New York AG Sues Ernst And Young

This week, the attorney general of New York state sued the accounting firm Ernst and Young — the same firm that audited Lehman Brothers. NPR's Robert Siegel speaks with Columbia law professor John Coffee about the suit.

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From NPR News, this is ALL THINGS CONSIDERED. I'm Audie Cornish.

ROBERT SIEGEL, host:

And I'm Robert Siegel.

The attorney general of New York state sued the accounting firm Ernst and Young yesterday. And while civil suits against corporate auditors may not typically warrant national attention, this one does. Ernst and Young was the auditor for Lehman Brothers, the fabled investment bank that went bust in September 2008.

The New York civil suit says the auditors were aware of transactions by Lehman's that were not shown in its financial reports, but that Ernst and Young signed off on those reports. The complaint says that Ernst and Young sat by silently while Lehman deceived the public.

The accounting firm issued a statement saying it will fight this case and that Lehman's audited financial statements - this is a quotation - "clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry."

Well, joining us now is Columbia law professor, John Coffee. Welcome to the program.

Professor JOHN COFFEE (Law, Columbia University): Glad to be here.

SIEGEL: And what do you make of a civil complaint not against the bankers at Lehman Brothers, but the accountants who did not document the bankers' deeds?

Prof. COFFEE: Well, of course this is Mr. Cuomo's last week in office and I think he sees one void that is not being filled by the other regulators. It's widely believed that the FCC has long been negotiating a settlement with senior executives at Lehman, so that they will not escape. We don't know what will happen, we don't know what the penalties will be, but the FCC is not acting against Lehman's accountants.

And that takes us all the way back to 10 years ago when after Enron and WorldCom, the major question was, why aren't the accountants more accountable? And it looks like we've returned to that same position because Ernst and Young really did have clear knowledge of these transactions and their view is that it was simply window dressing and it was authorized by very esoteric accounting principles.

And the view of much of the public and certainly the view of Attorney General Cuomo is that you didn't provide full and fair disclosure. You managed to leave out the critical facts that would've made a difference to investors.

SIEGEL: Now, we should say, first of all, the attorney general, Andrew Cuomo, is in his last days there because he's the new governor. He's the governor-elect of New York state.

Prof. COFFEE: He certainly is.

SIEGEL: And this is his parting shot as attorney general. We used to hear a great deal about the dazzling innovations on Wall Street and the banks and how the banks, say, look with some contempt on, say, ratings agencies that reviewed those complex instruments. What about the auditors? Do we assume that Ernst and Young, looking at strange transactions in which liabilities are cast offshore and supposedly sold to other entities and then bought back, would they clearly have understood all this stuff?

Prof. COFFEE: I think in this case it's quite clear that they did understand it because before they would sign off on this transaction, they had to receive an opinion from counsel that this was a true sale. There's a very esoteric accounting rule here that distinguishes sales of assets from loans. And Lehman's position was this was a sale of assets and not a financing transaction. And here's the really strange symptomatic fact. There was no U.S. law firm that would give an opinion that these transactions were true sales.

So, Lehman had to take the transaction over to England and get an opinion from English counsel under English law. That all to me suggests that Ernst and Young wouldn't do this without blessing from counsel. But they knew this was something that no U.S. firm would bless. And that just adds to the suspicious character of these kinds of transactions.

SIEGEL: We're talking about these Repo 105 transactions, I guess they were called at Lehman's. And they were that well known about that various New York securities lawyers knew about them and said that you can't call that a true sale?

Prof. COFFEE: They certainly knew about repurchased transactions. And repurchased transactions themselves are not a problem. What was problematic here was the belief that you could unwind these transactions on the last day of the quarter and not borrow again till the first day of the next quarter. And then at that magic moment at the end of the quarter, you didn't have this loan outstanding.

Thus, you are in a position where you are saying our liabilities today are X, but we really know that they were 50 billion higher yesterday and they'll be 50 billion higher tomorrow.

SIEGEL: Well, Professor Coffee, thanks a lot for talking with us today.

Prof. COFFEE: OK.

SIEGEL: That's Columbia law professor John Coffee.

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