It’s not really my area, but I’ve been especially interested this week in reading about the new civil fraud case brought by the State of New York against Ernst & Young. The case arises from E&Y’s auditing work for Lehman Brothers, an early and important casualty of the financial crisis. In this post, Matt Taibbi explains the basics of the Repo 105 transactions that Lehman used to hide its precarious financial position. E&Y is now in trouble for signing off on Lehman’s questionable accounting statements.
For some helpful commentary on E&Y’s expected defense, see this post by Caleb Newquist at Going Concern. In essence, E&Y’s position seems to be that it cannot be held liable under the New York law because it was Lehman, not E&Y, that produced the misleading financial statements and that used the statements to sell billions of dollars of securities before the collapse. Apparently, there is no precedent under the state law for the prosecution of an accounting firm based on its role as an auditor, so the courts may have to wrestle with some difficult questions in the case.
What particularly interests me about the case is the way it echoes the prosecution of Arthur Anderson, which destroyed the venerable accounting firm as a result of its role in the Enron collapse.
Might E&Y now go down like Anderson? Unlike Anderson, E&Y is not a criminal case. However, even a civil damages judgment, if large enough, could potentially put a company out of business. At Concurring Opinion, Lawrence Cunningham asks what damages E&Y could afford. His back-of-the-envelope answer? “Probably $1 billion, but not much more.”
In a post at Forbes, Francine McKenna discusses the implications of any of the Big Four accounting firms going out of business, as well as the possibility that any of the other three besides E&Y will face a company-threatening judgment arising out of the financial collapse (she thinks not). In a separate post, she suggests why it is that New York, and not the federal government, is going after E&Y:
Charges against EY, the firm, by US federal authorities would be embarrassing at best and catastrophic at worst. Civil charges by the SEC against Ernst & Young could put its bosses, the US Treasury, in a very bad spot. The Treasury is paying EY millions to help clean up the mess left by other firms as contractors to the government’s various bailout programs like TARP. Criminal charges against EY by the DOJ could precipitate a failure of the firm, a la Arthur Andersen. No one in the US federal government has a plan in the event another large audit firm fails and they certainly don’t want to be the ones to cause it.
Would it be a good thing for E&Y to go down? Taibbi seems gleeful at the thought:
My guess is that this suit is the beginning of the end for Ernst and Young and, who knows, may be the beginning of a series of investigations that ultimately take down the auditors and ratings agencies that made the financial crisis possible. Without accountants and raters signing off on all the bogus derivative math and bad bookkeeping, a lot of this mess would never have happened.
But here is David Zaring’s response to Taibbi at Conglomerate:
Killing Arthur Anderson, a worldwide company with tens of thousands of employees, all but maybe four or five of whom had nothing to do with Enron, never struck me as particularly good policy, but more like, it’s the cover-up-not-the-crime style discipline. So I think it is naive to wish for it, nor do I think it is in the least likely to happen. . . .
Another thing — I always think that the bankster crowd should take a deep breath when presented with indictments, and pretend that the conduct that occurred happened to someone they like. You know, what if a union official was convicted of fraud? Kill the union?
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