One of the top four globally renowned Public Accounting Firms, Ernst & Young has just gotten a Christmas gift no one else desires. The accounting firm got sued on 21st December 2017 to the tune of $2 billion, for aiding fraudulent practices by its client, and negligence on its part leading to the downfall of Lehman Brothers just over two years ago. According to prosecutors from New York City, Ernst & Young concealed a “massive accounting fraud” which enabled its client to give a false impression that Lehman Brothers was on a strong financial footing for over six years; from 2001 till it filed for bankruptcy in 2008.
The accounting treatment used to perpetuate this act and deceive investors is referred to as Repo 105, which was a loop hole that allowed the repurchase of risky assets to be treated as sales in the books of Lehman Brothers. In essence, the debts of Lehman Brothers were traded in repurchase agreements towards the end of each reporting period and bought back after financial reporting ended. Then, all of these were treated as sales making the books look really good. Ernst and Young approved these transactions as sales during yearly audits over a period of time. Reports indicate that Ernst and Young raked in $150 million in professional fees from Lehman over the period in question.
The Attorney General of New York has been considering this law suit for some time, with his office stating that it needs to confirm if the use of Repo 105 was legal in the case of Lehman Brothers and for extended periods of time. Billions of dollars in risky assets were exchanged using Repo 105 for a number of years before the final collapse of Lehman Brothers in 2008. The lawsuit against Ernst and Young seeks that all fees enjoyed by the firm over the period be returned in addition to damages. However, Ernst & Young claims its approvals of Repo 105 sales transactions had nothing to do with the bankruptcy in 2008.
This brings to the fore the need for greater responsibility and accountability on the part of public accounting firms. They are viewed as the watchdog for investors and should not be found wanting, especially in cases bordering on fraud, independence and the likes. Look back to the case of Arthur Andersen and the fall of Enron to the cases of failed banks in Nigeria and their external auditors. From China to Singapore, The United Kingdom and Australia, these firms seem to be disappointing investors, their staff and the general public world over.
To forestall these issues, the watch-dogs need to be watched and scrutinized by independent bodies. Though regulations are in place and independence requirements are being stipulated for these firms, legal actions have to be taken against management of companies and public accounting firm that have been found to conceal such issues that lead to the loss of jobs, investors’ funds and also lack of confidence in the polity.