prosecuting the Lehman executives. Without denying the potential for and the legal basis for prosecutions, John Carney of Clusterstock asked what purpose criminal prosecutions would serve.

I ask the opposite.

Whose interests would it serve to avoid criminal prosecutions?

My response to John Carney and a scathing indictment of his point of view by Ryan Chittum in The Audit, a Columbia Journalism Review (CJR) blog, earned me a substantial mention in a later post by Ryan at CJR.  I also was linked to by Aaron Task in a summary of the controversy on his Tech Ticker site.

I posted two stories in early 2008 discussing Erin Callan and Ian Lowitt, the last two non-accountant CFOs of Lehman, and the vilification of David Einhorn for questioning Lehman’s accounting.

A post on March 9th anticipated a defense which may be used by Ernst and Young in the Lehman case, in particular given its status as a bankruptcy trustee’s case.

In Pari Delicto: Are Auditors Equally At Fault In The Big Fraud Cases?

In addition to my Going Concern column written to comment on the John Carney/Ryan Chittum debate, I also wrote here on the major accusations against Ernst & Young in the Examiner’s Report.

Liberté, Egalité, Fraternité: Big Lehman Brothers Troubles For Ernst & Young

I have also posted a letter Ernst & Young sent to Audit Committee members defending themselves against the numerous allegations in the Lehman Examiner’s Report.

An Ernst & Young Response: Dear Audit Committee Member…


The Financial Times FTAlphaville blog links to the Audit Committee Letter this morning.

Reuters Emily Chasan picked up on this and linked to me today in her story on the Lehman whistleblower.

Blogger extraordinaire Zero Hedge follows up Emily Chasan’s story with his own including a shoutout to Emily and I.

The Times of London in the UK wrote a story this morning on the Audit Committee Letter with a link to re: The Auditors.

Accounting Web has the story here.

The UK’s Financial Reporting Council has begun an investigation into EYs role in the Lehman fraud. Expect to see much much more on this in the weeks to come. I wrote a short piece for Accounting Web UK to summarize the issues for their European audience.

Nowhere to hide: Accounting firms face increased scrutiny after Lehman report

I will be writing much more on this in the next few weeks. Topics I plan to address include looking more deeply into the valuation issues, which were barely touched on, the impact on the other large audit firms, the role of Lehman’s internal audit function, the specific accounting for the Repo 105 transactions, the relationship of this bankruptcy to the Lehman bankruptcy case in the UK, my prior theory about the fraud and additional theories for litigation.

16 replies
  1. Sara McIntosh
    Sara McIntosh says:

    Hi Francine,

    Wow–what a way to kick-off Monday morning at a fever pitch! I LOVE reading your posts and am really quite amazed at how you do all that you do.

    I couldn’t agree more with your lead-in statement, “There was widespread fraud at the highest levels and the Big 4 auditors will eventually be accused of malpractice and complicity for doing nothing to prevent it, to warn us, or mitigate the impact on stakeholders.”

    And, I can’t wait to read your in-depth accounting of how they did it and how that caused the financial crisis. Somebody needs to lay it all out for Congress to read, and you’re better at it than anyone I’ve read. I just hope all of your hard work can bring about some of the fundamental changes we need in the industry.

    I am usually against added governmental intervention and believe open market conditions do take care of a lot of sins–but not always. As I outline in my blog post today, “Massages Gone Wild,” we can’t possibly expect the SEC or any other government regulator to be able to stop the rampant, and often fraudulent, financial massaging that goes on in the largest corporations while the auditors are controlled and paid for by the companies they audit. If the SEC needs an “independent audit,” then they should be the client controlling and paying for the audit, period. There is no other way for them to ever have a prayer of getting out in front of the next financial trainwreck, even with Mary Schapiro’s $1.3 billion budget request.

    Here’s a link to my post

    Happy Monday and keep up the outstanding work, Francine. You’re an inspiration to us all!

    Ciao for Now,

    Sara McIntosh

  2. Marek Bruekner
    Marek Bruekner says:

    Hello Mrs Francine,

    my name is Marek Bruekner. I started to fight against the Citibank and organizing the German Lehman victims in October 2008.

    We are actually organized in 18 cities with round about 1300 victims. As far as we can trust the statistics we talk about 50 000 victims in Germany who had lost about 600 to 900 Mio. €. A part from this we have a lot of cities and local authorities and fundations who have lost money abd had not been covered at all!

    While we looked through Europe we found a similiar system in Belgium, Spain, Switzerland, Poland, as well as Singapur and Hong Kong and obviously in England.

    Round about 200 000 victims might be involved world wide by the EUROPEAN NOTE Program. Main partner for these deals in Europe had been the Citigroup.

    The middle age of our victims is 68 years. They might be even older because we can only talk about the victims that had got in contact with us. We mainly are organized in the following structures:

    The german wide network (this network got out of function 4 month ago and we still do not know exactly why? It had worked fine for 15 month and had up to a million page views and hundred of articles, video and press relations and so on…
    My “research for proves organization”
    Or the

    Verbraucherzentralen – customes defense organizations or
    Round about 120 advocates in charge to defend Lehman Brother victims. (CITIGROUP, DRESDNER BANK, FRASPA BANK)

    I would be very happy to talk to you and exchange our informations about Lehman and the CITIGROUP. We would appreciate your police and Staatsanwaltschaft to research in cooporation with the German organs.

