State Suit Against Lincoln Accountants Dismissed : Litigation: Judge’s action in Ernst & Young lawsuit guts state’s case against Charles H. Keating Jr. and other defendants. Other actions are still pending.

A federal judge has thrown out a $250-million lawsuit that the state attorney general had filed against Ernst & Young over the accounting firm’s alleged negligence in auditing failed Lincoln Savings & Loan and its parent company.

The dismissal last week guts the state’s case against the few remaining defendants, including Charles H. Keating Jr., former chairman of the Irvine thrift’s parent company, American Continental Corp. in Phoenix.

U.S. District Judge Richard M. Bilby ruled last week that the state failed to make a case for enjoining the accounting firm from further illegal acts and, therefore, cannot seek $250 million in restitution, plus civil penalties.

A spokesman for Ernst & Young, which was sued under the name of one of its predecessor firms, Arthur Young & Co., had no comment Tuesday. The company has repeatedly denied doing anything improper in its 1986 and 1987 audits of Lincoln and American Continental.

The parent company used those audits to help gain approval for the sale of bonds at Lincoln’s Southern California branches. Small investors, mainly elderly Lincoln depositors, have charged that they were duped into believing that the bonds were safe investments.

“If investors had known the truth, no one would have invested a dime in those

bonds,” John Van de Kamp, then the attorney general, said in announcing the filing of the suit last year. “But with Arthur Young standing behind them, their bonds sold easily.”

The attorney general’s suit contended that the accountants failed to follow standard procedures, thereby making American Continental look healthier than it was. In 1987, financial statements prepared by Arthur Young showed American Continental with operating earnings of $27 million when the company actually lost between $30 million and $50 million, Van de Kamp had said.

The state sued under a state law that required it first to obtain an injunction. The state contended that Arthur Young provides auditing services to other S&Ls; and that a “continuing threat” of wrongdoing exists.

Bilby pointed out in his July 2 order that Arthur Young cannot be enjoined from providing services to other S&Ls; and that the state cannot allege any ongoing unlawful conduct subject to an injunction.

Ernst & Young, Keating and a host of other professionals and former executives still face more than two dozen lawsuits brought by the federal government and thousands of bondholders. Keating and his top aides also have been indicted in state court and have been notified that they are targets of a federal grand jury investigation. Keating and six other former American Continental executives also have been defending themselves in an action brought by the Office of Thrift Supervision. The regulatory agency seeks to ban them from the industry for life and to provide $130.5 million in restitution for losses at Lincoln on four deals.

By Tuesday, the fifth day of the OTS hearing in Los Angeles, the lawyers for Keating and at least five others had indicated that their clients would invoke their Fifth Amendment privilege against self-incrimination and refuse to testify.

Lawyers for the OTS and the respondents, as they are known in the hearing, were expected to reach an agreement over the issue today. The agreement would allow Keating and the others to invoke the privilege in writing and avoid appearing at the hearing.