E & Y accused of “massive accounting fraud”

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As the FT reports:

New York prosecutors accused Ernst & Young of helping Lehman Brothers engage in a “massive accounting fraud” by approving a move that temporarily reduced the investment bank’s debt and gave investors an impression it was in a stronger financial condition.

The civil lawsuit, filed in a New York state court, alleges the auditing firm “substantially” helped Lehman mislead investors from 2001 until the brokerage firm’s 2008 bankruptcy filing by signing off on the accounting sleight of hand.

The strongly worded lawsuit goes further than accusing Ernst & Young of misconduct. It alleges Lehman engaged in a “massive accounting fraud” by using the accounting treatment, known as Repo 105.

The form v substance debate rolls on – and is, of course, reflected in much of the tax debate as well.

The form of these transactions was compliant, I presume to E & Y’s satisfaction, with regulation.

The suggestion is the substance was not. And I think we can have little doubt, considering the language used, that motive was the key factor here. Fraud can be defined as “an intentional deception made for personal gain or to damage another individual”. Note intent is key. I think so much resolves on this in so many situations. The prosecutors will, of course, have to show this intent. If they do the form will not matter much: the substance will prevail and in that case E & Y will be in trouble. If they can’t show intent then E & Y are in the clear in all likelihood.

But right now the message to the profession could not be clearer: substance matters. That has to be the message.

PS For more on this read Francine McKenna's summary