    I gave up my normal work as an real estate consultant about 18 month ago and I do nothing else than looking for the “facts of criminal acts of the CITIBANK”.

    Any contact and advice is helpful and appreciated.

    I hope that your activities will be of a great success and would appreciate to assist. II beg your pardon for my english and I might count on your understanding. I can over you my help in Polish, Portugese, Italian and German and would be glad to talk to you.

    Anyhow lots of luck

    With best regards

    Marek Brükner
    Self defense organization for Lehman victims in Germany

    Bahnhofstrasse 51 A
    61118 Bad Vilbel

    Tel. 0049 6101 5481 400
    skype marek.bruekner

    I am very happy if you could send my contact details to the american lawyers, advocats, defense organizations, SEC and so on. We collected a huge amount of indirect proofs and would be glad to talk about. We are actually contacting more than 1000 victims with a 250 questins questioneer to get a clear idea about what had happened from March 2007 until Sept. 2008 in the sales activities of the Citigroup in Germany.

  3. Carl Olson
    Carl Olson says:

    There is also a lawsuit against Lehman execs and Ernst & Young by the County of San Mateo (Calif.) and other losing government entities. It was filed a few years ago. How is it coming? Worth reporting. .

  4. Richard Archer
    Richard Archer says:

    Hey Francine – With the release of the bankruptcy investigation papers on Lehman Brothers; the investigator’s findings that there is likely cause for action against Lehman, EY, and various executives; and the recent 60 Minutes story on CBS, are you planning any further updates on your analysis and views of the situation and likely outcome? Although the SEC has issued a statement that possible action against Lehman is still under consideration, that looks more like a smoke screen, feel good statement to try to keep the public from asking too many questions, rather than an indication that the current administration will actually do anything. Since you were reporting on this very early and your comments and questions about a large number of Lehman Brothers’ activities and EY’s complicity in allowing (enabling??) it to happen have been proven accurate, what is your take on the bankruptcy investigation report? Will we ever see any of the responsible people taking extended work leave due to a well deserved stay at “Club Fed”?

  5. Francine
    Francine says:

    @Richard Archer

    Thanks for all that. I was quite excited by Tony Valukas’ appearance on 60 Minutes and his emphatic reminders that there are colorable claims against EY and the executives. I’m as disappointed as he is that nothing seems to be happening. I have been following the EY situation at NYAG with them and with the SEC. I am only assured that the investigation and claims are still active and that they are listening to what I have said and written. I think, unfortunately, a great deal of patience is required here. It may take too long, but I can wait.

Trackbacks & Pingbacks

  1. […] There were reports, later denied by Chairman Shapiro in Congressional testimony, that the SEC would not pursue any charges against Ernst & Young for the Lehman failure. I’ve always said that serious sanctions against Ernst & Young by the SEC or DOJ are unlikely. The SEC and PCAOB would be totally remiss, however, if they did not eventually sanction some Ernst & Young individual partners at least, if not Ernst & Young as a firm, for its role in the Lehman failure. That role has been eloquently described by the Lehman Bankruptcy Examiner Anthony Valukas. […]

  2. […] and time consuming, litigation, especially as a result of the failure of Lehman Brothers. But the cases against Ernst & Young for Lehman drag on with no word from the SEC about their investigation – except rumor and innuendo about no likely […]

  3. […] We’ll have to see what the upcoming Ernst & Young and Deloitte reports show. Ernst & Young has been criticized for the Groupon multiple S-1 issue, as well as questions about accounting at future IPOs Zynga and Facebook. Now we have Olympus, too. And, of course, the jury is still out on the firm’s role in Repo 105 and Lehman Brothers. […]

  4. […] writing should make my case, prima facie, about why it’s important for you to read it.  Events have caught up to my rhetoric. My natural tendency to investigate, instigate and illuminate has resulted in a […]

  5. […] News broke late Sunday night that the New York Attorney General would charge Ernst & Young (EY) with fraud over their involvement as auditors of Lehman Brothers. […]

  6. […] Lehman bankruptcy examiner’s report, issued in March 2010, is a 2,000-word work of compelling non-fiction.  Anton Valukas, the […]

  7. […] decibel level is not as high in the US as in the UK and EU.  The “outrage” over Ernst & Young’s role in the Lehman bankruptcy lasted about a month here.  Hell, we still haven’t seen any Congressional inquisitors call […]

  8. […] The Auditors will continue to cover Lehman, Repo 105, Tony Valukas, and the bankruptcy examiner’s report, as well as related topics. For […]

  9. […] the Lehman Bankruptcy Examiner’ Report was issued on March 11th, the auditors had experienced a “good crisis.” No serious […]

  10. […] re: The Auditors » Blog Archive » Ernst & Young and Lehman Brothers: A Summary of Qu… […]

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