The New York attorney general Tuesday sued Ernst & Young, accusing the accounting firm of helping Lehman Brothers, its client, "engage in a massive accounting fraud" by misleading investors about the investment bank's financial health.
The lawsuit, filed more than two years after Lehman collapsed and the global economy buckled, is the first major legal action stemming from Lehman's demise.
Ernst & Young, Lehman's longtime outside auditor, certified the bank's financial statements from 2001 until it filed for bankruptcy in September 2008. The suit focuses on Ernst & Young's approval of a much-criticized accounting maneuver that shifted debt off the books before the close of financial quarters.
The transactions involved "the surreptitious removal of tens of billions of dollars of securities from Lehman's balance sheet to create a false impression of Lehman's liquidity, thereby defrauding the investing public," the complaint said.
The lawsuit seeks the return of more than $150 million in fees that Ernst & Young collected for work performed for Lehman from 2001 to 2008, plus investor damages.
Among the world's largest accounting firms — and one of the Big Four auditors — Ernst & Young audits the financial statements of many of the world's largest corporations, including Coca-Cola and Google.
In a statement, Ernst & Young denied the lawsuit's claims.
"There is no factual or legal basis for a claim to be brought against an auditor" when the transactions at issue followed generally accepted accounting standards, the firm said.
"Lehman's audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry," it added.
With just 10 days left as the attorney general of New York, Andrew Cuomo, the governor-elect, will hand off the lawsuit to Eric T. Schneiderman, who is succeeding him.
Schneiderman and his yet-to-be-announced legal team will have to bone up on an accounting maneuver known inside Lehman as Repo 105.
This tactic temporarily removed as much as $50 billion of assets from Lehman's balance sheet to give the appearance that the firm had reduced its debt levels. It often did this just before the end of a financial quarter, the lawsuit said.
"This practice was a house-of-cards business model designed to hide billions in liabilities in the years before Lehman collapsed," Cuomo said in a statement. "Just as troubling, a global accounting firm, tasked with auditing Lehman's financial statements, helped hide this crucial information from the investing public."
The 32-page complaint, filed in New York Supreme Court, follows the contours of the claims made in a 2,200-page report by a bankruptcy court examiner, Anton R. Valukas, a lawyer. The attorney general's investigation of Ernst & Young began after the release of the report in March.
Repo 105, the transaction at issue, was a variation on a corporate finance tool used by every Wall Street bank. In such a transaction, known as a repurchase and sale, or "repo," agreement, an investment bank like Lehman would typically raise cash by selling assets and buying them back a few days later.
But in the case of the Repo 105 transactions, Lehman moved assets that represented 105 percent or more of the cash it raised, which it claimed that it could treat as a "sale" rather than a "financing" under accounting rules. Ernst & Young approved Lehman's Repo 105 transactions, the lawsuit said.
"We believed their conclusions were acceptable under the accounting literature," Kevin Reilly, the Ernst & Young partner at one point in charge of the Lehman work, said in a deposition with the attorney general.