M. Continuo

NY prosecutors set to sue Ernst & Young: report

By Emily Chasan

NEW YORK (Reuters) - Prosecutors in New York are set to file civil fraud charges against accounting firm Ernst & Young LLC over the collapse of Lehman Brothers Holdings Inc, the Wall Street Journal said on Monday, citing people familiar with the matter.

The suit, led by Andrew Cuomo, could come as early as this week and might seek to impose fines and other penalties, the paper said.

A spokeswoman for Ernst & Young said the company did not comment on speculation and repeated a previous statement made by the firm about its dealings with Lehman Brothers.

"Throughout our period as the auditor of Lehman, we firmly believe our work met all applicable professional standards, applying the rules that existed at the time," the statement said.

Andrew Cuomo's office did not immediately respond to requests for comment.

The lawsuit stems from Lehman's use of a controversial accounting technique called Repo 105, the paper said.

Lehman's court-appointed examiner, Anton Valukas, has said that the use of Repo 105, which dated back to 2001 and was used without telling investors or regulators, gave the appearance that Lehman was reducing its overall leverage levels in 2008, when it was not.

Lehman, which filed the largest U.S. bankruptcy in history in September 2008, used Repo 105 to temporarily remove $50 billion of assets from its balance sheet in 2008, according to the examiner's report released in March. At the time, Valukas said that Lehman's bankruptcy estate could have "colorable claims," or grounds to sue, Ernst & Young for negligence and professional malpractice.

The case against Ernst & Young would be unusual, legal experts said, as it has been rare for prosecutors to charge audit firms directly since auditor Arthur Andersen collapsed after the government sued it for its role in the crumbling of energy trader Enron.

That reduced the number of big accounting firms that audit the overwhelming majority of large companies globally to just four, including Ernst & Young. Since then, many have been worried about the possibility that another firm could collapse and prosecutors have been more likely to charge individual auditors rather than firms.

But despite the rarity of this type of case, any actions by Cuomo could help Lehman's creditors recover more money from the firm's collapse, said Michael Missal, an attorney at the K&L Gates law firm in Washington, who was the examiner in New Century Financial Corp's bankruptcy and worked with the examiner in the WorldCom bankruptcy.

"This shouldn't hurt the creditors. It depends on if there is an award and where that award will ultimately go," Missal said, saying that in the WorldCom and New Century cases money obtained in prosecutions ultimately went to the bankruptcy estates.

The lawsuit should also not prevent creditors from bringing their own actions against Ernst & Young, as creditors have already requested the power to investigate possible claims against the auditor, according to court records.

(Additional reporting by Tom Hals in Delaware, Santosh Nadgir in Bangalore and Kylie MacLellan in London; Editing by Greg Mahlich and Gerald E. McCormick)