Law360 article quotes Jeff Ifrah regarding lawsuit brought against Ernst & Young for its alleged role in Lehman Brothers collapse.

Dec 23, 2010

Law360 article quotes Jeff Ifrah regarding lawsuit brought against Ernst & Young for its alleged role in Lehman Brothers collapse.

By Abigail Rubenstein
Additional Reporting by Jacqueline Bell
December 21, 2010

New York Attorney General Andrew Cuomo’s lawsuit over Ernst & Young LLP’s alleged role in the collapse of Lehman Brothers Holdings Inc. has raised the specter of Arthur Andersen LLP, with some predicting the case could push the accounting giant toward similar troubles.

The civil lawsuit, filed Tuesday in the Supreme Court of the State of New York, New York County, accuses Ernst & Young of helping Lehman secretly remove tens of billions of dollars of fixed-income securities from its balance sheet in the years leading up to the investment bank’s September 2008 bankruptcy filing.

Cuomo claims that Ernst & Young violated New York’s Martin Act by helping Lehman hide its so-called Repo 105 transactions — in which Lehman transferred fixed-income securities to European counterparties in return for cash, with an understanding that Lehman would shortly repurchase the equivalent securities.

Lehman used these deals, particularly at the end of financial quarters, to reduce its balance sheet leverage, the suit alleges.

The suit is the first brought by regulators against a major accounting firm for contributing to the financial crisis, and has already prompted comparisons to the Arthur Andersen scandal. The accounting firm went out of business following a conviction on criminal charges stemming from its audit of Enron Corp., though the verdict was later overturned by the U.S. Supreme Court in 2005.

“This lawsuit is a reminder that the same thing could happen to any one of the Big Four,” University of Denver law professor Jay Brown told Law360 Tuesday.

The complaint recalls shades of Arthur Andersen, which may have been a deliberate choice on the part of Cuomo, according to Jeff Elkin of Porter & Hedges LLP.

“Change out the name of the investments and substitute Enron for Lehman and the allegations portray a very similar scenario to the Arthur Andersen case — that the auditors were in the room and they knew what was going on. It looks like he’s trying to paint the same picture,” Elkin said.

Attorneys were quick to point out that, unlike Arthur Andersen, Ernst & Young is not currently facing criminal charges.

Nonetheless, a powerful regulator accusing an accounting firm of fraud, even in a civil context as Cuomo has, could have serious repercussions, experts say.

“It’s extremely rare for a regulator to bring an action against an accounting firm with these kind of charges, and typically when accounting firms have been sued by the SEC they usually settle the matter so the complaint is done in a settled context,” said Michael Missal of K&L Gates LLP.

While Cuomo’s lawsuit may not be enough on its own for public companies to lose confidence in the auditor, there is nothing to prevent spooked companies from taking their business elsewhere if additional suits follow, according to Brown.

“This isn’t a perfect storm, but it could be a piece of a perfect storm,” he said.

Part of that may depend on whether other civil litigation, large-scale investigations or even criminal charges will ensue, but they already have a good roadmap if they choose to do so, attorneys said.

The current allegations are rooted in findings bankruptcy examiner Anton R. Valukas of Jenner & Block LLP released in a March report attacking decisions Lehman executives made to buy themselves time after the collapse of Bear Stearns Cos.

The report castigates Ernst & Young for not questioning the Repo 105 deals or the fact that Lehman was not disclosing them, and could give others a similar blueprint for filing charges.

The U.S. Securities and Exchange Commission is said to be contemplating such a move, with Fox Business Network reporting Monday that Ernst & Young was in preliminary settlement talks with the agency. The Department of Justice has also reportedly been investigating the events surrounding Lehman’s collapse.

European regulators may also step into the fray.

Britain’s Accountancy and Actuarial Discipline Board said in June that it had opened a probe into the conduct of Ernst & Young related to Lehman, including the use and accounting treatment of Repo 105 transactions.

“If the federal government steps in — if the SEC or DOJ decides to take action you will see a more significant impact on Ernst & Young,” said Carlos Gonzalez of Diaz Reus & Targ LLP.

But experts agree that, given what happened in the wake of the prosecution of Arthur Andersen, federal regulators and prosecutors are likely to carefully weigh the potential consequences before launching their own suits against Ernst & Young.

For the federal government, it will come down to a matter of policy and whether they think punishing Ernst & Young’s alleged misconduct is worth the potential collateral damage from going after one of the Big Four, according to Gonzalez.

“No one is interested in destroying one of our nation’s leading accounting firms,” Ifrah PLLC founder Jeff Ifrah said. “If discovery demonstrates that individuals acted with criminal intent, I would fully expect criminal charges to be considered. But against [Ernest & Young]? No way.”

Despite the potential impact on the accounting industry, some experts question whether regulators and prosecutors would be right to show restraint if allegations that Ernst & Young knowingly helped Lehman perpetrate a fraud prove true.

“Is it the legacy of the Arthur Andersen prosecution that large accounting firms get a ‘pass’ from prosecutors for criminal acts lest the Big Four becomes the Big Three?” said Boston University School of Law Professor Cornelius Hurley. “Have we progressed to the point where the corollary to the too big to fail policy is that certain firms are also ‘too big to jail’?”