Lehman's Repo-105 Auditors in UK Lose Shield From US Accounting Probe

Lehman's Repo-105 Auditors in UK Lose Shield From US Accounting Probe

U.S. inspectors blocked from examining whether British auditors of Lehman Brothers Holdings Inc. improperly cleared questionable accounting will get access to the books under an agreement announced today.

Authorities in the U.S. and U.K. have settled a jurisdictional dispute that since 2008 has prevented the U.S. Public Company Accounting Oversight Board from reviewing British auditors of U.S. companies, according to the agreement.

The U.K. unit of Ernst & Young LLP was largely responsible for reviewing Lehman’s so-called Repo 105 transactions, allegedly used to conceal billions of dollars in debt before the firm collapsed in 2008, according to a report last year by Lehman’s bankruptcy examiner.

The accounting board “was unable to carry out inspections in the United Kingdom -- as well as the rest of the European Union -- due to obstacles raised by the European Commission and European Union audit regulators,” Rhonda Schnare, the board’s director of international affairs, said in an interview.

The PCAOB, which was established in 2002 by the Sarbanes- Oxley Act to oversee auditors of companies with U.S.-registered securities wherever they do business, has been barred by Switzerland and China, in addition to the EU. The new cooperative agreement with the U.K., reported earlier today by Bloomberg News, re-opens one of the world’s major financial centers to joint inspections.

Because earlier federal law wouldn’t allow inspectors to share documentation with their non-U.S. counterparts, the talks to open EU borders were hampered until the Dodd-Frank Act, enacted in July, permitted the exchange.

Bilateral Agreements
In September, the European Commission authorized EU nations to “enter into bilateral agreements” with U.S. regulators of auditors. The commission is working with EU members and the PCAOB, “trying to solve any outstanding issues,” Chantal Hughes, a commission spokeswoman, said in an e-mail.

The new arrangement “reflects the increasingly global nature of the audit market,” Barbara Mills, chairman of the U.K. Financial Reporting Council’s Professional Oversight Board, said in a statement. It will “strengthen and streamline” information access for inspectors in both nations, Mills said.

U.S. Securities and Exchange Commission Chairman Mary Schapiro, whose agency oversees the PCAOB, said in a Dec. 6 speech that she was looking forward to agreements with overseas regulators “that will allow those inspections to go forward.”

The U.K. allowed the PCAOB to examine Ernst & Young’s work in London in 2006. It shut down inspections when the European Commission closed the door in 2008.

New York Lawsuit
New York Attorney General Andrew Cuomo sued Ernst & Young over its Lehman work last month, alleging it participated in a “major accounting fraud” by helping the investment bank mask its condition. The state aims to recover more than $150 million Ernst & Young charged Lehman from 2001 to 2008.

Lehman’s Repo 105s were short-term asset sales that included repurchase agreements, which helped the company raise quick cash. The Lehman bankruptcy examiner’s report said the transactions were booked as true sales. The report described three consecutive quarters in which Lehman’s repo transactions totaled $38.6 billion, $49.1 billion and $50.4 billion.

“We stand by the audit opinions issued by Ernst & Young relating to the financial statements of Lehman Brothers,” said Sarah Jurado, a spokeswoman for Ernst & Young in the U.K., in an e-mail. “Ernst & Young is cooperating fully with the regulatory authorities in the U.K. and the U.S., including the PCAOB and SEC, on this matter.”

Other Clients
Ernst & Young has said previously that Lehman’s bankruptcy wasn’t brought on by accounting problems.

Other companies that have filed financial reports audited by the Ernst & Young’s U.K. affiliate, according to information it files with the PCAOB, include BP Plc, Virgin Media Inc., Aviva Plc, Intercontinental Hotels Group Plc and GLG Partners Inc., a hedge fund founded as a unit of Lehman.

The jurisdictional dispute means investors may be unaware that U.S. officials aren’t watching people who audit major portions of global companies including International Business Machines Corp., Coca-Cola Co., General Motors Co., Chevron Corp. and Exxon Mobil Corp., said Lynn E. Turner, a former chief accountant at the SEC. “The work of their auditors may not have been examined by the PCAOB,” he said.

Colleen Brennan, a PCAOB spokeswoman, said the board is “acutely aware” that investors haven’t been protected by the regulator in such cases.

China Sovereignty
While China cites sovereignty in its denial of U.S. inspections, EU officials have said they prefer that U.S. authorities rely on the work of European watchdogs. “The EU does not view joint inspections as the final goal of international cooperation,” Hughes said.

The PCAOB, under U.S. law, doesn’t have the option of accepting other countries’ inspection work.

In October, the PCAOB said new requests to audit U.S. public companies from firms operating in blocked jurisdictions will be subject to board hearings and may be delayed.

While U.S. inspectors were denied access to Ernst & Young in London, the U.K.’s Financial Reporting Council’s Audit Inspection Unit reviewed the auditor annually. The U.K. regulators said in their 2008-2009 report that the firm generally maintained good or acceptable standards, while citing weaknesses in “the identification of significant risks.”

In June, the FRC’s Accountancy and Actuarial Discipline Board said it had begun an investigation of Ernst & Young’s auditing of Lehman Brothers International Europe -- specifically “the use and accounting treatment of transactions known as ‘Repo 105s’ and ‘Repo 108s.’”

In October, the U.K. disciplinary board announced another investigation, examining the auditor’s conduct in preparing a report to the U.K.’s bank regulator on Lehman’s 2007 compliance with rules governing the protection of clients’ money.

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net.