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.

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Provocative but not wholly unpersuasive slant from zerohedge.Com, who say that Obama is, in true Roman fashion, distracting the people with bread and circuses (well, at least circuses) from the main story:

“For those who care where the real news is, we direct your attention to today’s Daily Treasury Statement, which disclosed that total US debt just jumped to $12.817 trillion, $51 billion higher on the day, $101 billion higher for the month of April, and $965 billion higher for the fiscal year beginning October 1, 2009 (so six months ago).”

The figures are staggering. Which is what makes one sit up and think, Hmmm, not so far-fetched, perhaps.

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Senator Ted Kaufman Comments On Goldman SEC Charge:

“‘To restore the public’s faith in our financial markets and the rule of law, we must identify, prosecute, and punish with stiff fines or prison those who broke the law. Their fraudulent conduct has severely damaged our economy, caused devastating and sustained harm to countless hard-working Americans, and contributed to the widespread view that Wall Street does not play by the same rules as Main Street.’”

Via zero hedge, whose coverage on the Goldmans issue is extensive and interesting.

And according to the Huffington Post this may be only the first of many such actions:

…in going after Goldman Sachs, the SEC is sending a message, Tavakoli [a Chicago-based derivatives expert and founder of Tavakoli Structured Finance] said. Firms like JPMorgan Chase are reserving more of their cash for an expected onslaught of lawsuits, according to regulatory filings. JPMorgan set aside an additional $2.3 billion for “increased litigation reserves, including those for mortgage-related matters,” according to its first quarter filings released this week.

For, um, balance, here is Goldman’s response, just out. Basically, “we lost money too and everyone knew the risks“. [Note the interesting comments to the post, too].

Watch this space.

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Toyoto is not having a good time. A couple of days back I wrote about the Toyota slow-motion PR wreck. Yet here is another perspective on the whole matter from Ed Wallace on Business Week.

He cautions, soundly, against knee-jerk reactions and suppositions, citing very very biased reporting and investigation in the cases of Audi, Suzuki (do you remember the rolling-over jeep?) and Firestone tyres. According to Wallace, almost everything in those cases was invented, there being, in truth, either no fundamental defect or one that was minor, limited and quickly remedied.

Talking about the Audi 5000 incident in particular, Wallace is instructive:

In the 60 Minutes piece on Audis’ unintended acceleration that put this story over the top, they brought in William Rosenbluth to prove that Audis were defective on camera. As 60 Minutes correspondent Ed Bradley said, “We took a car that had already been involved in two sudden-acceleration incidents and, without his foot on the gas pedals, showed it could do this.” Again from the book, Junk Science[1]: “… and 30 million viewers saw it with their own eyes.” What they saw was the gas pedal apparently moving under its own power.

But what the viewers didn’t see was also revealed in Walter Olson’s column, “It Didn’t Start with Dateline NBC:” Off camera, they had drilled a hole in the vehicle’s transmission and pumped extreme high-pressure air into it, which had the effect of moving the gas pedal down without the driver pressing it.

The audience and all of America came to believe that this Audi with two black marks against it was possessed. In reality, it was rigged.

As you’d expect, an Audi official appeared on that broadcast. He said his company had investigated these incidents and could find nothing wrong with their vehicles. Nobody believed him.

So it will be interesting to see what happens here.

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Just when you thought it was all over, safe to go in the water etc, it looks like the banks are going to get hit all over again. Mrs. ReRisk has been predicting this for some time and it looks as if she is going to be vindicated.

From data compiled by DeMontfort[1] University, Savills estimate that there is £38bn of negative equity currently on investment properties but this might rise to £50bn once you factor in the drop in the underlying land values, or 25% of the entire lending book in round terms. Shopping centres are particularly badly affected, with as many as 1 in 5 capable right now of being put into receivership.

Accordingly, the banks are said to be doing what they can to keep the loans viable, even if it means only paying back the interest. The last thing they want is for the loans to materialize on their books.

But sooner or later, you have to guess that they will. One somehow doubts that anyone is squirrelling away the odd bonus payment to offset this.

Source: BBC News

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Oh dear. The train-wreck-in-slow-motion that is Toyota’s current crisis has got a lot worse today with the announcement that they are having to recall all their Prius models worldwide to sort out brake problems. Toyoda-san, the grandson of the founder, can’t be having a good day.

What sort of claims will emerge from this? Product liability perhaps, though the fact that the cars have been recalled is likely to mean that there will not be that many incidents now and hence nothing to which such claims could attach. Product recall plainly, though one wonders just at what level Toyota have bought cover.

