A Tale of Two Clients – And Lessons Lehman Learned Late or Not at All

by cactus

A Tale of Two Clients – And Lessons Lehman Learned Late or Not at All

My first “real” job (i.e., after grad school) was at what was then a Big 6 accounting firm (and is now a Big 4 accounting firm) doing “transfer pricing.” I wasn’t right for the job (or the environment), nor was the job (or the environment) right for me. But I did learn a lot about how the world works.

One of the big clients serviced by the transfer pricing group from the office I was working is a household name. Other than North Koreans and people with some form of mental impairment, I doubt there’s anyone anywhere in the world over age eight who would fail to recognize the company name or its logo. And to be honest, I’m not sure about the North Koreans. Another big client has a name that is only slightly less recognizable. I’ll call them Co. 1 and Co. 2.

Now, when I was there, Co. 1 was very aggressive on tax issues – which means it was willing to push the envelope and see how far it could push the IRS. The odd fine or two for going too far was just a cost of doing business, and it expected its highly priced Big 6 accounting firm to produce, ahem, tax plans that fit the bill. Essentially that meant coming with, ahem, tax plans that were cutting edge enough that the IRS hadn’t seen them yet but that on the face of it resembled something that had in the past gotten an official OK, either through a regulation or some court decision. That would be enough to get a law firm to write a letter saying it was their opinion this was OK, no matter how much what was being done might sound, to the uninitiated, to be questionable or even illegal. Incidentally – on the rare occasions when the firm came up with a scheme on its own, it was the job of its advisers (i.e., accounting firms and law firms) to get the client to make sure that whatever changes were necessary to keep things on the right side of the blurry line were made.

Co. 2 took more the pussycat approach with the IRS. They seemed to feel that if they didn’t push too hard, they’d avoid a lot of hassle from disputes with the IRS. They were, of course, right, and it cost the Big 6 accounting firm, but then the Big 6 accounting firm wasn’t exactly losing money on this client so it was happy to oblige.

In other words, accounting firms are like criminal attorneys – they represent the client and try to do what their client believes is in their best interest. They advise their client when they think their client has taken a suboptimal turn, but when the client wants to do X, if its not explicitly illegal, the firm finds a way to make it happen.

All of which is to say, if the allegations that came out last week about Lehman’s accounting schemes are true, and if as those stories indicate, Lehman was forced to find a non-American law firm to sign off on what they were doing, one of the following must be true:
a. Ernst & Young personnel working on the account had no idea what Lehman was doing.
b. E & Y personnel working on the account knew what Lehman was doing (perhaps having peddled the scheme to Lehman themselves) but had no idea it was an obvious no-no to the IRS.

Either way, it looks to a casual outsider like me that E & Y had a B-team made up of PONIs (partner of no importance) on the job, and that should have been obvious to Lehman. Now Lehman should have been a big enough client to warrant a few POGIs (partner of great importance). If Lehman did not seek out out or deliberately avoided the best possible representation, they were guaranteeing an eventual disaster. Deliberate ignorance or deliberate evasion (the allegations would imply one of these two to be true) of the law doesn’t go over well when the doo-doo hits the fan.

But it goes the other way too. E & Y’s POGIs should have realized that Lehman’s business model involved taking big risks. Why would they have assumed that Lehman was going to be satisfied with orthodox accounting practices? And as the old saying goes, you don’t send a boy to do a man’s job. The Anderson/Enron debacle is a clear demonstration that if some partners certify a client’s shenanigans, and those shenanigans come to light, the entire firm will take a hit. (And that, of course is the flip side of everyone benefits from the shenanigans as long as they haven’t been forced to a complete halt.)

So, what do you think about the situation?