×

Attorney General's Suit Against Ernst & Young Is a Road Map for a Lehman Criminal Case

The New York attorney general’s lawsuit accusing Ernst & Young of helping Lehman Brothers disguise its financial condition for more than seven years paints a road map for a criminal case against Lehman Brothers executives.

Lehman Brothers
Getty Images
Lehman Brothers

The lawsuit claims that Lehman’s financial statements misstated its leverage. Indeed, the four causes of action against the accounting firm are all based on the idea that E&Y was “aware that the public was being misled.”

Three of those causes of action are made under the Martin Act, the powerful anti-fraud statute passed in 1921 that gives the New York Attorney General an edge over national regulators such as the SEC when it comes to securities fraud cases. After decades of dormancy, the statute was revived aggressively by Eliot Spitzer.

Perhaps most importantly, the Martin Act gives the Attorney General broad discretion in whether to file civil or criminal fraud charges. It’s good news for Ernst & Young that the attorney general is only filing a civil suit. But this could be bad news for former Lehman Brothers executives. If Ernst & Young is guilty of fraud for merely helping Lehman executives mislead the public, the Lehman Brothers executives are likely to find themselves faced with criminal charges.

Criminal charges under the Martin Act do not require the AG to prove an intent to defraud. All that is required is an intent to commit an act that constitutes fraud. “”Fraud” is broadly construed under the act, to include misrepresentations and omissions.

“The words ‘fraud’ and ‘fraudulent practice’ as used in the act are given a wide meaning to include all deceitful practices contrary to the plain rules of common honesty,” one New York court has explained.

Andrew Cuomo’s office is arguing that Ernst & Young committed fraud by helping Lehman executives commit fraud. It’s only a matter of time before they get around to prosecuting the underlying fraud they claim happened at Lehman.

Based on the AG’s complaint, the two executives who seem to be especially imperiled are Erin Callan and Ian Lowitt. Both executives are quoted at length in the complaint to establish that the public was being misled about Lehman’s attempts to reduce its leverage. Ernst & Young’s auditors are accused of being aware the public was being misled, and of failing to disclose the truth just because they heard these statements. Of course there will be actions filed against the executives who actually made the statements.

Questions? Comments? Email us atNetNet@cnbc.com

Follow John on Twitter @ twitter.com/Carney

Follow NetNet on Twitter @ twitter.com/CNBCnetnet

Facebook us @ www.facebook.com/NetNetCNBC