The NY Attorney General, Andrew Cuomo, has just filed a damning lawsuit (available here) against Ernst & Young, the auditor of Lehman Brothers in its run up to failure. The lawsuit focuses on various alleged accounting and audit failures, most notably the use of the notorious "repo 105" transaction which, with hindsight, sounds like a good ol' fashioned piece of accounting window dressing.
According to Cuomo:
“This practice was a house-of-cards business model designed to hide billions in liabilities in the years before Lehman collapsed,” said Attorney General Cuomo. “Just as troubling, a global accounting firm, tasked with auditing Lehman’s financial statements, helped hide this crucial information from the investing public. Our lawsuit seeks to recover the fees collected by Ernst & Young while it was supposed to be using accountable, honest measures to protect the public.”
Looking at this situation, a number of thoughts come to mind. One is self evident: common sense would imply that it is simply not possible to be truly independent when a client pays $100 million in audit fees for the period 2001 to 2008. Such a fee level simply precludes any aggressively inquisitive effort to disprove management's number's and accounting presentation.
We particularly like the closing comments from the Forbes article:
"Audit firms need to be disbanded and downsized. Auditors can’t be paid by management and report to boards. We need a public trust and new system of audit engagement.
Accounting should not be a game of trickery and deception; it should consist of good old-fashioned honesty and accurate reporting. We need more bean counters and fewer accountant tricksters acting like investment bankers and financial engineers."
Hedge Fund Operational Due Diligence
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