Repo men: Lehman and Ernst & Young

Will Lehman be Ernst & Young’s Enron?

That is the question everyone is asking after the publication of investigator Anton Valukas’s report suggesting that Lehman may have used an, um, unusual accounting practice — Repo 105 — to make it look as if its leverage was much lower at each quarter-end that in fact it was. The effect of this was to make it appear financially stronger than it was.

Ernst & Young arguably did not meet professional standards, both in investigating whistleblower allegations about the use of Repo 105 and in connection with the audit and review of Lehman’s financial statements, claims Mr Valukas.

reports the FT, though it also offers the surprising comment that “Accounting experts say the Lehman report will not be “an Enron” for Ernst & Young, in part because, with only four big accounting firms remaining, clients do not have many options to move elsewhere.” Oh, so that’s all right then — no matter what they may have done (if anything — and that is not established at this point), they can’t go down because there aren’t enough other auditors in the world to fill the gap.

Bad signal.

The FT have a reasonable slideshow on Repo 105 here, And there’s a pretty good explanation of the matter here by Simon Watkins of the Mail (of all sources).

Lehmans couldn’t get a US firm to sign off on the legality of the practice, so they took advice from Linklaters, who said it was doable under English law. Linkies’ comment to the New York Times’ DealBook team was standard:

The U.S. examiner’s report into the failure of Lehman Brothers includes references to English Law opinions which Linklaters gave in relation to a number of Lehman transactions. The examiner – who did not contact the firm during his investigations – does not criticise those opinions or say or suggest that they were wrong or improper. We have reviewed the opinions and are not aware of any facts or circumstances which would justify any criticism.

However, what I really love is the Lehman’s internal e-mail exchange quoted at the end of the NYT piece:

* “It’s basically window-dressing.”

* “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the street do it? Also is that why we have so much BS [balance sheet] to Rates Europe?”

* “Yes, No and yes. :)”

So, it seems to be a one-off practice to Lehman (see answer 2 above). I think E&Y are in trouble on this one.