Analysis:This is the first time an Irish bank has put the spotlight on its external auditors
The legal action taken by the former Anglo Irish Bank against its one-time auditors, the accountancy firm Ernst & Young, has come out of the blue and marks a watershed moment in the Irish banking crisis.
This is the first time an Irish bank has turned on its external auditors over their conduct before the financial crisis and, in Anglo’s case, in the run-up to the nationalisation of Ireland’s leading lender to builders.
The details of the case against one of the “Big Four” accountancy firms are sketchy so far. High Court records reveal little other than the bank’s solicitors are McCann FitzGerald.
The bank won’t elaborate beyond confirming that the case has been taken and that it relates to “legacy issues” relating to Ernst & Young’s role as auditors to Anglo prior to its nationalisation in January 2009.
Even Ernst & Young doesn’t have the full details of the suit yet.
Irish Bank Resolution Corporation, the new name for Anglo, didn’t send the firm a statement of claim, the record outlining its case. This would normally follow after a defendant entered an appearance to the proceedings in response.
Ernst & Young had simply been notified by the State-owned bank on Tuesday evening that it had issued legal proceedings against it. The firm said that it had not been formally served legal papers or received the statement of claim, and so could not comment.
The timing would suggest that the bank’s move comes to beat a six-year limitation period of December 5th which, if missed, would have blocked the action. The accounts for the bank for the year to September 2006, signed off on December 5th of that year, appear to be a key part of the bank’s legal claim.
Failures
Certain civil actions are barred by law after six years. This would suggest that the action centres on the failure to spot the hidden loans of former Anglo chairman Seán FitzPatrick over eight years. The bank concealed the full extent of FitzPatrick’s loans by moving them off its books over Anglo’s accounting year-ends using short-term loans each year from Irish Nationwide.
The disclosure of this and the full extent of his loans in December 2008 was the final nail in Anglo’s coffin. The bank was nationalised weeks later and in February 2009 Ernst Young withdrew its December 2008 audit report on Anglo’s September 2009 financial statement and issued a new audit report.
By the following August, rival Deloitte had replaced Ernst & Young as the bank’s auditors.
The subsequent deepening of the banking crisis and the property crash sent the cost of the Anglo crash soaring to €29.3 billion.
As recently as February 2009, Ernst & Young had signed off on accounts showing a profit of €784 million for the accounting year to September 2008. This raises further questions about the firm’s auditing. For the 10 years prior to Anglo being taken over by the State in 2009, Ernst & Young earned fees of €9.1 million for its yearly audits of the bank.
Public scrutiny
This week’s legal action isn’t the first time the accountants have faced public scrutiny over their involvement with Anglo. The regulator of the chartered accountants professional body started a disciplinary process against the firm after it found that Ernst & Young had a case to answer over three areas of Anglo’s financial disclosures. A special investigator appointed by the Chartered Accountants Regulatory Board, the accountancy watchdog, said in a report last year that the firm had failed to “detect the scale of Seán FitzPatrick’s loans and their systematic refinancing over year ends”.
Ernst & Young was unsuccessful in a court bid in May 2011 to halt that inquiry and later said it “fundamentally disagrees” with his views when they were eventually published, noting that “no adverse finding” had been made against it.
Disciplinary hearings by the profession’s regulatory body have been postponed pending the outcome of the criminal cases against Seán FitzPatrick and two other former Anglo bankers.
IBRC issued proceedings against former Irish Nationwide chief executive Michael Fingleton and his former board members in March in a similar move that beat a legal deadline that would have barred a case.
The action this week against its former auditors opens yet another front for the bank to fight.
Auditors have been sharply criticised for failing to flag concerns about the exposure of the banks to the property market. The report by Finnish banking expert Peter Nyberg described them as “the silent observers” in the Irish crisis.
IBRC’s move against Ernst & Young follows a similar action taken by the administrators of Quinn Insurance against the former auditors to the insurer, PricewaterhouseCoopers.
The actions mark the first attempts by failed institutions to hold auditors to account for the roles played in their demise.
Profile: Irish Bank Resolution Corporation
The former Anglo Irish Bank was renamed Irish Bank Resolution Corporation last year after taking over the former Irish Nationwide Building Society. The two most toxic lenders in Irish banking are costing the State €34.7 billion – €29.3 billion for Anglo and €5.4 billion for Irish Nationwide – following their nationalisation in 2009.
IBRC is running down the former loan books, which stood at €27 billion in June before any write-downs to cover bad debts.
The proceedings taken by the bank against Ernst Young on Tuesday fall under "legacy issues" – the bank's term for the controversial matters surrounding the collapse of the bank into State ownership in 2009 during the banking crisis. The bank said that the proceedings against Ernst Young are part of its continuing work to deal with "legacy issues" across every area of Anglo and Irish Nationwide before and after their nationalisation.
The former boards and management of both lenders have been removed and IBRC has taken proceedings
against former Anglo executives Seán FitzPatrick and David Drumm over unpaid loans at the bank.
The bank also took a legal action against former Irish Nationwide chief executive Michael Fingleton and the board of the building society over how they ran the lender.
Legal actions have also been taken by the bank against high-profile borrowers who are in default on their loans. These include the bankrupt and imprisoned businessman Seán Quinn, and members of his family.
Profile: Ernst & Young
Ernst & Young ranked fourth among the "Big Four" practices based on annual revenues last year. The firm earned revenues of €123 million in 2011 and audited 129 of the top 1,000 companies listed by The Irish Times.
The firm was auditor to Anglo Irish Bank in the early 1990s until the months after the bank was nationalised in 2009 when it was replaced by rival accountancy firm Deloitte. It earned fees of €9.1 million from Anglo over the last 10 years of its audit of the bank.
The reputation of the global firm has taken a battering as auditor to US bank Lehman Brothers, which failed in September 2008, and Anglo, which fell into State hands months later. New York prosecutors took a civil action against Ernst & Young in 2010 accusing the firm of helping Lehman's engage in a "massive accounting fraud" by approving a move that temporarily reduced its debt, creating the impression that it was in a healthier state.
The Irish arm of the accountancy division has been criticised for failing to highlight concerns about Anglo's growing exposure to the property sector.
The firm was also criticised for auditing Anglo at the time of the window-dressing transactions with Irish Life Permanent in September 2008 which made Anglo look to be in a stronger financial position. Ernst Young also audited Anglo at the time of Maple 10 transaction in 2008 when the bank made loans to 10 clients to buy shares linked to businessman Seán Quinn to prop up its share price during the crisis.
