Lehman Brothers Part I: When Is It Legal – But Not Right

The latest report on the collapse of Lehman Brothers indicates that the company indulged in shady, albeit legal, accounting maneuvers that masked the depth of its financial problems and precarious economic state.  What is astounding here is the report that the outside auditors were fully aware of these machinations and that nothing was hidden from government inspectors.  An absence of full facts always makes for interesting speculation, but the news as reported raises some very problematic questions.

For starters, the accounting rules are designed to ensure that financial statements accurately reflect a company’s economic condition and financial status.  Let’s say the rules are followed, but the financial statements in fact mask financial distress.  Is there an obligation nonetheless to clarify?  Did management, the auditors, or the audit committee have an obligation to qualify the financial statements with an explanation of the techniques that quarterly enhanced the company’s financial condition at the end of each quarter?

This situation suggests that audit committees would do well to raise this question, both with management and outside auditors.  Committees routinely ask in a myriad number of ways whether the accounting was done right.  Now perhaps they must ask whether the accounting reflects economic reality.  Stay tuned.

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