Audit watchdog closes Lehman probe against E&Y

People stand next to windows above an exterior sign at the Lehman Brothers headquarters in New York in this September 16, 2008 file photo.

LONDON (Reuters) - Audit watchdog has closed a two-year old probe into how Ernst & Young endorsed statements from failed U.S. investment bank Lehman Brothers, saying there was no realistic prospect of a tribunal finding a rule breach.

The Financial Reporting Council said on Friday its team obtained and reviewed E&Y's audit files in Britain, hard copy documentation from staff members' laptops and email, and information from other regulators.

"There is no realistic prospect that a Tribunal would make an adverse finding against Ernst & Young LLP in the UK or members within that firm. The investigation will therefore be closed and no further action taken," it said.

E&Y said the watchdog's decision confirmed "our belief in the quality of our audit work".

The FRC opened a formal probe in June 2010 to focus on E&Y's audit of the European operations of Lehman Brothers which collapsed in September 2008 and led to a global markets meltdown.

A 2,200 page report by Anton Valukas in March 2010 on the collapse of Lehman for the U.S. Bankruptcy Court criticised E&Y for failing to question and challenge improper or inadequate disclosures by Lehman.

The FRC probe looked at the accounting treatment of Lehman's use of what Valukas said was a "gimmick" -- Repo 105 and Repo 108 transactions channelled through the bank's London unit to make its balance sheet look smaller.

The bank transferred assets to its London unit where it could get lawyers at Linklaters to sign off on the deals, the Valukas report said.

The British watchdog is still pursuing a probe, opened in October 2010, into how E&Y prepared reports on the way Lehman in Britain complied with rules to protect client money.

(Reporting by Huw Jones; Editing by Dan Lalor)