Ernst Young hits behind at Lehman critics

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Ernst Young has hit back against criticism of its work as auditor of Lehman Brothers, the collapsed American investment bank, in a recent letter to clients.

The Big Four accountant was heavily criticised in a damning report published two weeks ago by Anton Valukas, an examiner appointed by the bankruptcy judge, who said that Ernst Young"s auditing of Lehman Brothers failed to meet professional standards.

Most controversially, Mr Valukas"s report highlighted Lehman Brothers" use of an accounting gimmick known as "Repo 105", which allowed the bank to hide $50 billion in bad loans from its balance sheet.

Ernst Young defended its work in a letter sent by several audit partners to the firm"s key clients and vowed to fight any follow-on legal action from regulators or creditors. "Ernst Young is confident we will prevail should any of the potential claims identified against us be pursued," the firm told clients.

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"Lehman"s bankruptcy was the result of a series of unprecedented adverse events in the financial markets. [Its] 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."

The letter was leaked to re:The Auditors, an American blog. In it, the firm described recent media coverage of Mr Valukas"s report as "at times . . . inaccurate, if not misleading".

Ernst Young said that its accounting of the Repo 105 transactions was in accordance with American financial reporting rules and "clearly portrayed Lehman as a leveraged entity operating in a risky and volatile industry".

In reference to the repo transactions, it said: "There has been significant media attention about potential claims identified by the Examiner related to what Lehman referred to as "Repo 105" transactions. What has not been reported in the media is that the Examiner did not challenge Lehman"s accounting for its Repo 105 transactions."

The letter denied allegations that Ernst Young ignored concerns raised by Matthew Lee, senior vice-president of Lehman Brothers, of "accounting improprieties" in the investment bank.

As soon as the firm"s lead audit partner learnt of a letter from the whistleblower, the partner "promptly" called the chairman of Lehman"s audit committee, Ernst Young said. It also insisted that Lehman"s management inform the Securities and Exchange Commission and the Federal Reserve Bank.

"Ernst Young"s lead partner discussed the whistleblower letter with the Lehman Audit Committee on at least three occasions during June and July 2008," it said.

Ernst Young said that it was prevented from investigating Mr Lee"s allegations because Lehman went bankrupt. "The allegations would have been the subject of significant attention had Ernst Young completed its third-quarter review and 2008 year-end audit," it said.

Mr Valukas said in his report that Ernst Young"s auditing of Lehman had left it open to potential claims. It is already facing several lawsuits brought by creditors of the bank in the United States and lawyers predicted that other cases will follow.

The Financial Reporting Council, Britain"s auditing regulator, has also asked the firm"s UK division to explain its advice to Lehman, in what could be the first step toward launching a formal inquiry.