But we could also see some pretty large D&O claims, not least because, despite Toyoda-san’s words today (he said that they would now be actively seeking out potential defects), it’s all been too little and too late — Toyota seem to have been consistently on the back foot, responding to events rather than seeking them out. Directors will be asked why they did not do anything sooner, and held accountable for not having done so.

And the sheer number of different models affected (now almost more than those unaffected) makes it look as if all their cars are shoddily put together. The long-term effect on Toyota, insurance or not, is going to be catastrophic.

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This is what happens when you start meddling in the insurance markets for short-term political gain — the markets dry up and blow away. In the Gulf and southern states likely to be affected the situation is thus:

• Primary capacity is down by an estimated 30-40%
• Traditional RI capacity is down by about 10%
• There have been cutbacks in the State reinsurance fund
• Capacity from hedge funds has dropped by about 30%

Net result? If they can get it at all, putative insureds are seeing rate hikes of anywhere between 20% and 100%.

If we have a hard hurricane season, the whole area could get a severe stress testing.

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According to the FT today

Companies based in the UK, Bermuda and the Cayman Islands account for 16 of the 29 ongoing investigations in Washington’s fast-expanding assault on graft by overseas companies.

Thus far, US prosecutors have secured fines of over $1bn against 43 companies in relation to bribery and corruption charges.

At the same time, a North London lawyer, Jeffrey Tesler, could become the first Briton extradited to the US on corruption charges (the NatWest 3 case did not involve corruption). Tesler is said to have channelled very large sums of cash to Nigerian officials, along with a Ugandan accomplice (bring on Private Eye!).

This corruption case is being closely watched, as the first of its kind. Interestingly, it was only in 2002 that anti-corruption law in the UK actually made it an offence to bribe foreign officials. Tesler’s activities are said to have spanned the period 1995 to 2004, and he may argue that the US has no right to extradite him for alleged involvement in activities that were not, for at least part of the time in question, offences in the UK.

The US is focusing heavily on UK and UK-dependency based companies because of their close ties with the US. There is little doubt that centres that make a selling point of privacy are going to be on the short-list for investigations into alleged corruption, and that is why the BVI, the Caymans and, to some extend, even Bermuda are coming under greater scrutiny.

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At least from Barlows.

Word is that “Barlow Lyde & Gilbert (BLG) insurance heavyweight Colin Croly has left the firm following the merger of its insurance and ­reinsurance practices. Croly was tipped to take the senior ­partner position last year, but was beaten to the post by ­professional ­liability head Simon Konsta. It is not yet known whether Croly is planning to join another firm.”

ReRisk wishes both Mr Croly and Barlows all the best in their mutually exclusive futures.

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DiscoveryResources has published a list of 20 top e-discovery predictions for the coming year.

These in particular struck me:

5. Software as a Service will start gaining inroads due to lack of credit and a reluctance to make capital purchases.

i.e. hosted discovery services. I’ve been using these for about 5 years now and the people I am currently with, Trilantic, have proved good, responsive and, which the clients especially like, inexpensive. The days are gone when these people had you over a barrel and could charge pretty much what they liked — now there is more flexibility and the hosting charges themselves are so low that they are pretty much a no-brainer, even for cases that are not particularly document heavy.

12. e-Discovery providers will discover diversity and alternative billing.

See above.

13. There will be a dramatic increase in international e-discovery (e-disclosure) requirements due to the financial crisis, arbitration, class actions and competition law.

I think this is going to be linked generally to a more intrusive (invasive?) regime of regulation that will be ushered in by the Obama Administration and by the exigencies of the post-crash landscape.

19. Insurance providers will get involved earlier and more visibly in the e-discovery process.

Definitely so. At least on the bigger cases, though it may be more difficult to justify internally on disputes that don’t appear so large or complex. One problem here is that it is not always immediately obvious that a case will become that difficult/costly until you are quite a way into it, and the temptation is (in the UK at least) to defer the decision to go electronic for a while. Of course, the further you go in a case without going electronic the more difficult it is finally to take the decision, and the more benefit is lost as a result of that delay. I push for early adoption where I even suspect it would help.

20. Law firms will be sanctioned for not having their own e-discovery houses in order.

I am not sure whether ’sanctions’ here means some actual costs penalty against them, but if so I think we may be a little way off that in the UK. However, I’ve recently seen, for example, an arbitration tribunal suggest quite positively that a party complaining of being swamped by the other side’s documents might do well to adopt (as it had not done until then) an electronic system to deal with the papers, and I think we will see an increasing number of such suggestions until, in a few years time, it really is the norm and thus sanctionable if not adopted.

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