Cuomo sues Ernst & Young

December 21, 2010, 9:31 PM UTC

New York sued the giant accounting firm Ernst & Young Tuesday, saying it helped Lehman Brothers deceive investors about its true health for seven years.

The complaint, filed in state Supreme Court, seeks the repayment of at least $150 million in fees the audit firm collected between 2001, when Lehman’s aggressive accounting began, and 2008, when the venerable bank collapsed, precipitating a global bank run.

Seeks $150 million or so

“Our lawsuit seeks to recover the fees collected by Ernst & Young while it was supposed to be using accountable, honest measures to protect the public,” said Attorney General Andrew Cuomo.

The suit centers on Ernst & Young’s failure to confront Lehman about its practice of reducing the size of its balance sheet through routine securities repurchase agreements that it improperly accounted for as sales. That practice was known as Repo 105.

By going along with this ruse, the attorney general charges, Ernst & Young encouraged investors to continue pouring their funds into Lehman long after a properly compiled set of books would have alerted them to the investment bank’s increasing instability.

“This practice was a house-of-cards business model designed to hide billions in liabilities in the years before Lehman collapsed,” said Cuomo, who next month will become New York’s governor. “Just as troubling, a global accounting firm, tasked with auditing Lehman’s financial statements, helped hide this crucial information from the investing public.”

Ernst & Young didn’t immediately return a call seeking comment. The firm has in the past sought to defend itself by, conveniently, claiming Lehman’s collapse can’t be understood outside the framework of the global financial meltdown that claimed numerous other large firms.

The attorney general’s suit is noteworthy in part because it raises questions about the culpability of auditors in fueling the global investment bubble that ended in mid-2007, and because actions against auditors would normally seem to be the province of the Securities and Exchange Commission.

The SEC has been more aggressive in recent years, pursuing for instance a huge hedge fund/tech company insider trading case right now. But it spent previous years asleep at the switch and its silence on this issue has puzzled observers who say advisers must be held to account for what went on during the bubble.

Meanwhile, there is no sense that any criminal charges are likely to arise out of this episode, in part because the government can hardly afford to reduce the much consolidated Big 4 accounting firms to the even Bigger 3. As Fortune’s Allan Sloan notes, it is not just the banks that are too big to fail nowadays.