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Auditor says it told Lehman board of whistleblower

* Ernst & Young fires back at Lehman examiner allegations

* Says auditors alerted board of whistleblower letter

* Says asked Lehman management to alert SEC, Fed

NEW YORK, March 22 (Reuters) - Ernst & Young [ERNY.UL] is firing back at allegations that the Big Four auditor failed to detect accounting tricks at collapsed investment bank Lehman Brothers Holdings Inc LEHMQ.PK.

Some Ernst & Young partners have sent letters to audit committee members at the firm’s clients over the past few days, defending their firm’s audit of Lehman and how it dealt with a whistleblower’s letter about the bank’s accounting policies, according to Ernst & Young spokesman Charlie Perkins.

According to a copy of the letter [ID:nN22210897], the audit firm said it believes it “will prevail” if any of the examiner’s potential claims against the firm are pursued by Lehman or its creditors and said some recent media coverage of the firm’s role, such as the firm’s use of “sham transactions” to hide bad assets, has been “inaccurate.”

“The months leading up to Lehman’s bankruptcy were among the most turbulent periods in our economic history,” the accounting firm said in the letter.

“Lehman’s bankruptcy was caused by a collapse in its liquidity, which was in turn caused by declining asset values and loss of market confidence in Lehman. It was not caused by accounting issues or disclosure issues.”

Lehman’s court-appointed examiner said in a report earlier this month that Lehman could have “colorable claims” against its auditor for negligence, and failing to abide by professional standards relating to communications with Lehman’s audit committee about accounting transactions. [ID:nN11252693]

When Lehman filed for bankruptcy on Sept. 15, 2008, Ernst & Young was just in the beginning stages of planning for its year-end audit and had “reviewed but did not audit” Lehman’s first and second quarters of fiscal 2008, according to the examiner’s report and Ernst & Young’s letter.

The last full audit the firm had done of Lehman’s books was for the year ended Nov. 30, 2007, which Ernst & Young says “clearly portrayed Lehman as a leveraged entity operating in a risky and volatile industry,” according to the letter.

The letter, which was first reported on the re:The Auditors blog, also includes details about how the firm responded to a May 2008 whistleblower letter featured prominently in the Lehman examiner's report.


According to the examiner’s report, Matthew Lee, a senior vice president in charge of global balance sheet and legal entity accounting at Lehman, wrote to senior managers, raising concerns about “accounting improprieties” at the firm.

The whistleblower letter did not mention the Repo 105 transactions questioned by Lehman’s examiner for their use in temporarily shifting some $50 billion of assets off of Lehman’s balance sheet, but rather Lee brought them up in a subsequent interview with Ernst & Young auditors.

“When we learned of the letter, our lead partner promptly called the Audit Committee Chair; we also insisted that Lehman’s management inform the Securities and Exchange Commission and the Federal Reserve Bank of the letter. EY’s lead partner discussed the whistleblower letter with the Lehman Audit Committee on at least three occasions during June and July 2008,” Ernst & Young said in the letter.

“In the investigations that ensued, the writer of the letter did briefly reference Repo 105 transactions in an interview with EY partners. He also confirmed to EY that he was unaware of any material financial reporting errors.”

Anton Valukas, the Lehman examiner, said in his report that he believed the Repo 105 transactions created a “materially misleading picture” of Lehman’s financial condition in late 2007 and 2008. When Ernst & Young’s lead audit partner for Lehman, William Schlich, was interviewed by the examiner, he “did not recall” Lee saying anything about Lehman’s Repo 105 transactions at the meeting, according to the examiner’s report.

In its letter to audit committees, Ernst & Young referenced a footnote in Lehman’s 2007 audited financials that said the bank had off balance sheet commitments of almost $1 trillion.

While Ernst & Young said in the letter that it is common for investment banks to use repo transactions to fund their daily operations, they also said the whistleblower allegations would have gotten significant attention in its third-quarter review and year-end audit for Lehman, had the firm not filed for bankruptcy.

Offering a preview of Ernst & Young’s potential legal defenses, the firm also said that Lehman’s senior executives “did not advise” Ernst & Young about any reservations they had related to Repo 105 transactions, and that regardless of any potential claims it does not believe that Repo 105 brought down Lehman.

“The decline in Lehman’s reported leverage from its first to second quarters of 2008 was not a result of an increased use of Repo 105 transactions,” Ernst & Young wrote. “Lehman’s Repo 105 transaction volumes were comparable at the end of its first and second quarters.”

Reporting by Emily Chasan; Editing by Phil Berlowitz