Ernst & Young Gets Pulled Into Lehman Ugliness

There have been questions about the role of Lehman Bros auditor Ernst & Young since an investigation into the bankruptcy done by an independent party–Anton R. Valukas, Chairman of Jenner & Block — was release. The 2,200 page report indicated that E&Y was at least incompetent in its final Lehman audit which was for year ending November 2007. The term Valukas used in his document was “professional malpractice”. That judgment in and of itself is not enough to set off litigation, but it is close. A group of unsecured Lehman creditors told the bankruptcy judge today “that it wants information from Lehman’s former auditor about the transactions to determine, for example, whether the group could sue parties who profited from Lehman’s use of the deals,” according to Bloomberg.

To the extent that in legal actions one thing often leads to another, the creditors may be more interested in why E&Y did not catch Lehman’s use of Rep0 105 instruments to temporarily improve its financial picture. The creditors may have little actual interest in “parties who profited from Lehman’s use of the deals.” E&Y is a huge and rich target and its negligence in catching Lehman’s financial tricks could be the source of significant negligence suits.

The press has gotten over-excited by the prospects of seeing E&Y in court making the comparison to the Enron audit that brought the energy firm’s auditor, Andersen, down in 2002. But, the Andersen problem was substantially a case of fraud on the part of the audit firm as it became clear that some of its workers shredded Enron documents to cover their trails.

What is highly likely is that any litigation by either the government or a class of shareholders will put E&Y in a position not unlike Goldman Sachs Group’s (NYSE: GS). Guilty until proved innocent.

Douglas A. McIntyre