LONDON, Jan 29 (Reuters) - Britain's accounting watchdog said it won't take any action against Ernst & Young (E&Y) over the way it checked the books of Lehman Brothers, the U.S. bank whose failure triggered a near meltdown in global markets in 2008.
The Financial Reporting Council (FRC) probe focused on how E&Y, one of the world's "Big Four" accounting firms, audited the London-based European arm of Lehman.
"Following the conclusion of the investigation, the FRC's executive counsel, Gareth Rees, has decided that no action should be taken against E&Y or any individuals in connection with their conduct in this matter," the FRC said in a statement.
E&Y had no immediate comment.
Lehman's collapse, along with bank rescues by taxpayers across Europe and in the United States, prompted policymakers to question why lenders had been given clean bills of health by their auditors in the run up to the 2007-09 financial crisis.
The FRC's decision not to take action against E&Y was agreed despite its finding that administrators had identified a "significant shortfall in the pool of money held on trust for clients" after Lehman failed in September 2008.
UK rules in force at the time of the Lehman collapse already required banks to segregate funds that could be handed back to customers in the event of their failure and the watchdog said E&Y had signed off to the effect that Lehman had complied with these rules.
A key issue was whether money relating to Lehman's "prime brokerage", or major wholesale, clients required segregation.
The FRC called in an expert to consider the case but concluded there was no realistic prospect of proving a case in front of a tribunal and therefore decided to end the matter.
Last June the FRC closed a separate probe into how E&Y endorsed financial statements from Lehman that used special mechanisms - known as Repo 105 and Repo 108 transactions - channelled through the bank's London unit to make its balance sheet look temporarily smaller and therefore less risky.
A report for a U.S. Bankruptcy Court had described the transactions as accounting "gimmicks" and had criticised E&Y for failing to challenge their use.
The European Union is in the process of approving a law requiring auditors to improve the quality of their work and be more sceptical of what management at clients, including banks, tell them.