New York Suit Against Accountant Over Lehman Takes Detour

New York state regulators face their first test soon in their accounting fraud lawsuit against Ernst & Young LLP over its role as auditor for Lehman Brothers Holdings Inc.

The first major government legal action stemming from Lehman’s 2008 bankruptcy filing, the lawsuit first brought by then-New York Attorney General Andrew Cuomo accused Ernst of helping the Wall Street investment bank engage in a massive accounting fraud in the years before its collapse.

Ernst, the world’s third biggest auditor, has said it acted properly and that Lehman’s accounting complied with national standards.

The firm has moved the case to federal court from state court, saying it involves questions of federal auditing standards. But Cuomo’s successor, Eric Schneiderman, wants to move the case back.

Some lawyers said Ernst’s move could be an attempt to streamline defenses, as the auditor is already fighting a similar lawsuit in federal court.

But the move could also benefit Ernst by throttling a “home court” advantage that Schneiderman could have in state court, according to Anthony Sabino, a law professor at St. John’s University in New York.

The biggest benefit from a change in court is that cases move faster in federal court.

While defendants often want to slow cases down, he said “the accountants clearly are confident in their ability to win” and want to dispose of the case quickly.

“Bringing the action to the federal courthouse levels the field,” he added.

Miles Ruthberg, a Latham & Watkins LLP partner representing Ernst, declined comment.

“We believe this civil lawsuit by the New York Attorney General presents important questions of federal law that should be decided by a federal judge,” a spokesman for Ernst said in a statement.

Moving the case would allow it to be heard by the same judge who is already overseeing other Lehman civil lawsuits and understands the issues, Ernst said.

Ernst has asked that its case be moved to U.S. District Judge Lewis Kaplan, who is hearing another case involving Lehman in which Ernst is a defendant.

That lawsuit, led by several pension funds that invested in Lehman securities, also accused the auditor of signing off on misleading accounting.

This included a so-called “Repo 105” device that Lehman used to lower its reported leverage and make its balance sheet look less risky.

Kaplan, however, may decide not to take the New York state case, according to Jake Zamansky, a securities fraud lawyer and founder of Zamansky & Associates.

When he sued Ernst in December, Cuomo cited violations of the Martin Act, a 90-year-old law giving New York state regulators broad enforcement powers over securities fraud.

Zamansky said that because of the Martin Act, previous attempts to move cases brought by New York attorneys general have been allowed to proceed in state courts, even if they appeared to involve federal matters.

“The attorney general’s choice of forum will govern here,” Zamansky said.

Ernst should probably settle because of its potential liability for the Repo 105 accounting, which was apparently meant to deceive investors, Zamansky said.

“If Ernst & Young knowingly allowed it, they could be complicit,” he said.

Schneiderman has until March 4 to respond to Ernst’s attempt to move the case, a court filing shows. Cuomo is now New York’s governor. A spokesman for Schneiderman declined comment.

The attorney general’s case is New York v. Ernst & Young LLP, U.S. District Court, Southern District of New York No. 11-00384. The earlier Ernst & Young case is In Re: Lehman Brothers Securities and ERISA Litigation in the same court, No. 09-md-02017.

(Reporting by Dena Aubin; editing by Andre Grenon)