​​Lessons for Internal Auditors From the Lehman Brothers Saga

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​The facts are still unfolding from the Lehman Brothers story. As a reminder, they filed for bankruptcy on September 15, 2008 — the largest bankruptcy filing in U.S. history, with Lehman holding over US$600 billion in assets. You can read the background here.

I have been among those following the situation ever since the court-appointed examiner released his report. It makes very interesting reading. I recommend the Executive Summary (which can be found in volume 1) and the discussion of the accounting device that has come under great scrutiny, called Repo 105 (in volume 3).

The story raises important questions for internal auditors, and should be required reading and consideration for every internal audit executive.

Once you have absorbed the background, I recommend reading through my various blog posts — starting with Lehman – question for US GAAP/GAAS experts. I am intrigued by the thought that Lehman might have been in technical compliance with U.S. GAAP, but failed to provide a "fair presentation" of the company's results and financial condition — and that EY accepted Lehman's accounting. The examiner suggests that technical compliance with U.S. GAAP is insufficient, and that EY should have required disclosure of the accounting, its extent, and the effect on the balance sheet.

I also recommend the Lehman blogs by Francine McKenna, who follows the activities of the CPA firms, starting with this summary.

I believe there are several important questions and issues for discussion for internal auditors:

  1. Are there any accounting practices that are intended only for "window-dressing" rather than business purposes? Have they been fully disclosed to the audit committee or board of directors? Do they affect the 'fair presentation' of the organization's results and financial condition? Do they affect any valuation or other assessment of the organization by investors and other stakeholders? Are they adequately disclosed in public filings?
  2. Does the audit committee or board of directors have an adequate process for assessing the quality of the external auditors? Do they have information on the experience and technical knowledge of the partners, managers, and senior staff? Do they receive objective feedback from management and internal audit?
  3. Is the level of non-audit services (i.e., services not directly required to the mandated audit opinion) a potential impairment to the objectivity of the external auditors and their willingness to raise issues with the audit committee or board of directors?
  4. Does the organization engage the external audit firm to assist or lead investigations? In the Lehman case, there are questions as to whether EY should have been asked to investigate the whistleblower's assertions of inappropriate accounting. While some say these were forbidden internal audit services, for me the issue is whether they could have looked objectively at accounting policies and practices the audit partners had apparently accepted as compliant with US GAAP (SFAS 140).

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