UK watchdog closes Lehman case against auditor E&Y

Britain's accounting watchdog declined to take any action against Ernst & Young (E&Y) over its auditing of Lehman Brothers before the U.S. investment bank failed in 2008 and triggered a near meltdown in global markets.

The Financial Reporting Council (FRC) probe focused on how E&Y, one of the world's "Big Four" accounting firms, had audited Lehman's London-based European arm.

"Following the conclusion of the investigation, the FRC's executive counsel, Gareth Rees, has decided that no action should be taken against E&Y or any individuals in connection with their conduct in this matter," the FRC said on Tuesday.

E&Y said the decision "confirms our believe that the quality of our audit work met with the appropriate professional standards".

Lehman's collapse, along with bank rescues by taxpayers across Europe and in the United States, prompted policymakers to question why lenders had been given clean bills of health by their auditors in the run-up to the 2007-09 financial crisis.

The FRC decided not to take action against E&Y despite finding that after Lehman failed in September 2008, its administrators identified a "significant shortfall in the pool of money held on trust for clients".

UK rules in force at the time of the Lehman collapse already required banks to segregate funds that could be handed back to customers in the event of a failure, and the watchdog said E&Y had signed off to the effect that Lehman had complied with these rules.

A key issue was whether money relating to Lehman's "prime brokerage", or major wholesale clients, required segregation.

The FRC called in an expert to consider the issue but concluded there was no realistic prospect of proving a case in front of a tribunal and decided to end the matter.

Last June the FRC closed a separate probe into how E&Y endorsed financial statements from Lehman that used special mechanisms - known as Repo 105 and Repo 108 transactions - channelled through the bank's London unit to make its balance sheet look temporarily smaller and therefore less risky.

A report for a U.S. Bankruptcy Court had described the transactions as accounting gimmicks and had criticised E&Y for failing to challenge their use.

The European Union is in the process of approving a law that would require auditors to improve the quality of their work and be more sceptical of what management at clients, including banks, tell them.