Will Ernst & Young Survive The Lehman Fiasco?

Ernst & Young is standing behind the work it did for Lehman Brothers.

But the example of what happened to Enron accountants Arthur Andersen should have E&Y very worried.

In both its public statement released today and in interviews with the bankruptcy examiner, E&Y says it agreed to the Repo 105 transactions only in theory. It apparently never blessed or even evaluated any particular transaction, much less audited them or assessed the impact of them on the balance sheet.

The examiner says that the firm may nonetheless have committed professional malpractice.

The Examiner concludes that sufficient evidence exists to support colourable  claims against Ernst & Young LLP (“Ernst & Young”) for professional malpractice arising from Ernst & Young’s failure to follow professional standards of care with respect to communications with Lehman’s Audit Committee, investigation of a whistleblower claim, and audits and reviews of Lehman’s public filings.

That may not sound like a mortal threat against Ernst & Young. But the damages here could be enormous. A successful lawsuit against E&Y could result in a court finding that the failure to properly advise the audit committee prevented Lehman from taking genuine steps to substantially reduce its leverage, which may have saved the firm from bankruptcy. Which is to say, E&Y could find itself blamed for all the losses to Lehman shareholders. That would be a stretch—such a claim would be speculative—but it still should be scaring the heck out of the partners. When the bankruptcy examiner’s report on Enron came out, the language about Arthur Andersen was quite mild. It merely noted there was “sufficient evidence from which a fact-finder coulconclude that Andersen: (1) committed professional negligence in the rendering of accounting services to Enron…” It went on to note that Andersen likely had a strong defense against liability since so many Enron executives were implicated.
“Enron brought down Arthur Andersen,” Felix Salmon notes. “Will Lehman do the same for E&Y?”

If we had to bet, we’d agree with Lex, which says that E&Y will survive. But its reputation is in for a torching.