March 15, 2010 / 5:45 PM / 10 years ago

UPDATE 2-UK watchdog asks E&Y for Lehman audit details

* FRC does not rule out wider probe of auditing industry

* E&Y says will cooperate fully with watchdog

(Updates with E&Y reaction, more FRC comment, background)

By Huw Jones

LONDON, March 15 (Reuters) - The Financial Reporting Council has asked Ernst & Young to explain how it audited the books of U.S. investment bank Lehman Brothers before it went bust in 2008, Britain’s accounting watchdog said on Monday.

The FRC officials spent last Friday and the weekend poring over a 2,200 page report from U.S. examiner Anton Valukas on the collapse of Lehman in Sept. 2008 which brought the world’s financial system to the brink of meltdown.

The report, published last Thursday, said there was sufficient evidence to support a possible claim that the firm’s auditor, Ernst & Young, had been “negligent” and that Lehman could pursue claims against the firm for “professional malpractice”.

“Following the publication of the recent report on Lehman Brothers, the FRC is ascertaining the facts on how the ‘Repo’ transactions were accounted for and audited in the UK in order to determine any implications,” the FRC said in a statement.

“To that end, we have asked Ernst & Young to provide further information in relation to what happened in the UK,” the FRC said.

Ernst & Young said it would cooperate fully with all relevant parties.

E&Y said last week its last audit of Lehman was for the fiscal year ending Nov. 30 2007 and it still believed the bank’s financial statements for that year were fairly presented in accordance with U.S. accounting rules.

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ > Examiner sees accounting gimmicks in Lehman [ID:nN11252693] > Could Lehman be Ernst & Young’s Enron? [ID:nN12157852] > Lehman inquiry is a big worry for bank auditors[ID:nLDE62B0LK] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Repo 105 refers to an accounting technique — described by Valukas as a gimmick that dated back to 2001 — that helped to temporarily lower the struggling bank’s apparent leverage by $50 billion.

The repo effectively allowed Lehman to park $50 billion of assets and liabilities off balance sheet, lowering its reported leverage at a critical time.

FRC spokesman Jon Hooper said the response from E&Y will help the watchdog determine whether the issues raised in the U.S. report were relevant to the broader auditing sector.

“We need to establish the facts at this stage. We are taking this very seriously and we will not brook any delay in this matter,” Hooper said.

Valukas said Ernst & Young’s lead partner on the Lehman audit “became comfortable” with the use of Repo 105 to lower apparent leverage.

Lehman transferred assets to its London unit where the bank could get lawyers at Linklaters to sign off on the deals.

Some in the accounting industry find it hard to believe that Lehman was alone in the banking sector using Repo 105.

The FRC’s probe will underscore EU worries about concentration and competition in the sector as the Big Four check the books of nearly all the world’s listed blue chips.

Britain and other EU states use International Financial Reporting Standards (IFRS), rules that have been adopted in over 100 countries but the United States has yet to fully decide if it will follow suit.

An analysis of Repo 105 showed it would not be permitted under IFRS rules, an accounting expert said.

IFRS rules are drawn up by the International Accounting Standards Board whose chairman, David Tweedie, may be quizzed on the Lehman findings when he meets with EU finance ministers on Tuesday.

The IASB had no comment on the FRC’s announcement.

Reporting by Huw Jones, editing by Ron Askew

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